A Perfect Storm Could Be Brewing for The Euro

We forex traders like a little volatility. After all, without it there would be no trading opportunities at all. However, I for one actually stood back from the currency market in the middle of January.

I took the decision to do so because of what I saw as a perfect economic and political storm brewing in what I see as being the lumbering, dysfunctional and badly managed eurozone.

There is great uncertainty in the eurozone: decisions on quantitative easing, the Greek election outcome and a long term failure to properly manage the euro as a currency amongst them. Collectively these concerns made me decide to let things settle before entering any new trades.

I have several basic problems with the euro which I see as a basket of mismatched currencies with disparate interest rate requirements and differing needs to revalue all with an inability to make necessary adjustments. I see currencies that should never have been allowed to join the euro, which got in as a result of the misguided dream of fools. I see power being exercised by the stronger members at the expense of the weak and no agile decision making or action being taken when it is needed.

Any of these factors may bring the currency down and we are seeing an increasingly strong likelihood of this. However, the euro could be brought down in the end by a factor which is only indirectly related to its management. That factor is the inequality that is growing within states both inside and outside of the eurozone.

Here is my current analysis of what is happening in the eurozone.

Europe to print €60bn-a-month to
fight deflation and euro

The eurozone, via the European Central Bank (ECB) is to start effectively, if not actually, printing money at the rate of €60bn per month in a quantitative easing (QE) programme. This is an attempt to halt deflation and low-growth by lowering the value of the euro.

ECB president Mario Draghi announced a programme of €60bn in bond purchases lasting until September 2016 aimed at increasing inflation to the ECB’s two per cent target.

Most commentators seem to agree that this is worth doing but probably too little, too late.

Stock market reactions to the news were mixed, initially rising and then falling back. The euro dropped against the dollar and the pound.

Supporters of the decision say QE will pump money into the eurozone economy keeping borrowing costs low for troubled member nations while encouraging business and consumer lending and keeping the euro low against other currencies.

Critics say that money-printing will let irresponsible economies that borrowed too much in the boom years off the hook – and allow them to avoid necessary austerity measures to get their finances in order.

As though to confirm our concerns about over powerful leaders in the eurozone Germany objected to the move and is believed to have voted in its own narrow interests. It managed to influence the decision in its own favour while reducing its effectiveness for less strong members.

Based on Draghi’s announcement the ECB will deliver €1.2trillion of bond-buying within the programme. However, he also said that the programme would continue until there was a meaningful change in the path of inflation towards the two per cent target.

There is no guarantee that this will work. It has been said that QE is like spraying vast quantities of oil onto a broken engine to keep it running. It does not fix the root cause of the problem; it just buys time for other actions to work.

The main concern over eurozone QE is that it is too little too late – and that it will allow weak economies to backslide on much-needed reforms. This is reflected in the influence that Germany had over the structure of the programme. It was not prepared to stand shoulder to shoulder with other members by bearing the risk of such backsliding or of the programme not working. No-one blames them for this but it does highlight the folly of unequal economies sharing a currency.

As a result of Germany’s opposition the ECB will only take the risk on 20% of the debt being bought, the rest will be held by national banks.

Meanwhile, the Greek election results are out!

There appear to be even more rocks in the road ahead for the euro as weaker nations elect governments that reject the ECB regime. On 25 June Greece saw the extreme, left wing Syriza party led by Alexis Tsipras sweep to victory on an anti-austerity manifesto finishing eight points clear of the incumbent conservatives, New Democracy

Alexis TsiprasSyriza promises to renegotiate the international bailout that imposed austerity on Greece. They pledged that they will roll back austerity and renegotiate Greece’s mammoth debt. They were just two seats short of an absolute majority with 36.3% of the votes while New Democracy had 28%.

Tsipras will lead the first eurozone government to openly oppose bailout conditions imposed by the European Union and International Monetary Fund. This will undoubtedly set Athens at odds with Brussels and Berlin. The result had “made the Troika [the EU, IMF and European Central Bank] history,” said 40 year old Tsipras.

Unprecedented spending cuts and soaring unemployment saw 3.1 million people, or a third of the population, lose their social security and health insurance. Almost one third of Greece’s population now lives below the poverty line, while 18% are unable to afford basic food needs.

However, to get its programme through Syriza needs a coalition partner and its choices were limited. Right wing, Nazi inspired, Golden Dawn was not an option and the Communist party refused to cooperate with Syriza. The right wing, populist Independent Greeks, who agree with Syriza on almost nothing except that austerity has to end, has been chosen. The alliance will not be an easy one.

Greek election resultsThe prospect of a Syriza victory spooked creditors who worry that Athens will seek a write-off of at least part of its €320bn debt. Some analysts fear that a tough Syriza approach to negotiations could push Greece out of the eurozone, although Germany’s Chancellor, Angela Merkel, insisted on Friday that this was not what she wanted.

Tsiaris’s line has softened in recent weeks. However, several EU capitals remain alarmed by Greek promises to cancel the most draconian budget cuts imposed as part of the country’s €240bn bailout package.

This election could herald a tide of political change across the eurozone that throws the whole euro project into disarray.

Even in the larger and more stable nations such as Italy and Spain, some people already question the merits of the euro, as the union has prevented them from allowing their currency to slide in value to improve competitiveness, as they have done in the past.

The perfect storm

There seems to be a perfect storm brewing in the eurozone. When economic times seemed good, as debt fuelled growth, everything was fine. Now in the midst of a long downswing that looks as though it could become permanent, things are different.

We have:

The inability of eurozone members to adjust interest rates and currency values to match the needs of their economies.

Members who should never have been allowed to join and that now have economic conditions too far removed from the leaders to be able to live with the fiscal conditions that suit the stronger nations.

Stronger members, such as Germany, that can’t bring themselves to give enough support to the weaker members or even to accept fiscal measures that would suite an “average” member.

A slow to act, weak central bank that seems to be incapable of prompt strong action due to internal division based on members self-interest.

Growing disparity in living standards between the member nations as the strong get what they need and the weak get austerity conditions imposed by the strong.

As if all of this is not enough to destabilise the euro we also have growing, now stark, inequality within just about all of the member nations at a national level.

The rich are getting much richer, the poor are getting poorer and the middle classes are being squeezed up or down into what increasingly look like hour glass economies. The outcome of this alone could be political destabilisation and an increasing number of fringe political parties coming forward threatening the established order and its recipe for overcoming economic woes.

Surely, we do live in interesting times and face a perfect economic and political storm? We wait and watch.

About The Author

Jeff Fitzpatrick

Probably the UK's most successful home Forex trader