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“The foolish man wonders at the unusual; the wise man at the usual.”
                                    Ralph Waldo Emerson

Commentary & Analysis
Speaking of the euro? Here’s something interesting …

I remember one of the underlying assumptions put forth during a financial newsletter copywriting course I attended:

The audience may not even care about your trading recommendations (success or failure); they just want information they can share at a cocktail party that will make them sound interesting.

Between you and me, it would probably be cheaper to drink Dos Equis. But if you’re not a fan of beer and you’re itching for something to talk about as we enter the season of holiday parties and get-togethers, consider this …

The euro is going to parity.

More specifically, before the eurozone economic and financial woes are resolved, the euro will have fallen to equal value against the US dollar, if not further. And if someone tells you you’re wrong about that, just punch them in the face (they’ll have the urge to thank you, eventually.) And if someone asks you why the euro will fall to par, just tell them BLACKSWAN said so. (Also tell them that Blue Horseshoe loves Anacott Steel).

So here is your new ice-breaker …

I don’t always read financial newsletters, but when I do … I prefer BLACKSWAN.
We issued a euro report back in 2009 hinting at the coming destruction of the Economic & Monetary Union via the common currency. Then in March of 2010 we updated that report with additional predictions.

Those predictions are unfolding.

Prediction #1: “… now, before any level of austerity has been imposed, these countries cannot fund government needs. Austerity measures should lower government needs, granted, but it will also clobber existing tax receipts because the burden of austerity will fall on the private sector; they are already overburdened with debt and taxes.
“Additional burdens placed on the private sector will likely increase bankruptcies and social unrest and kill growth in these countries.”

Proof: Greece continues to struggle to cut enough of its public sector spending to appease the austerity demands of the Troika (EU, ECB, IMF). If it fails to make enough headway on implementing austerity, it risks not receiving the additional bailout money pledged to help Greece up off the pavement. Let’s just say the Greeks aren’t taking too kindly to austerity: Greek Tax Collectors, Others Strike Over Government Reforms

The 2009 recovery in GDP growth among eurozone periphery nations seems to have reached a stopping point. While Portugal, Italy and Spain struggle to grow at all, Greece finds its economy contracting relatively quickly (greater than 5%):

Here is another way of looking at it:

Prediction #2: “If the solution to the current crisis is for countries to implement deep austerity, it will clobber Germany’s exports. And yet that seems the only alternative, and here’s why: Germany has a massive lead on all these countries in terms of labor productivity, which translates into massive manufacturing efficiencies compared to the rest of the countries in the Eurozone. How can these other countries export their way out of their fiscal problems when they effectively compete with Germany for the same relative export share? They cannot. And it is highly unlikely Germany would purposefully toss away its manufacturing advantage for the sake of Eurozone unity.”

Proof: There is no question that Germany holds the cards. But their decision of what to do with a dysfunctional system is not an easy one. Either a) jettison the captive export market that is the eurozone deficit nations or b) risk societal and political upheaval by bailing out the eurozone deficit nations on the verge of default.

Based on the contraction and stagnation of eurozone deficit nations’ economies, the captive export market is not all that appealing anymore. But it is said that fleeing the euro would be dramatically worse for all involved. From UBS:

The economic cost (part 1)

The cost of a weak country leaving the Euro is significant. Consequences include sovereign default, corporate default, collapse of the banking system and collapse of international trade. There is little prospect of devaluation offering much assistance. We estimate that a weak Euro country leaving the Euro would incur a cost of around EUR9,500 to EUR11,500 per person in the exiting country during the first year. That cost would then probably amount to EUR3,000 to EUR4,000 per person per year over subsequent years. That equates to a range of 40% to 50% of GDP in the first year.

The economic cost (part 2)

Were a stronger country such as Germany to leave the Euro, the consequences would include corporate default, recapitalisation of the banking system and collapse of international trade. If Germany were to leave, we believe the cost to be around EUR6,000 to EUR8,000 for every German adult and child in the first year, and a range of EUR3,500 to EUR4,500 per person per year thereafter. That is the equivalent of 20% to 25% of GDP in the first year. In comparison, the cost of bailing out Greece, Ireland and Portugal entirely in the wake of the default of those countries would be a little over EUR1,000 per person, in a single hit.

German Balance of Trade (right) is shrinking.

It is not a pretty picture for Germany being locked up in a “heads we pay, tails we pay big” situation. More than likely the leaders of euro land will make every effort to avoid a disintegration of the eurozone.

Prediction#3: “The risk of implosion of the European Monetary Union is rising. That risk is the catalyst for a very powerful self-reinforcing process that chases huge pools of capital away from the euro and into US capital markets to hide.”

Proof: Back in March 2010 we also provided charts showing the spreads on 10-year periphery nation debt over 10-year German bunds. Here are updated charts that show increasing costs/risks to borrower/lender, reflecting the growing uncertainty that the eurozone can escape this economic and financial chaos:







Now that these levels have skyrocketed over the last year and a half (we added the USA/German spread for a frame of reference), the commentators are beginning to take notice. We’re starting to get predictions of just how bad a breakup of the EMU might be on the economies involved.

The breakup concern had been dismissed as preposterous for so long, but now that the concern is gaining credibility, the leaders are putting everything they can towards building confidence the euro will stay.

Angela Merkel most recently remarked:

“We are using all the tools we have to prevent this. We need to avoid all disorderly processes with regards to the euro.”

Merkel was right when she said “… we would see domino effects very quickly.”

We only have to wonder, now, if this is just the same game they’ve been playing all along. It seems even more unlikely Greece will avoid some sort of default; and it seems even more unlikely that contagion will not further impact the eurozone economy and banking system:

Can the leaders continue the “kick-the-can” rhetoric and maintain any shred of credibility as the things they tell us will not happen eventually do?

It is our guess that the euro has not nearly priced in what the common currency system has so far been shield from: simultaneous political and economic disorder.

Sooner or later the politicians will fail the stress tests too.