The Zombie Euro Marches On

Includes: FXE, UUP
by: Bo Peng

It's a good day to die, but the day is not yet over.

--Lt. Worf, Star Trek.

But it's Groundhog Day, Klingon, so drop that tedious heroic face and relax, will ya?

I'm getting a serious case of Euro Complex. I'm increasingly sick and tired of the never-ending twists and turns, meaningless little tweaks laboriously pretending to be solutions. Yet I can't help obsessing over it. Apparently neither can Mr. Market.

To underscore the fragility of eurozone, the mere mention of a break-up is supposedly devastating. It pains me to bring up the emperor-has-no-clothes analogy here, due to its sheer lameness but, again, I just can't help it. There's got to be some way for me to sue somebody in eurozone for psychological torture. If something is so fragile as to be devastated by the mere mention of its demise, then it's already dead.

But there's no denial that the undead is still walking, so there must be some reason for it (is the fact that I'm getting existential yet another piece of evidence of my psychological devastation?). Why do the peripheral Europeans -- let's call it PFIIGS (now with the latest French action), after the new ECB head Draghi coming to motherland's rescue while France was not downgraded by S&P -- choose to play along their technocratic leaders, live with the promised austerity, and put up with the humiliation of being dictated by foreigners and international bureaucrats?

There's only one rational explanation: They either really like this eurozone idea, or are sure they can play their own little game, or much more likely, both. The peripherals get to enjoy the low borrowing cost at home and a strong and respected currency abroad without doing any real work. Can you imagine, going from getting paid in drachma/lira/peseta to deutsche-mark-on-steroids? I'd love it, too.

And I bet the peripherals will never reach their pain threshold to demand exit in an orderly and corporative way. All the promises, agreements, monitoring, etc., have no teeth. Both the European leaders and the people know it, they just keep their vow of silence. It's their unspoken contract, much like the old Soviet joke: "They pretend to pay me, I pretend to work." If the external pressure becomes too high to bear, they could always hijack the core: Give us more money or we'll leave, default, or otherwise throw a tantrum, and let's see who has more to lose. I'm not being judgmental on the peripherals at all. The setup is such that this is to their best self-interest. Blame the setup if you must.

How about the German people? I do not pretend to understand their thinking any more than I do the peripherals. But, again, existential argument dictates that the German people have not reached their pain threshold yet. As the call for ECN to print ramps up (most recently from -- ready for this? -- the Portugese president), it could push Germans over the threshold at some point.

Or, if you believe that the real issue of the eurozone problem is a balance-of-payment crisis, flow of capital will force up inflation in Germany, therefore pushing Germans toward the threshold. Or at some point Germans will realize that the never-ending crises and bailouts are costing them too much, in various ways, to be worthwhile. But that's after we somehow find a way to break out of Groundhog Day.

By the way, I find the parallel between core vs peripheral Europe and China vs the US quite amusing. With China's currency peg, the G2 is somewhat like a super-eurozone in the sense of trade and savings/deficit. The big difference is that Fed has printed and forced inflation in China, while PIIGS can't do that to Germany. And the US has forced a sustained, albeit slow, appreciation in CNY, while PIIGS can't do that, either. But the most crucial pillar of the analogy is that Europeans want to share a lifestyle no more than Americans and Chinese do.

In summary, the market may go up, the market may go down, but two things are for sure: The euro is dead, and the euro will keep walking for awhile.

If you can't fade the rallies and crashes, it's crucial to get the timing right, which is pretty much impossible unless you're Goldman (NYSE:GS), with direct lines to every office of any import in Europe and beyond. But the fact that even Goldman lost money trading recently should give every brave soul some reason to pause and reflect -- things are actually not controlled by the offices of any import; they've lost control, along with their credibility. For us mortals, it's probably better to stick with volatility and correlation plays, and be quick taking profits and losses.

Disclosure: I am long UUP.