Tuesday 11 October 2011 7:19 pm

Looking at both sides of the Eurozone debate

AS the Eurozone crisis rumbles on, it is easy for traders to get caught out by the news headlines. But too much pessimism can blind you to short term opportunities. Yes, there are weekly crisis talks from European leaders, banks being nationalised, recapitalisations and bailouts. And when those aren’t quite enough, a ratings agency decides to stick the boot in and downgrade a couple of the Eurozone nations from time to time. If you were to watch the news headlines and never take a peek at a chart, you would be forgiven for thinking that the euro had gone Zimbabwean by now. But as you can see from the chart, right, the euro has held its own against its major currency pairs. This highlights the importance for traders to differentiate between the fortunes of the Eurozone as a politico-economic structure and the performance of the euro as a currency and as a tradable financial instrument. And on such a divisive political issue, there are few who do not have some form of prior prejudice when it comes to trading the euro. Think that a single currency for the economies of Greece and Germany is probably quite a bad idea? You are probably more likely to jump on the bandwagon to short the euro when things get a bit wobbly on the political stage. But this is a mistake. WITH OR WITHOUT YOU Greece is seen by many as the first domino in a Eurozone chain of contagion. But even a Greek default does not mean the end of the euro. We would likely see haven flight into the dollar, and so a euro-dollar position looking to a target of $1.3200-$1.3100 would be a good bet. But any euro downside would be limited by vast institutional holdings of the extremely liquid single currency – a Greek default will not trigger China to liquidate its euro holdings. It is difficult to over-emphasise just how determined those at the heart of the Eurozone are to maintain life in their creation. They will do everything they can to keep the Eurozone intact – whether Greece is a part of its future or not. But whatever attempts are made to keep the euro intact – whether that is by shedding some of its weaker nations or moving to closer fiscal union – traders should always ensure that they trade what they see happening to the euro and not what they want to see happen. Politicians face increasing pressure to ditch the euro, writes Philip Salter THE head of Europe’s central bank Jean-Claude Trichet said yesterday what most people have known for many months: that the Eurozone crisis has reached “systemic dimensions”. Bureaucrats across the continent are no doubt confused at the failure of politicians to get their act together. For them, this is the time to bulk up Europe’s institutions. And hope appears to spring eternal for a lot of traders and investors that Germany will put its economy on the line. Economists point to the benefits of a relatively low and stable euro for German exports and the economic disaster if politicians don’t act. However, they will all be disappointed. Yesterday’s Slovakian debacle is the latest stumble as events continue to outpace politicians. Alpari’s George Tchetvertakov says “the fact that the future of the European Monetary Union (EMU) is in the hands of a country that contributes less than 1 per cent of Europe’s total output demonstrates how restrictive and divisive Europe’s political framework is.” Simon Smith of FX Pro has been repeating for over a year that the choice is between partial break-up or greater fiscal integration. Without a closer, even if reduced, union, “attracting international finance and funding a rising public debt burden will simply prove untenable for an increasing number of countries in the coming years,” says Smith. “Regardless of what the markets and papers are saying, the public holds the key to getting the Eurozone out of this glitch,” thinks Jamie Blake of London Capital Group. The problem, according to Blake, is the widespread doom and gloom, which means even better than expected news is ignored. However, most commentators are bearish for a reason and the chaos in Greece will continue to make headlines until it defaults. Nobel prize for economics winner James Buchanan once described public choice theory, of which he was an architect, as “politics without romance.” Extending the rational actor model to politics, public choice theory demonstrates that politicians are largely driven by elections. Although an incomplete prism in which to view all political actions, this theory best explains why politicians across Europe, particularly in times of crisis, turn to their electorate instead of European institutions. Duncan Black’s median-voter theorem postulates that in majority elections politics tends to move towards the centre – right now this centre is becoming increasingly eurosceptic. May’s eurobarometer poll, undertaken by the EC, shows that the people of Europe don’t speak with one voice – 51 per cent versus 37 per cent think that the euro didn’t cushion them from the effects of the economic crisis. Major parties will increasingly come to reflect the euroscepticism of the people they court. Political will for bailouts will further dissipate to reflect the views of the electorate. The euro might survive. However, the Eurozone will likely shrink – and the euro, in the market turmoil, will tumble against major currencies.