For most of 2012, the EUR/USD cross has been trading mostly sideways. It feels like the Euro is losing ground, and indeed once or twice it took reasonable dumps when compared to the USD, but the fact is that the EUR/USD started the year at around 1.2933 and right now it trades at 1.2800, barely down 1%.
All along, the Euro fears have been strong. Greece is always on the verge of leaving the Euro - and might ultimately have no other practical choice but to leave. And Portugal might not be that far behind, if Greece ever follows that route. From there, it's not hard to speculate on Spain or Italy also leaving, leading to some kind of huge breakup of the currency.
Given all these fears, one already has to wonder how the Euro lost so little. But today, I'm going a bit farther. I am going to say that I am turning long term positive on the Euro in spite of all the fears and the fact that in terms of purchasing power parity, it's mostly fairly valued.
Why am I turning long term positive - and indeed went as far as hedging all my USD accounts just this past Friday? There are three main reasons for this.
Less monetary printing
The first reason is that due to Germany's past experience with money printing, leading to the huge hyperinflation during the Weimar Republic (1919-1933-in practice/1946 formally), the Germany of today is always seeking limits to money printing.
This has meant that although the southern states plus France are always calling for more printing, Germany is always pushing back. The end result is that even though the ECB has seen balance sheet expansion on a par with the Fed's, this is mostly due to short and long term loans, and not as much due to outright buying of Government debt as is the case with the Fed.
Conditional monetary easing
Even more significant, whatever little ECB buying there is, it's now tied to the participation (of the States receiving this buying) in austerity programs designed to reach budgetary equilibrium. That is, the monetary easing is conditional on working towards eliminating the need of such monetary easing through austerity. This is hugely different from the Federal Reserve's unconditional and ever-expanding quantitative easing, whose latest iteration even dropped the amount and time limits.
In the US, fiscal cliff notwithstanding, there's virtually no incentive to put an end to the budget deficit. Politicians now know they can spend as they see fit because the Fed will always be there to print more. This is hugely negative for the USD over time, as not only is dilution happening now, but there's nothing in place to keep dilution from happening in the future.
Not so with the Euro. Although some dilution might happen now, it happens in the context of programs which will, over time, lead to no more need to dilute further.
Improving external trade position
The austerity programs being implemented in Europe's southern periphery destroy internal demand, some of which is directed towards outside the UE, while at the same time goosing exports, some of which are also directed towards outside the UE. Both of these effects tend to increase the UE export imbalance. The hallmark of a strong currency is having a strongly positive trade balance (just think of the German Mark of yore or the Chinese Yuan of today if it were left to float freely).
All in all, the measures being adopted in Europe are those of a hard currency, so they will tend to retain and improve that currency's value, versus measures being taken in the US and Japan that are downright hostile for the currencies (USD, JPY, GBP).
The chart below shows how, after a period where the Euro area saw weak trade numbers, mostly due to the housing bubble also taking place in many of its members, the trade balance is now once again strongly favorable (source: Tradingeconomics.com).
Contrast that with the US numbers, which mostly saw a brief improvement after the 2008 debacle, but are now mostly back to showing consistent deficits (source: Tradingeconomics.com):
The UK, home to another main currency, the GBP, is also showing a consistently negative balance of trade (source: Tradingeconomics.com):
And even Japan wiped out its traditional positive balance of trade (source: Tradingeconomics.com):
The main risk
The main risk lies in the unknown regarding the possible exit of some Euro members. The very fear of this happening can lead to a weaker Euro not because the resulting currency is weaker, but simply because of the uncertainty about what would happen under such an event.
A more real risk in a breakup, however, would stem from a less-likely event where the Euro would see Germany -- not Greece or Portugal -- exiting the Euro. In that case there would be no doubt that the resulting currency should trade weaker, as it would then be composed mostly of countries wanting to print it into oblivion.
In short, not only is the Euro home to more benign monetary policies, not only are these policies conditional on trying to fix the mistakes from the past, but already currency-favorable results can be seen in the trade numbers emanating from the Euro area.
All of this makes me be positive for the Euro when compared to the other main currencies (USD, JPY, GBP in this article). And personally, it led me to hedge my USD exposures back to EUR.