Why You Don’t Want to Hold Euros in 2011

 |  Includes: DRR, ERE, ERO, EU, EUO, FXE, UDN, ULE, URR, UUP
by: Investment U

By Karim Rahemtulla

It’s safe to say that the trials and tribulations of Europe and the euro currency in 2010 resemble a wild rollercoaster ride.

Except for the adrenalin rush, of course.

Back in February, we covered the problems with the PIIGS (Portugal, Ireland, Italy, Greece and Spain) and the impending European crisis that would follow. The story has played out according to the script so far -- except for one aspect: The euro.

It’s obvious that Europe’s litany of deficit-born woes has hit the single currency. But the surprising thing is that the problems haven’t dented the euro as much as they should have. In other words, the euro should be trading a lot lower today than it is.

Consider the fact that after bailing out Greece and Ireland, in addition to the previous stimulus and bank bailout packages, it’s cost Europe close to €1 trillion. So with many more euros printed, it’s quite surprising that the euro’s only down around 15 percent. Moreover, most of that decline occurred during the first quarter of 2010 -- even though the rate of printing increased as the year went on.

How can this be possible? And what are the next twists and turns for the European rollercoaster in 2011?

Thanks, Uncle Sam

The only logical conclusion for the euro’s failure to disintegrate lies at the feet of the U.S. dollar. If this were just a self-contained euro crisis, the currency should have – and would have – fallen off a cliff. But since this is a global crisis in a global economy, the euro is falling -- but at a diminished rate, due to the fact that the monetary authorities have printed just as many dollars.

However, this trend might not continue in 2011 and the euro’s slide may resume, which would take the currency to new lows.

Not Just One Shoe to Drop in 2011 -- But Two

If you had just one word to define the economic climate over the past couple of years, “bailout” would probably rank very near the top. Hot on the heels of the banks, auto companies, Greece and Ireland, we’re likely to see two more next year – Spain and Portugal. Why?

Simple. Both countries are suffering from:

  • A weak business climate.
  • High unemployment.
  • A failed real estate sector.

Just last week, Standard & Poor’s downgraded Spain’s debt rating, promptly sending shivers down the spine of an already nervous Spanish central bank. Still, the fact that most observers have now resolved that Spain and Portugal will be next on the bailout list should mitigate some of the euro’s downward action.

What people don’t know, however, is the size of the impending bailout. That will determine the fate of the euro in the near-term. As for the fifth member of the PIIGS that I haven’t mentioned so far – Italy – it’s not likely to require a bailout, as it didn’t participate in the same real estate bubble markets of Spain or Portugal.

The Eurozone: All Alone in the Printing Room

Another bearish force for the euro is the situation here in the United States. In 2011, the U.S. dollar may relinquish its position as the Cincinnati Bengals of the currency world. Early indications are that the U.S. economy may post stronger than expected growth in 2011, which would lessen the need for an additional stimulus. In addition, there’s a small chance that we’ll see more U.S. government austerity plans, given the promises made in the recent elections.

If these scenarios play out, the eurozone might find itself as the only major currency printer left.

Germany May Want Strength … But It Likes Weakness

Remember, though, that it’s in the eurozone’s best interest to have a low euro currency, regardless of what the talking heads from the European Union say publicly. (Similar to what U.S. officials say about advocating a “strong dollar policy,” when the truth is far from that.)

For example, German factories are currently humming away at capacity, as the low euro drives exports higher. You can bet the Germans will talk tough, but have you seen them do anything about the euro’s slide?

Germany is in the best and worst position when it comes to the euro. On one hand, as the strongest nation in the eurozone, it’s suffering the greatest currency debasement. But as its biggest exporter, it’s also reaping the greatest benefits of a low euro, too. Talk about a Catch-22.

But regardless of what you hear about the euro’s imminent break-up, it’s not going to happen. Why?

Goodbye to the Euro? Nein!

Simply put, Germany won’t allow it.

Yes, you heard right. Regardless of the rhetoric coming out of Germany (which has been the loudest), the country isn’t going to back a dismantling of the euro. And while some have estimated that the stand-alone Deutschemark would be worth twice the euro – and most of the euro member currencies (except for the Dutch guilder) – if Germany were to leave the union, it would plunge the country into a quick and major recession, as its goods and services would be uncompetitive in the region where it trades the most.

The bottom line is that the euro isn’t going to disappear in 2011 … or anytime soon, in fact. But it should be worth less in 2011.

My target for the euro in 2011 is 1.15 to the U.S. dollar. Based on purchasing power parity, it should be even lower, but as we saw in 2010, while the euro did plunge below $1.20, it recovered as America cranked up the printing presses. 2011 may not be as kind to those holding euros.