Welcome to 2019 – may it be a happy and successful 12 months for you all.
The nice stuff out of the way, let’s revert to type – and talk about the prospects for destruction of the euro.
I have read quite a bit over the past two weeks about how the euro enters it’s 20thyear on shaky ground and while I don’t actually agree with the analysis, or the fact that the euro may implode in the coming five years, one has to say there are issues bubbling away that may present challenges to the EU as it seeks to reach the drinking age in most US states in one piece.
Sadly I cannot remember the source and therefore this has to be anecdotal (or in the modern vernacular ‘fake news’), but I vividly recall reading somewhere that the average length of a monetary union in Europe over the centuries was 21 years. I need to stress before a whole generation of former FX traders metaphorically dust off their phones and dream of a return to francs, escudos, pesetas, liras and marks (there was a schilling and a guilder thrown in as well of course, but they were always pretty boring even pre-euro), that this statistic, to the best of my memory, is largely the result of relatively short term military conquests – make of that what you will.
It is strange when I talk to a certain generation (mostly my own I have to confess) and the complaint is always the same – markets just don’t react to events the way they once did. Brought up as we were on currency crisis after currency crisis I suppose it is an inevitable sentiment, but it ignores the changed market structure.
I may be in a minority here, but I am firmly of the belief that the human element served to exacerbate the aforementioned currency crises in the 1980s and 90s – profit is a strong incentive and as such inevitably moves are going to be exaggerated. That doesn’t often happen in the modern world of the G3 FX markets, where things are much more automated, mean reversion holds sway and there are simply less people taking on directional positions. Yes, there is plenty of risk being held (for a much shorter time than before) but it is not deliberate risk – a play on the market’s medium or long term direction.
So I don’t think there is a threat to the euro from market structure, but what about economics? Well there could be if anyone actually cared. The euro was born behind a blind eye when several countries (including Italy) were given membership even though they failed to meet the Maastricht Criteria designed to create a stable economic environment in the Eurozone.
This lack of concern over the economic niceties continues to this day with Italy again at loggerheads with the EU over its budget deficit and, perhaps notably (although again I don’t think so) France also likely to breach EU thresholds thanks to the deal with the Yellow Jacket protesters. We can talk all we like about how the euro is vulnerable to this nation or that nation not adhering to the rules but who is going to enforce it? The European Central Bank isn’t in a position to do so, it’s a political issue – and that is simultaneously the comfort blanket for Europhiles and the biggest concern.
The euro is a political project first and foremost – and as long and the political will exists it will muddle through. It will be amidst much white noise in the era of social media and 24 hour news, but muddle through it will – like a three year old child, there will always be another “big” story to grab the media’s attention in a day or two.
The challenge may be in that political will, however, especially in Germany. To my (admittedly simple) mind, the euro has merely assumed the mantle of the Deutsche mark, which was the dominant European currency from the 1960s when Britain went through a series of devaluations. In the Bank for International Settlements’ 1998 survey – the year before the euro came into being – the Deutsche mark had a 30% share of FX turnover (in 1995 it was 37%); in the latest survey in 2016, the euro had a 31% share. Not a lot has changed.
So the euro is not so much a proxy for the Deutsche mark, rather it is a progression and as such it’s not really as new as some people believe. A currency union requires a dominant economic member and that country is Germany – again, not a lot has changed.
The threat, therefore, is if Germany gets fed up with bailing out other members of the union, or suffering from inappropriate monetary policy because the ECB is battling a fire elsewhere in the single currency area. Speaking to people I respect, who have a deep understanding of German moods and politics, I don’t think the general will is there to create upheaval on the scale of the UK – in the case of the latter an historic antipathy to Europe managed to get a day in the sun, for Germany to go the same way political extremists will have to have a strong power base and that country, quite naturally, remains averse to such developments.
While, then, stories of the euro’s demise make for a diverting read during the quiet holiday season, I don’t hold much store in these predictions. Of course, some will see a weaker euro as evidence the project is falling apart but it isn’t – it’s just a reflection of economic fundamentals, foreign exchange rates rarely predict future events anymore, they merely react after them.
I am not convinced in any way that the architects of the euro have got it right, nor am I that the founders of the project would be happy with how it has turned out, but exist it does, thanks to the political will.
Of course one could observe that the euro has been, from an historical perspective, an outstanding success, for before rubbishing its achievements critics could do well to note that it took the US 140 years from independence to establish an independent national central bank and 90 years to create a single currency. It may be coming at it from the other direction (one currency before one political authority) but compared to the US, the euro is racing ahead!