Too bad for the weak (or late) EUR shorts that got spooked out Monday. The short squeeze was indeed scary if your time horizon got narrowed to the ticks and seconds.
I find it amazing how rarely the importance of time scale is talked about in investing. There are an infinite number of profitable games in the market, each with -- among other characteristics -- its own time scale. An essential part of investing is to know the time scale of your game and stick with it. But equally important is to know when to scan other time scales. It may help you filter out the noise in your time scale and give you clarity and conviction.
Monday's EUR short was a classic case. Surveying longer time scales would've easily helped a short to tough out the squeeze and stay the course.
Besides austerity measures, the other essential thing for the PIIGS to do is to devalue the currency. This would increase the competitiveness of their products and services across the border, therefore helping productivity growth. But since they are caged in the pipedream of a social experiment called the EUR, and the EU heads put up a last heroic effort to keep the experiment going, for the moment, the only choice is to devalue the EUR. If the EUR devalues fast and big enough, the eurozone might even be able to avoid a double-dip recession.
European heads and the people may or may not want it. But at this point it hardly matters. It will happen. The EU/ECB/etc will step in to stop perilous dives in the EUR, using for example the dollars the Fed swaps over. But the downward pressure on the EUR will last until the PIIGS manage to rebalance debt/deficit and productivity or the EMU breaks apart, whichever comes first.
The overall situation is extremely complicated. But as far as the long-term direction of the EUR goes, it's this simple.
This is the best case scenario, assuming the EU duct tape tying the rocks with the ship would not sink the ship along with the rocks. The prevailing bet is that it won't work. You can easily find many excellent arguments by people with excellent credentials so I won't repeat them. But if the EUR depreciates quickly and sufficiently, it might just work.
Since everything is relative in a global fiat currency system, the real question is: depreciate against what?
The key is how the US and Japan will react to a EUR devaluation. For now everybody is for "stabilization" of course. But when EUR devaluation continues for a year or two, pain will surface and self-interest may dominate.
Japan stands to lose the most since much of their exports compete directly with Germany's. I think they have no choice but to engage in competitive devaluation. In fact Japan has already started curbing the Yen's rise. But it remains to be seen whether they can succeed against a depreciating EUR over the time scale of years.
The US stance on the dollar's strength seems very schizophrenic. I'll be watching this area closely. But my bet is the US response will come very late in the game and only in some indirect ways, since the US has many currency manipulation tools, unlike Japan.
If the EU's stunt works, meaning the EUR goes down a lot, then risk-on trades would take off, and both the USD and JPY would go down somewhat, but mostly against Australia, Canada, and Brazil rather than the EUR. And gold would retreat somewhat in this scenario.