Euro in Question

Euro bulls are still beating their drums and the overall consensus was still advertising the pullback in the euro as an attractive buying opportunity. The median forecast of 43 economists by Bloomberg was calling for the euro to trade at 1.51 to the dollar by the end of March.

My main concern is that this type of market scrutiny surrounding sovereign debt can snowball quickly. These problems have a history of being contagious and spreading throughout the world. In that sense, the dollar doesn’t look so bad, while the euro looks increasingly vulnerable to a break up or at least a structural change of the monetary union. We may be seeing that this is a decisive moment for the future of the common currency.

With Portugal, Ireland, Italy and Spain all under the hot spotlight and the Greek situation worsening, European leaders stepped in last week in an attempt to stem the negative pressure on the Greek bond market and the euro. Nevertheless, a bail-out of a fellow EMU member country is a direct violation of rules set forth in the Stability and Growth Pact – the principle upon which the euro was built.

The Bank of International Settlements shows that European banks have $2.1 trillion exposure to sovereign debt of the weakest EMU countries and this exposure has been exacerbated by the European Central Bank’s answer to ‘extraordinary monetary policy’ – unlimited 1% funds for one year. What did those banks do with the money? They bought up sovereign debt of the weak-link EU members – backdoor quantitative easing.

Regardless of the outcome, the euro’s credibility has taken a major hit. This week, former executive board member of the European Central Bank, Otmar Issing, wrote an op-ed piece in the Financial Times, warned against a Greek bailout and further questioned the viability of the euro.

Then to add to the Eurozone’s problems, a controversy recently broke out exposing off-balance sheet funding that Greece engaged in through ‘special currency swap’ agreements with Goldman Sachs and other investment banks. These special currency swaps appear to have allowed Greece to hide debt to gain entry into the currency bloc in 2001. Now, several Eurozone countries are under investigation for their currency swap agreements.

In short, the global economic crisis has left the Eurozone with uneven economic performance. Some countries are recovering, many are not. With a one-size fits all monetary policy and currency, they lack critical tools to work their way out.