46 JULY 2010

CURRENCY FOR SALE

It seems that wherever you look right now, everyone hates the Euro. The news on television, radio, newspapers, websites, as well as investors and many hedge fund managers say the European common currency is doomed. Their arguments are very convincing, but is this the end of a beautiful era of prosperity and growth? Karim nakhle investigates

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The outlook is grim and the Euro has certainly lost its charm as evidenced by the hard selling this year, especially since May. However, as any seasoned investor knows, even when a prevailing view

dominates, there is more than one side to an investment. Take for example the fact that only six months ago, the dollar was hated and the Euro was revered.

At the time the United States (US) government’s massive stimulus programmes were working in the short-term, but all the paper printing was killing the US currency. With the Euro at 1.50 to the dollar – the highest it had been in about a year and a half – some swore that this was the end of the greenback. However, since then, the Euro has been in a decline to levels not seen since late 2008.

Prognosticating the future of the Euro is a difficult task, especially since the financial meltdown of 2008. The currency has slumped 19 percent against the dollar in the past six months as the fiscal crisis that started in Greece made money managers wary that some debt-swamped nations might default, or even revert to old currencies to devalue their way to salvation.

With investors selling sovereign paper from Athens to Dublin and buying safer German bonds, yield spreads ballooned in May and June, rendering the European Central Bank’s (ECB) one-size-fits-all monetary policy ineffective and threatening to tear the currency union apart. Meanwhile Spanish, Greek, Portuguese and Irish government bonds were plunging, sending shudders through world markets and fuelling speculation that Europe’s 11-year-old monetary union could collapse.

The ECB’s president Jean Claude Trichet travelled to an emergency Brussels summit of heads of government armed with graphs to dramatise how bad things were and convince European leaders that the Euro was in grave danger. While addressing the crowd, Trichet’s main message for the governments was loud and clear. “Some of you have behaved very improperly,” he said, “and have created an element of vulnerability for your own country, and by way of consequence for Europe. Now the situation calls for taking up responsibilities.”

ThE coST oF rEcoVEryEuropean leaders knew that the price of that responsibility

was not cheap: it came to an unprecedented EUR750 billion (QR3.3 trillion) aid package to prevent a debt spiral, backed by a credibility-testing pledge from the ECB to purchase the bonds of distressed governments – all to keep the 16-nation economic and monetary union afloat.

Indeed, the ECB’s chief had to make a huge gamble, agreeing to buy government debt in order to halt the surge in yields, all in the hope politicians will respond by fixing their budgets and therefore allow the ECB to return to fighting inflation. However, the risk is that profligate nations will renege on the deal and expect stronger eurozone neighbours such as Germany and France to save them just as they rescued Greece.

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JULY 2010 47

Critics say the ECB has abandoned a founding principle to not bail out cash-strapped governments and may have to buy more debt, which could ultimately undermine its primary price-stability mandate. According to the ECB, eurozone banks face another EUR195 billion (QR823 trillion) in potential write-downs towards the end of 2011 in a second wave of losses from the financial crisis.

In its latest financial stability report, the ECB said public finances posed the biggest threat to the region’s financial steadiness as high debt and deficits continue to unsettle investors, and floods of new government bonds could hamper access to market funding.

The ECB estimates banks will need to make provision for further losses in 2010 of EUR90 billion (QR402 trillion) and EUR105 billion (QR469 trillion) in 2011. This is the first time where the ECB has given an estimate for next year, probably to show that it is in control of the forecast. This comes on top of the estimated EUR238 billion (QR1000 trillion) already written down to cover bad loans by the end of 2009. Overall, the ECB said total write-downs from bad loans and securities between 2007 and the end of 2010 were likely to be lower than earlier expected, at EUR515 billion(QR2300 trillion) from EUR553 billion (QR2400 trillion) forecasted in December.

Risks to the growth outlook appeared broadly balanced but the ECB warned a shortfall could be damaging. In reality, the Euro, inspired by the German mark, is now starting to look more like the Greek drachma. Europe now blames its governments for what went wrong. Greece’s budget deficit was 13.6 percent of output last year; Ireland’s shortfall was 14.3 percent and Spain’s 11.2 percent. Germany’s deficit was 3.3 percent.

JULY 201048

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