Why the endless downward pressure on the euro?
Despite a $1 trillion bailout euro debt rescue plan, despite tradition-smashing euro bond buying by the European Central Bank, despite expressions of support from the Euro Zone’s political and financial leaders, the currency keeps tumbling.
Yesterday the euro fell to its lowest level against the U.S. dollar since April 2006. And European and U.S. analysts are openly speculating that the euro could fall even further from the recent lows in the $1.22-$1.24 range. Analysts are saying that $1.10 is a real possibility. That’s another 10% decline from here.
And you can even find projections that the euro will hit parity at $1.00. That would roughly an 18% further drop in a currency that’s already down 14% against the dollar in the last 12 months.
Why so much pessimism about the euro? Is it just typical market over-reaction to a crisis?
I don’t think so. I think analysts and the currency markets understand that despite all the talk from politicians in support of the currency, a cheaper euro is the closest thing national governments in Europe have to a free lunch right now.
Here’s the choice confronting politicians, as the market sees it:
 On the one hand, end the euro debt crisis by cutting budget deficits and lowering economic growth, perhaps enough to send countries from Greece to France into prolonged recessions.
On the other hand, allow the euro to fall further giving European exports a boost, which would support growth, at the cost of somewhat higher inflation, which would, happily, have the effect of reducing the burden of debt for euro-borrower governments.
Gee, that’s a tough one. How long do you think it took government leaders from Paris to Athens to figure that one out?
The OECD (Organization for Economic Cooperation and Development) has even put some numbers to the trade off. For every 10% drop in the value of the euro, sustained over 12 months, the Euro Zone economies pick up 1 percentage point in growth at a cost of about 0.5 percentage points in higher inflation.
That’s a huge inducement to let the euro fall some more in an economic bloc that’s forecast to grow by just 1% in 2010 and only 1.4% in 2011.
The 14% decline in the euro over the last 12 months would add 1 percentage point to that anemic growth. A further 10% drop would bring the gain to 2 percentage points.
And more economic growth means higher tax revenues, which will make it easier for countries to reduce their budget deficits to the European Monetary Union’s target of 3% without the kind of draconian cuts to salaries and pensions that cost governments votes.
Seems to me like betting on further declines in the euro is just common sense.
EdMcGon,
I had the feeling that you might already be using the physical ETFs, but I felt it might be useful to put the thought on record for everyone to see.
What would an ETF named IOU be like?
yx,
I agree the PIIGS won’t see any tourism increases in the near future. But once all the EU problems shake out, and assuming the euro is still lower, I think anyone with the means would easily consider a trip to those destinations.
Ed:
I am not sure Greece or even Spain would thrive on tourism this time around. When I saw the violent protest in Greece, I said to myself, “forget”. Even if I do want to see the Greek islands, I’d get on a American-run cruise ship and watch it from outside instead of staying in Greece. Cruise ships all have local excursion trips. So, you sleep and eat on the ship and sightseeing on land during day time.
neilplus,
I tend to use the physical ETF’s myself, when I do invest in commodities.
flgator,
I wouldn’t touch oil right now. There are too many economic factors at work right now.
bought a little uco today…..more fun at the roulette table…..come on black.
EdMcGon: I think Forex allows gold-currency investments, but don’t hold me to that.
I can confirm that some forex providers do let you do that. I don’t play gold myself, but I do keep the gold / USD rate on my screen just so I can keep an eye on what other people are up to. Depending on your forex provider, you may be able to work with other commodities like silver and platinum as well.
Personally, if I were playing precious metals, I’d be more inclined to use an ETF backed by physical metal. I see my forex account as a way to hedge against currency exposure on international stocks, not as a way to make a profit in and of itself.
southof8,
Look at it this way: The U.S. economy is just the best house in a bad neighborhood.
As for how the weak euro helps the PIIGS, think tourism. Countries like Greece and Spain thrive on it.
Thanks, Jim and Ed.
The other thing besides the stronger dollar that’s dinging commodities is the fear that growth will slow in Europe, China, Brazil, etc. and that will drive down demand. Not clear how true that is for the emerging markets. Yes, China may grow at 8% instead of 11% and Brazil at 5% instead of 6.5% but it takes a better psreadsheet than mine to say what that does to demand. My guess-timate is that below $70 the actual lower demand from the emerging economies is in tghe price of oil and that any drop below that is on fear.
EUO is a great play…. until everyone remembers the USA has $14 trillion in on balance sheet debt and another 30-50 trillion in off-balance sheet debt. And how exactly does a weaker Euro help the PIIGS? When was the last time anyone bought spanish exports? When Bob was singing about boots of spanish leather?
