The Euro Is Dead, Long Live the Euro
The Global Financial Crisis put the single European currency, the Euro, under the microscope as never before. Many analysts were convinced that the currency could not survive the European Sovereign debt crisis with all 17 members intact. Whilst the sovereign debt crisis can't completely be consigned to history yet, few of these analysts expect any of the members to be forced out of the Euro and nobody is predicting that the currency itself will disintegrate.
It is instructive to compare the Euro against the Dollar and to look at the causes which triggered the sovereign debt crisis. Firstly, the population of the 17 states which currently use the Euro is comparable to the US population; 333.8 million vs. 313.9 million. Equally, the GDP of the two economic super powers is also roughly comparable with the US GDP weighing in at $15.7 trillion whereas the Eurozone's GDP comes in at $12.2 trillion. The current account deficits of both are also similar at about 3.3% of GDP. Lastly, both are shared currencies with 17 nation states, in the case of the Euro and the 50 largely autonomous States which make up the USA in the case of the Dollar, of course. Just as sovereign debt has been a major problem in Europe, the United States is not immune from the problem as those living in California can attest. California's debt is estimated to be $443 billion which is not vastly better that Greece's public debt estimated at $520 billion - but then California's economy is the ninth largest in the world whereas Greece ranks as the 34th largest. So broadly, in economic terms the strength of the Euro and the Dollar must surely be regarded as comparable.
Edge of the precipice
The European sovereign debt crisis was triggered when investors lost faith in the ability of Greece to meet its debts whilst the Global Financial still raged. The reason for this was that it had become clear that the Greeks had fudged the convergence criteria that the Greek economy needed to meet to be allowed to join the Euro when the single currency launched in 2002. A major requirement was that the deficit be no more than 3% of the nation's GDP; in 2009, the new Greek government declared that its predecessor had underestimated the deficit and raised it from a stated level of 6.7% to 12.7% of GDP (almost all Eurozone nations have run deficits above the convergence limit as they strived to alleviate effects of the Global Financial Crisis). The upshot of this was that investors lost confidence in Greece's ability to meet its obligations, triggering an escalation of borrowing costs which ultimately became unsustainable, freezing Greece out of the money market and sparking rumours of "Grexit"- Greece's forced departure from the Euro. Greece had to turn to it Eurozone partners and the IMF for two bailouts in order for the nation to be able to meet its obligations. The loans had strings attached which were designed to put the economy back on an even keel through austerity policies and reforms of labour laws, taxation and social security; they also attracted interest repayments.
The crisis spread to Ireland, Portugal and Cyprus which also needed sovereign bailouts. Spain needed a limited bailout to ensure survival of its banking sector and there was much speculation that Italy would be forced to join the club when its borrowing costs soared. The sovereign debt crisis largely abated when the European Central Bank was able to undertake unlimited bond purchases for nations which found their borrowing costs becoming unsustainable with the caveat that they were existing recipients of a bailout.
Eurozone public debt in perspective
The obvious elephant in the room of all of the world's major economies is public debt, but Eurozone public debt is less problematic than US debt and both are less than Japan's public debt when expressed as a proportion of GDP. Total Eurozone debt is estimated to be $11.4 trillion (~99% of combined GDP) whereas the current US debt mountain stands at almost $17.2 trillion (101.6% of GDP). Japan is the world's third largest economy and its public debt is said to be 214% of its GDP, roughly $10.5 trillion. The UK debt to GDP ratio is 90.7% and the total debt is $1.9 trillion. Broadly speaking then, the Eurozone is in no worse a mess than the USA, Britain or Japan, but it has started on a package of financial reforms and harmonisations which should set it in good stead in the coming years. Many of the Eurozone economies have already adopted painful austerity plans which are designed to get deficits back under the 3% of GDP level required under the convergence criteria, but this will still take some time.
If the start of the Global Financial Crisis is taken to be August 2007, 1€ would buy you: $1.3664; ¥168.39; or £0.673. Today these rates are: $1.3459; ¥134.26; or £0.837. Broadly then, the Euro is unchanged against the US Dollar, depreciated by 25% against the Yen has strengthened by 20% against the Pound.
Quo Vadis?
The USA still has to convince the world that it is not intent on financial Armageddon and resolve the debt ceiling and Federal budget crisis which it put a sticking plaster on last month - then there's the thorny issue of the "Taper" which must be addressed sooner or later. The Taper will devalue the Dollar somewhat, but it is likely to be a short-term phenomenon.
Japan's currency enjoyed a boost that its economic fundamentals did not warrant when the Yen was perceived to be a safe-haven currency. Prime Minister Abe has made ending deflation a priority and monetary policy will continue to be accommodative. Japan has the world's largest debt mountain, an aging workforce with social security costs set to burst. The Yen is likely to fall further against other major currencies.
With the Eurozone out of recession and recovery beginning to be more than a baseline blip, the worst of the sovereign debt crisis behind it and deficits heading back under control (let's be Bullish), the Euro should hold its own or strengthen. The Eurozone is the UK's largest trading partner, so it is unlikely that there will be a major shift in the value of the Pound to Euro pair - absent a new financial cataclysm, that is.
