Why Cyprus Is Not Really A Negative For The Euro

| About: CurrencyShares Euro (FXE)

The Cyprus news is, as predicted, leading to a sell-off in the equity futures as well as in the Euro (NYSEARCA:FXE). However, I believe there are two powerful reasons why over the medium to long term the news is actually positive for the euro. Let me explain…

The first reason: It shows a willingness to not print and take losses

In stark contrast to the U.S., United Kingdom (NYSEARCA:FXB) or Japan (NYSEARCA:FXY), Europe is at this point showing some willingness to take losses. Be it through the austerity drive in Greece, Portugal and Ireland, or now through these losses forced on Cyprus' depositors.

Even if the ECB at times provides financing and/or buys a small amount of sovereign debt, this is being done while forcing bitter medicine on the countries showing imbalances. Over time this will eliminate the imbalances and thus the reason for any possible printing.

The same is not happening in the U.S., United Kingdom or Japan. There, printing is the first option and austerity or losses an afterthought. The end result is simple - printing begets more printing to avoid the same recessionary consequences. Obviously, printing and diluting a currency is hardly positive for said currency, so over the medium to long term, the euro's lack of printing (or just temporary printing) will make it more valuable than the endless monetary debauchery taking place in the other majors.

The second reason: It's deflationary!

This reason is somewhat tied to the first, but slightly different. Basically, forcing austerity or the taking of losses is deflationary, while printing is inflationary. Now, a currency's value in relation to others can be established through purchasing power parity. If a potato costs 2 units of currency A and 1 unit of currency B, then over time (and ignoring a lot of stuff) one would expect currency B to be worth about twice as much as currency A.

So, if the euro area is undertaking deflationary measures whereas all the other majors are undertaking inflationary measures, one would expect the euro to have a lower inflation rate overall. And cumulatively, as time goes by, one would then expect the euro to gain in value due to its purchasing power parity implying higher and higher value versus the alternatives.

This is also one of the reasons why the Japanese yen was so strong for so long (too long) even while Japan's economy showed weakness.


While in the short term many different and temporary fears can lead to a lower euro, over time measures such as the one taken in Cyprus will be more likely to strengthen, rather than weaken, the euro's value.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.