THis is a knee-jerk reaction to an intractable problem. Trading on it is dangerous…
marr.bo,
Glad I could help! 🙂
Ed, Im’ not sure about all your other suggestions, but EUO was definitely a winner, thanks for the suggestion…its up more than 10% since you first posted on here a week or two ago…and practically the ONLY thing thats up 10% the last two weeks
yx,
(continued)
In the case of oil producers, look at what happened during the oil peak of 2 years ago. Because the price of oil reached new highs, as measured in dollars, the oil companies had a field day. But when the price dropped, as measured in dollars, the oil company profits also dropped.
yx,
Commodities are priced in the international markets. Commodity producers are all over the world map, so you have to look at them individually. This doesn’t even consider the fact that different commodities react differently to economic conditions.
When we look at commodities from an American perspective, we unfortunately have to look at how they are priced in dollars. I would love to be able to invest in commodities in different currencies, but I’m not aware of a way to do it. (I think Forex allows gold-currency investments, but don’t hold me to that. And I’m not going to open a Forex account just to get a different gold play.)
Anyway, when the dollar strengthens, commodities drop in price generally (not always, since there are other factors at work), since it takes fewer dollars to buy the same amount of any commodity.
bobisgreen,
I know in Greece tomorrow, there won’t be ANYONE driving the busses! (unions on strike…again.) 🙂
baveld,
With ETF’s like EUO, you have to look more at the underlying index/commodity than the specific ETF, since the price of the ETF is based on that.
In the case of EUO, you would ask if the euro is over or undervalued compared to other currencies. If you think, as I do, that the euro should be at least equally valued with the dollar, then the euro needs to drop more, and EUO is a good play. If you don’t think the euro is overvalued, or you aren’t sure, then you would avoid EUO.
When thinking of currency values think in terms of baseball cards. There are two ways to look at baseball cards: (1) the “value” of the player whom the card represents; and (2) the number of copies of that particular player’s card you have.
In baseball card terms, the “euro” player is having a VERY bad season, and because there are even more copies of the “euro” card being created, nobody wants it. Hence it’s value has been dropping.
I hope that helps.
Ed:
I thought higher dollar would boost earnings of commodity producers like oil companies, etc.
Ed I am interested in EUO but it looks very overbought now. Can you give me some insight?
Ed,
Hey, remember that “bus” the other day? Guess who’s driving the bus? Thought you’d get a laugh out of that!
I’d like take a look at some Europe’s biggest exporters (like those Jim mentioned in previous postings), but the heavy social burden, their combative union and now add the prospect of higher taxes due to the bailout & austerity, all makes me very hesitated to buy them.
Will the cheap Euro hurt the earnings of US companies with heavy exposure in Europe?
Jim- a couple of excellent articles to mull over this fine day…
“Clowns to the left of us, jokers on the right…”
The Eurozone and China- “…another fine mess you’ve gotten us into, Ollie.”
Can’t help but think that these two albatrosses have got to come home to roost directly over Wall St. before too long…
And I believe I’ll just wait and watch and keep quite a lot of dry powder on hand, as you recommend.
[Mixed metaphors, anyone? Begging yer pardons, yer honors.]
Domino412,
As the euro declines, the dollar gets stronger. As the dollar gets stronger, the price of oil gets cheaper. Expect other commodities to drop as well.
AndyM… it was partly with tongue in cheek that I posted. Jobs has done a fabulous job and a few Billion here or there is probably not a big deal.
I agree with the insight in the Euro dropping further, but I can’t figure out what this will do to the oil and equity markets. Oil seems to decline with the Euro, as well as equities. It’s just too darn confusing for me…I’m in for the long haul, but honestly if you get caiught up in this day-to-day jibberish, it’ll drive you nuts. I play with a currency trade account, and honestly am doing better with that than equities.
Run: Wasn’t that also when Steve Jobs reduced his salary to something nominal, like $1? I don’t know if it counts as a mistake, since it was probably motivated more by trying to save his company from going under rather than hedging against his own future success. Say what you want about Steve Jobs, he has no lack of faith in his own ability to succeed.
As much as Germany cries over all the aid its forking out, a cheaper euro i imagine is really good for them considering how heavily they are tilted toward exports.
Why isnt BMW’s at my local dealership cheaper yet? HA! :p
Looks like $1.12 is support, then it’s off to all-time lows of around $0.89 to the dollar. Yeah, EUO continues to look great.
Off topic… if you are feeling like you messed up on a trade or 2, at least it (hopefully) didn’t cost you $10B like this did for Steve Jobs:
http://www.marketwatch.com/story/apples-steve-jobs-blunders-on-options-swap-2010-05-18
But he’s still got a sweet iPhone though and he can walk on water.
PS – makes me feel better since this was close to the time I bailed on my Apple stock.
Jim,
You keep talking like this, and I may have to add to my already large EUO position. 😉