This time really, truly must be different.
The majority of the European Union is either in or entering recession. Rising bond yields are creeping from peripheral nations to core nations. Governments have collapsed and stalwart political supporters are losing elections. To top it off, central banks' printing presses are working overtime. The banking sector has attempted to solve a solvency crisis by borrowing more money. While this temporarily bolstered liquidity it ultimately rendered it more insolvent.
Yet through all this the Euro remains stable at a time when rational analysis points in the direction of the common currency setting new lows.
Now, I am no foreign exchange trader. Just yesterday I paid Bank of America (BAC) a $7.00 fee to convert US $100 to CAN $100 so my 14 year old son could go on a school trip to Quebec this upcoming weekend. So this opinion is worth exactly what you are paying for it.
But as the son and grandson of career equities traders and having spent some time on a trading desk and a lot of years doing fundamental analysis in the industrial and private equity world - this time must really, truly, absolutely be different or there is a major shock coming to the Euro in the future.
Let's keep it simple and look at some fundamental realities. The Euro's recent stability in the face of wave after wave of bad news is in direct conflict with the fundamentals of the greater European economic picture. For example;
- The Euro's stability in recent weeks - especially within the last few days - is in direct conflict with the political uncertainty that now exists in the core of its strongest supporters. The defeat of Sarkozy in the first round of French elections and the collapse of the Rutte government in the Netherlands - both are stalwart Euro supporters - confirms that a major swing in political support and sentiment is now taking place away. That alone should weaken the Euro.
- It should be noted that lacking a core consensus on a strategic direction within the EU, the discussion has now become binary. Either implement austerity plans to control deficits as Germany would prefer or return to Keynesian spending to stimulate growth. But since the individual states cannot themselves issue new Euros per the term of the EU Treaty, a vote for stimulus spending is really a vote either to rewrite the original European Union Treaty or a vote to dissolve it. Referring back to Point 1 above, as of Wednesday the political momentum favors the stimulus spenders. Yet the Euro's value holds strong.
- Just Wednesday, the EU Council President Herman van Rumpoy admitted that the EU is in a recession. Yet the Euro stays within a tight trading range.
- Sovereign debt yields? Up in Italy, Spain, France and The Netherlands. There is no greater sign that investors see growing risks in owning these government bonds than increasing yields. In fact, Wednesday an auction of 30 year German bonds was met with a tepid response when the bid to cover ratio - a symbol of the strength of the bond auction - was an uninspiring 1.1. A bid-to-cover ratio of 2.0 means that there are two Euros in offers to buy for every one Euro in bonds available for sale. Therefore a 1.1 ratio means that the auction just barely got filled. As I write this a few hours after the German auction, the Euro is essentially unchanged to slightly up on the day.
So why hasn't the Euro lost value? Is it really, truly, absolutely different this time?
Only two explanations make sense:
First, over the winter European banks borrowed vast oceans of money - approximately €1 trillion from the ECB at 1% rates. The loans have a three year term. The collateral they provided for these loans is believed to be illiquid and of subjective value. Yet the ECB lent against it anyway in an effort to stave off a full scale bank liquidity crises and potential collapse of the financial sector.
Perhaps EU banks trading operations are providing support for the € in the form of open market purchases using the borrowed money and are thereby putting a floor in the market for the common currency? I don't know. Traders are pretty smart folks. I can't see them recycling money borrowed from the ECB into full scale support of the Euro. That's too many eggs in one basket.
Second, perhaps it really isn't different this time and the market is heading for a huge sell-off. The weight of all these negative events must at some point overtake whatever is artificially propping up the cost of the Euro.
Look at it this way, if you took a yellow legal pad and drew up a list of negative forces on the Euro on one side and a list of positive forces on the Euro on the other, the number of entries on the negative side could probably get close to the bottom of the page.
On the opposing side of the pad the positive forces would have just one entry - Germany. But if Sarkozy is voted out on May 6th - and it appears that is likely - then Angela Merkel will be pretty much alone.
Sure, Merkel does have her supporters in other countries but Rajoy in Madrid is on life support from the ECB and Monti in Italy - who is appointed not, elected - is a breath behind him. So the world will discount their support. Yes, she also has the ECB and the IMF on her side as well. It is always good to have the money on your side.
But this crisis has now moved from a mostly financial one to a mostly political one, In a political crises well-coiffed bureaucrats making speeches at expensive conferences from posh resorts just won't sway a lot of voters who are worried about how they are going to deal with life's more basic requirements of food, shelter and clothing.
See, I don't think this time is different at all. I simply think that when the marketplaces realizes that the weapons assigned to fight the crises are dwarfed by the size of the crises itself then the Euro's fall will be quick and steep.
It may seem like it is different this time. But it isn't and it never really was.