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"What matters in financial markets–and life–is not what you see straight ahead but what you glimpse out of the corner of your eye."

                                    John Percival

Commentary & Analysis

I solemnly declare the Eurozone healed. Just kidding!

It seems Eurozone economic numbers are improving. The usual suspects have declared the Eurozone has healed from its deep credit crunch and self-inflicted wounds. But has it really? Or is this just another period of moderate stabilization before the next storm?

Is it any surprise those with the most invested political capital are the first to declare the crisis has past, stabilization is taking hold, and growth will resume soon?


Since the beginning of the sovereign debt crisis in the euro area, important measures to stabilize the euro area, reform the rules and develop new stabilization tools have been taken. The recovery in the euro area is well on track and the euro is based on sound economic fundamentals. But the challenges at hand have shown the need for more far reaching measures. We reaffirm our commitment to the euro and to do whatever is needed to ensure the financial stability of the euro area as a whole. We also reaffirm our determination to reinforce convergence, competitiveness and governance of the Euro area.

July 2011

Granted, politicos and hyperbole are equivalent to death and taxes; we can avoid neither. But when the day to day implementation of policy produces the exact opposite effect of forecasted bliss one would think even semi-rational pols would cut and run; but not those who lord over the Eurozone. Is the wine, cheese, and chocolate in Brussels really that good?

Consider this before we make an assumption about the end game [this research was sent to us by a friend]:

  1. Eurozone GDP during the implementation of the single currency from 2002-12 averaged 0.93%; yet for 20 years prior to the euro, the average was 2.3%
  2. Total Eurozone debt was €20.9 trillion or 285% of GDP. Today it is €35.2 trillion or 371% of GDP.
  3. Productivity of manufacturing since the euro began grew at an average annual rate of 2% percent in Europe, 5.6% in the US, and 4% in Japan.
  4. Labor costs across Europe during the euro period (measured in dollars) grew at a rate of 8.6% across the Eurozone, 2.9% in the US, and 6.6% in Japan.

What is interesting is that during Japan’s lost decade [from 1991-2001] it outperformed the Eurozone in all categories: growth was faster, debt growth was slower, manufacturing productivity was higher, and labor costs grew more slowly.

Obviously there are several takeaways here, and we haven’t even broached the disastrous social impact of towering unemployment rates [specific country brain drain, birth rates, fall in scientific research, family strife, suicides, etc.]:

  1. If growth doesn’t resume soon, debt/gdp ratios across the Eurozone will mirror Japan’s; but in many ways because of such poor relative productivity and size of the Eurozone banking system the rise in debt will likely be that much more dangerous.
  2. As a hub for future industry in a globalized world where multi-nationals have so many choices, it looks bleak for countries inside the euro straight jacket. In short, foreign direct investment will go elsewhere.
  3. Instead of brining cultures together, the single currency is helping bring old animositiesto the surface, which are numerous thanks to two recent civil wars (WWI and WWII).

It seems unless something very big happensfairly soon, politicos across the Eurozone will be responsible for marginalizing the future of their people simply because they have invested so much political capital in this bold, but seemingly failed, experiment called the single currency despite passing by all the signs that read, "Turn back now!"

So, what is the endgame here?

In a research report I wrote back in Sep. 2012, titled, "What’s going to happen to the euro?" I said there are three ways this competitive distortion can resolve itself:

  1. The countries within the Eurozone can decide to suffer through a decadeor more of internal devaluation in order to realign local labor rates to a point where the country will then gain some semblance of competitiveness against Germany.
  2. Germany can decide to boost its local inflation rate and stimulate internal consumer demand through tax cuts and other measures. This would mean more demand for goods of Germany competitors’ i.e. German imports. Presently, Germany is more dependent on exports as a percentage of its total GDP than any industrialized country in the world. It is a model that has made Germany a wealthy country (i.e. excess savings is funneled to industry for capital investment to the detriment of consumer spending).
  3. Europe could abandon the euro and allow countries to return to their own currencies. The result would be an immediate appreciation in the German Deutsche-mark against the other countries’ currencies. So effectively, the struggling countries would no longer be stuck inside the straightjacket of the single currency. The relative devaluation of their currencies against Germany would mean the relative competitiveness on manufactured goods increases instantly; thus, helping to stimulate exports of periphery countries. Keep in mind that the currency is a pressure valve that is used to value goods across national borders. A single currency formed by countries with desperate economic efficiencies simply intensifies those inefficiencies until the system blows apart from the pressures.

But, there is another scenario; it’s the Grand Strategy.

  • The Grand Strategy says Germany will effectively backstop the massive debt obligations of the zone in exchange for direct control over other "sovereign" country budgets. Whymight they do that?
    • This would give Germany effectively complete dominance over Europe.
    • Germany would expect internal devaluation to continue and effectively create a massive pool of cheap labor for Germany industry. Thus, the calculation being local manufacturing hubs competing with China and the US.

…but, if Germany implements the Grand Strategy, according to our friend:

"If the program succeeds, Germany will likely find itself in the position of the dog that caught the car it was chasing: it will not know what to do with a Germany-controlled Eurozone or be able to manage it successfully. Such a Eurozone will consist of an impoverished and skill-depleted South and a technologically mediocre and financially exhausted and over-indebted North, as Germany and friends assume the debts of the South. Yes, the Euro would survive."

So, given the probable scenarios I have summarize (I realize many more exist) it’s my expectation that despite the surprising strength in EUR/USD at times, over time the euro heads lower against all the majors. It has not been, and will likely be, an "easy" trade. But in the end I think it will be the "right" trade.