While traders are bearish on the euro we need to remember the greater context of Europe and the origins of the euro currency. The euro as an economic union was built on a similar U.S. model, that of a Federal State comprised of individual "united" states. However, Europe is much different than the U.S. historically, demographically, and geopolitically.
Europe will survive one way or another even if there is financial Armageddon. It would not be the first time that financial calamity plagued Europe. In fact Europe is steeped with history of financial crisis, going as far back as the Roman Empire's debasement of their currency.
United States model
One useful thing Europeans have today is they can look to the U.S. as an example of what worked and what didn't work regarding the Federal state system and single currency.
We should remember that the financial system in the U.S. evolved from crisis. The Fed was only possible to introduce a central bank to a cautious U.S. environment after the Panic of 1907.
Early in 1907, banker Jacob Schiff of Kuhn, Loeb & Co. warned in a speech to the New York Chamber of Commerce that "unless we have a central bank with adequate control of credit resources, this country is going to undergo the most severe and far reaching money panic in its history".
The FDIC was created in response to bank failures during the early years of the depression. Forward 40 years, and the CFTC was created in 1974, during a time of much economic consternation from the Nixon Shock to the 1973-74 Stock Market Crash, and the Oil Crisis.
The U.S. dollar is still the world reserve currency, but only after many previous currencies collapsed or caused economic upheaval.
Before 1945, Europe was mostly ruled by force; groups with the larger armies would dominate the rest. Alliances between groups would form, such as the Austro-Hungarian Empire. This make shift system evolved over time from the origins of civilization in Europe, and although weapons and other technologies evolved, the process was relatively similar.
What may have been a wild-card to upset this delicate geopolitical balance was the industrial revolution. For the first time, armies had weapons capable of mass destruction such as new synthetic chemicals, hardened tanks, and automatic weapons. Factories were manufacturing them as quickly as possible, for the first time mass production of weapons on a large scale could be achieved with the use of machines. Due to the types of weapons used such as flame throwers, and their widespread use, WW1 left Europe politically and economically exhausted and with much animosity. This animosity led to an unreasonable Treaty of Versailles, leaving the remaining German state to pay a $442 Billion (2012 U.S. Dollars) worth of reparations. We now know that this financial noose led to the rise of hyperinflation and the introduction of a new currency the Rentenmark, and finally to the rise of Hitler.
Ironically, it was the German state of finances that would determine the fate of Europe, as it is today (although then they were the debtors and now they are the creditors). Also ironically, while there are no flame throwers being used, similar animosity is building in a forming rift of northern European creditor states and southern debtor states, as seen in this article.
Among other effects of the brutal WW1 were the growing concepts of a unified Europe, first publicly outlined in 1923 in a manifesto named Paneuropa which was the founding document of the Pan-Europa movement (the manifesto included a membership application). Ironically, this movement was co-founded by Otto von Hapsburg, previous ruler of one of Europe's most powerful empires, until his exile in 1918. His interesting view for the purpose of founding such an institution was:
"the only way of guarding against an eventual world hegemony by Russia"
Today, Russia supplies much of Europe's fuel (supplying over a quarter of EU gas consumption) as well as establishing itself as a financial power, and is one of the only major countries to be debt-free. It's interesting to note the intellectual Royal origins of the idea of the EU in its suspicion of Russia (at the time there was no USSR), and Russia is now a major economic force.
If you exclude the former Yugoslavia, the period since WW2 is Europe's longest period without war, even having its own name "Pax Europaea" which leaders will no doubt credit to the EU economic system.
Mario Draghi, the head of the ECB recently said:
"A new architecture for the euro area is desirable to create sustained prosperity for all euro-area countries, and especially for Germany," Draghi wrote. "Yet this new architecture does not require a political union first. Economic integration and political integration can develop in parallel."
The article goes on to say that:
That all-or-nothing approach has long appealed to the Bundesbank. In October 1990, more than a year before the summit in Maastricht, Netherlands, that set the stage for the euro, the German central bank said only a "comprehensive political union" could make a common currency work.
The Bundesbank here is correct, but not politically correct. For years detractors of the euro currency model have stated the only way for a common currency to work is a common country. Deep down Europeans know, from history, that by participating in a Federal European state they would in fact be giving up their sovereignty. Still, Draghi's comments are similar to those recently made by German Chancellor Angela Merkel in June of 2012:
"We need not just a currency union; we also need a so-called fiscal union, more common budget policies. And we need above all a political union. That means that we must, step by step as things go forward, give up more powers to Europe as well and allow Europe oversight possibilities."
This isn't very subtle, and has been noticed by many including New York Times writer Floyd Norris and others. A Daily Mail article actually reads "Leaders plotting EU superstate." Last year an internal German government memo shows their opinion that possibly one of the only ways to solve the euro crisis is a superstate with budget decisions coming from Brussels.
But what alternative?
Let's assume that there is an agreement that political union is out of the question. What is left? Countries can go back to using their domestic currencies, as suggested by academics and certain political leaders in Europe. Would that be such a bad thing? It seems either direction the will of Europe swings, each end of the spectrum would be a much better economic situation than we have now (either an EU Federal Superstate, or a return to the individual currencies of the 70s and 80s). What we have now is compromise; the idea of compromise is where no one gets what they want. There are also discrepancies between what Europe's leaders are promoting and what the people want, for example only 23% of Greek citizens want a return to the Drachma, they are happy to stay in the euro nearly at any cost.
How to trade it
Like any crisis, there will be deep opportunities in many markets, not only Forex. In previous articles, EES has outlined some euro (FXE) strategies involving options strategies (puts and strangles). The euro being the focus as it represents a lot of aspects of the European economy, those who are not full time professional investors and traders should focus on the euro strategies. The euro is the most liquid of all currencies, and also the most available in other markets (such as the FXE ETF and the euro is available on most futures exchanges). Shorting the euro certainly is a good short term strategy, however as time progress other strategies will emerge. For example there is a Grexit and other countries follow, the euro may increase due to the market perception that the low rated players are out.
What is important to remember is that Europe's situation is historically unique; when the colonies formed into the United States, they were not already fully functional independent countries with long histories and diverse cultures. The economic data never lies, however the financial crisis in Europe is much deeper than what is on the surface, it is a part of Europe's social evolution. Understanding this may give traders a better understanding of their strategies, not only in Europe but globally.
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