THE Eurozone is in crisis and it is impossible to argue otherwise. For years, the governments of member states spent more than they were able to collect from their citizens in taxes. So they went to the debt markets to make up the shortfall. The markets took the view that the stronger Eurozone nations would always come running to the rescue and underwrite the sovereign debts of their common currency brothers in arms – allowing them to borrow at artificially low rates. But when creditors saw through this, European bond yields rocketed and severed their close correlation with the German bunds. This is not breaking news and it will continue to run. However, the constant Eurogeddon headlines have created a number of misunderstandings about the nature of currency markets.
BONDS, EQUITIES AND CASH
The Eurozone has monetary union without fiscal union and political union. And yes, the euro is linked to the European integration that made the creation of the Eurozone possible. But one of the biggest fallacies is that this is somehow a currency valuation crisis. It simply is not and to fall into this trap can be a costly mistake for traders and investors. How many times have you watched rolling news headlines of one ineffective political summit after another, revolting Greeks and ever widening Club Med sovereign bond yields, but yet the euro has seen gains over the day? If you were trading simply on the views of political commentators, your bottom line would have been torn to shreds in days. If you trade what you see, rather than what you want to see, you will have much more chance of staying in the black.
You can argue that the adoption of a common currency across a collection of disparate economies, with no means for those member states to exert sovereignty over their currency, has contributed to the predicament in which we find ourselves. You can argue that Greece’s situation would not be quite so severe if it held a currency that was quasi-independent of its northern European neighbours. And you can argue that being part of the Eurozone caused mis-pricing of credit risk for European sovereign debt. Whether or not you agree with these arguments, they are all linked to the use of the euro by the Eurozone economies. But they are not linked to the euro as a currency and certainly not to its value. The Eurozone crisis has made investors less willing to hold certain European sovereign debts. But it has not undermined the euro’s ability to serve as a medium of exchange and a store of value. The 12-month cumulated seasonally adjusted current account of the Eurozone recorded a surplus of €9.6bn in March 2012 (around 0.1 per cent of Eurozone GDP), compared with a deficit of €16.7bn the same time last year (around 0.2 per cent of Eurozone GDP). This shift resulted from increases in the surpluses for goods (from €2.5bn to €15.4bn), services (from €51.1bn to €62.5bn), and income (from €31.5bn to €32.4bn), and a decrease in the deficit for current transfers (from €101.7bn to €100.6bn).
Another mistake is to conflate volatility in the European equity and debt markets with volatility in the euro against its pairs. Against the dollar, the euro’s annualised standard deviation of percentage change in daily price is 9.06 per cent. While this isn’t as flat as some pairs, it is par for the course among the majors. By way of comparison, Hungary, a country within the EU, but not the Eurozone, has a dollar-Hungarian forint volatility of 17.69 per cent.
If you want to see the price action of a currency in crisis, recent history is not short of them. Mexico in 1994, the 1997 Asian financial crisis, Russia in 1998 and Argentina’s woes from 1999 onwards. The faith in their currencies as a store of wealth simply disintegrated. Their bond crises are useful examples of the legal twists and turns of trying to settle sovereign debts in different legal jurisdictions (lex monnetae) – an issue that Greece’s creditors may have to face. But as comparisons with the current European situation they fall short.
The euro is stable, strong and in demand. And there is no reason why it should not remain so. Greece may leave the Eurozone and Spain may need another liquidity injection to keep its banks solvent. But as long as there is a core, solvent grouping of European economies trading in the euro, it can remain a strong currency. Even if that group is just Germany by itself.