[THS] Europe WANTS a Lower Euro

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Saturday, May 8, 2010
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Europe WANTS a Lower Euro
by Bryan Rich

The euro is in devaluation mode ... in a sharp 17 percent decline against the dollar
over the past five months. And I've written extensively on why, and why it still has
further to go.

Now I believe a covert policy decision has been made by the European Central Bank
(ECB) to use currency devaluation as a tool for the European monetary union (Emu)
to survive.

Of course, each individual country within the Emu doesn't have the luxury of
devaluing their currency when times are tough. They're locked into a monetary union
of sixteen countries. And monetary and currency policy decisions are made by the
ECB.

That puts countries like Portugal, Ireland, Italy, Greece and Spain (the PIIGS) at a
competitive disadvantage when trying to salvage themselves from debt burdens and
feeble economic activity.

The Emu will do whatever is necessary to save the floundering euro.

But now, it's becoming evident that the Emu as a whole is prepared to take such
drastic measures to keep the euro intact!

I think we'll find that the ECB will aggressively reverse course on exiting from the
emergency monetary policies they put in place to deal with the financial crisis of 2008
... returning to emergency mode, and in a big way. They'll likely be forced to openly
buy up the government debt of the weak economies to keep them breathing ­ i.e.
print money, and a lot of it.

The plan requires that Germany, the core of the euro, participate in serving the
interests of the lowest common denominator in Europe: The PIIGS. Of course,
they've already done so by agreeing to provide bailout funds to Greece. But the next
moves in the playbook will likely drag Germany headlong into it.

Germany: Swimming with the Fishes

Germany is the biggest, most robust country in the euro zone. It was among the first
major economies to emerge from recession. Its economy is expected to grow by 1.5
percent this year, and 1.8 percent next year. So things are going relatively well for
the Germans following the harsh recession.
Internal Sponsorship

Why, then, would Germany agree to be dragged down by the weak and expose
themselves to potential inflation problems in the process? Why not just hit the eject
button and remove themselves from the euro?

Here in a nutshell lies the problem: Germany has a lot to lose if other euro countries
end up in shambles. It's exposed on two fronts ...

First, Germany is on the hook for $668 billion in PIIGS sovereign debt. Not to mention
the fresh $30 billion they've agreed to give Greece.

A default, or worse, a string of defaults would be disastrous for German banks and
European banks in general. European banks bought about half of the general
government bond market last year.

And second, if these countries continue their downward spiral, Germany's intra-
Europe exports (10 percent of total exports) promise to dwindle with it.

So what does Germany gain from sacrificing for the weak?

For one, it averts the problems mentioned above. And two, it will enjoy a much
weaker euro in the near future, thus providing a nice kicker for its exports outside of
continental Europe.

ECB Already Taking the Plunge
ECB President Trichet would not discuss the euro's value in his recent press
conference.

Europe, the IMF and the ECB demonstrated this week that it's ready to go all out to
keep monetary union intact. They announced a massive multi-year bailout for
Greece. And perhaps in a bigger move, the ECB is now accepting Greek junk bonds
for collateral ­ jeopardizing the credibility and independence of the central bank.

As I was watching the ECB press conference following its monetary policy meeting
this week, central bank President Jean-Claude Trichet looked flustered and measured
his words very carefully. And two things gave me a sense that they had a plan, which
included a much weaker currency:
He adamantly said a Greek default is "out of the question."

And a biggie ... he ignored all questions about the value of the euro, despite its
slippery slide!

The Swiss National Bank must have sensed something, too. This week it chose to
back away from buying euros as an intervention tactic to curtail the strength of the
Swiss franc. Perhaps, the SNB knows that gobbling up euros at current prices is a
recipe for losing money.

In sum, financial crises and sovereign debt crises typically go hand in hand. As do
sovereign debt crises and currency devaluations. So be prepared to see a continued
decline in the euro and other global currencies ... and more capital flowing into the
U.S. dollar in search of a safe haven.