WITH Moody’s downgrade putting Greek government debt on a par with that of Romania and Latvia, analysts are starting to ask if this is end for the Eurozone. At a press briefing this week Theodora Zemek of AXA Investment Managers even commented that the next two years could see the wholesale break-up of the euro.
In this context, Moody’s is just playing catch-up. As CMC Markets’ Michael Hewson puts it: “The downgrade yesterday was a complete waste of a space.” And while the four-notch downgrade did see the euro dip to $1.22, it has now recovered to $1.23, close to the level it reached following better-than-expected European industrial production figures. Hewson thinks this rally could last a couple of weeks, perhaps even moving up to $1.27.
While the downgrade added little new information to the markets, it did demonstrate how jumpy investors are, sparking off a new round of speculation about the euro’s future. Most analysts expect the euro to end the year lower against the dollar, with estimates ranging from $1.12 to $1.10 or, at the lowest, parity. It is also expected to weaken against both sterling and the yen.
For many traders, that is only the beginning. Lombard Street Research’s Gabriel Stein says that over the next five years: “some countries will leave the Eurozone. What should happen is Germany leaving the Eurozone. But… more likely what will happen is that Greece will go first, then it will be followed by other countries in similar situations, most likely Spain, Portugal, Italy and maybe Ireland.” What will remain, he forecasts, is a core of Eurozone countries centred around Germany and France, who will be freer to implement fiscal union as they outgrow Europe’s periphery (see chart).
Stein and others argue that without this fiscal integration, the euro is conceptually flawed. Stein says: “There is only one type of example of successful monetary union that does not involve political union and that is when a minnow uses the currency of a whale.” So an uneven relationship can work, but equal partnership without the necessary cooperation on spending decisions is unstable.
This view is not universal. For Societe Generale’s Michala Marcussen, the main problem is not inherent but simply that the Mediterranean economies have been less competitive and less frugal than their northern counterparts. She expects coming EU regulation and a further fall in the euro to the $1.10-$1.20 level to help the situation: “The single currency was massively overvalued.”
Marcussen agrees, however, that if the Eurozone is to emerge whole from the crisis, it will require an overriding regulatory framework, potentially with penalties for rule-breakers: “We’ve done all the quick fixes, but now we need to go through the resolution phase. It really isn’t just about public finance; it really is about fixing a structural issue.”
In effect, then, even optimists for the euro admit that the current monetary union without fiscal cooperation is unsustainable. And as the European Central Bank struggles to make this a reality, the euro has been left treading air.