It's been a big couple of weeks for currencies, with the obvious market driver being the humongous bailout of the European Union. $962 billion of public and private loans have been approved to be shelled out when needed, as economic crisis rages not only in Greece, but in Portugal, Ireland, Italy, and Spain as well. Greece in particular is running with debt worth 113% of its annual GDP, but worse yet, a budget deficit that's 14% of its GDP, leaving it with insufficient cash flow to pay off those debts.
And thus, the timely (and perhaps inevitable) bailout by the European Union is saving Greece, and possibly others, from sure default. That bailout will not come without a price, however, and I see it further defacing the euro currency as we go through 2010.
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The beauty of the euro is that it unified the dozens of borders throughout the continent, making inter-country trade and travel far easier, while also being backed by the many economies it represents, including powerhouses like Germany and France. With that union came some responsibilities, however. The one restriction that is particularly relevant at this time is the requirement that each country's budget deficit not exceed 3% of GDP. While Greece is currently not the only country to exceed that level, its obvious budgetary recklessness, rife with pension payments for young retirees became simply unacceptable.
The thing about the European bailout is that it instantly undermines all of the restrictions that were put in place for EU members (for good reason I might add). It is suddenly clear to other EU countries and market traders alike, that the EU's "laws" are more like guidelines.
Of course, the alternative to the bailout would have been to let Greece default and to kick it out of the EU. This move would have had the effect of removing a weak sister and strengthening the core of the EU. Although, the move would have added some serious risk to various European banks with investments in Greek bonds, especially banks in France. Nevertheless, the communal bailout has taken the sharp risks of Greece and the other PIIGS countries and adopted them into the EU's core, weakening the heart of the currency.
Take a look at the 10-day chart of the euro below. On May 6th, it plunged to new lows as Greece introduced new austerity measures, causing large-scale riots. The currency made a sharp rebound to begin trading again the following Monday after the EU agreed upon the trillion dollar bailout. Traders weren't fooled for long however, as the euro proceeded to crash back down to May 6th lows.
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Nearly $1 trillion of loans was not the only part of the bailout either. The ECB also announced that it will begin buying securities (a.k.a. quantitative easing a.k.a. printing money). The printing press is about to be turned on, and that can only mean inflation is on the way.
Ben Bernanke has some experience with quantitative easing, which began last March. As you can see in the chart below, the dollar plunged soon after Ben turned on the printing press and it didn't turn back until the recent problems in the EU began to surface.
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The moral of the story is that the euro has a strong bear case against it. The integrity of the European Union has been compromised by the EU's massive bailout. Not only that, but it seems so far that many of the European citizens that are highly pampered by government overspending are unwilling to deal with the many austerity measures about to be undertaken by various European governments (including newly announced measures in Spain and Portugal).
Even with the bailout, we are likely to see a period of unrest in the region and it's going to seriously question the strength of the eurodollar. That nice European vacation you've been planning could soon become a lot cheaper.
Disclosure: No positions
