What the Russian-Georgian War Means for the Euro

The conflict in Georgia is greatly affecting the Euro across the board. What does this all mean, and where should investors go?

Forex [FX] is extremely sensitive to politics, because a shift in a domestic political system can be directly connected to a currency's value. For example, the Chinese government announcement that the Yuan would float, albeit a 'soft peg' to the USD, shattered the relationship between a previously pegged Yuan and the USD. Many watching the situation in Georgia are unaware how this impacts them, and how it impacts FX. Also, this war, like many wars, is an information war, and the media spin leaves viewers with a less than accurate picture of reality.

The strength of the Euro over the past 5 years has been in part, not European strength as much as American weakness. A combination of economic factors in the US has made investors fear the USD and purchase non-USD based assets in Euros and other foreign currencies. Also, the Fed has been lowering US interest rates to a finally negative real interest rate.

The recent strength in the USD is not USD strength per se, but Euro weakness. The fear is that Europe will be involved in a war with Russia, and energy will be involved. Russia supplies 25% of the EU's energy needs and over 50% to many Eastern European state[i], and the EU is Russia's largest trading partner, totaling $285 Billion[ii].

Immediately after the 4% drop in the Euro in 2 days, Bank of America issued a warning to its' customers summarizing the situation that, although the USD is showing signs of recovery, a war in Europe does not solve the fundamentally flawed US economy, and they expect further USD weakness[iii].

Russia's involvement in Europe is not only energy. The US has planned military bases in many eastern-bloc countries, one of which has been signed during the crisis in Georgia[iv].

One problem with Europeans is they cannot agree. This is what makes Europe charming and culture-rich but politically complex. USA is a 'melting-pot' which has become a mono-culture based on corporatism, while American's argue their thinking lies in the same direction. Since the US Civil war, US mono-culture has solidified the mainstream in a view that always agrees on some tenets, this is not the case in Europe. Entry into the EU and the Euro passed referendum in many EU states by thin margins, there are those who would like to revert back to national currencies.

One main difference between the Euro and other currencies: the Euro does not have a government behind it. Individual EU states retain their sovereignty, and those states central banks have essentially no power to influence the Euro directly, except for lobbying the ECB. So the Euro is a designer currency hanging on a thin margin, which could be toppled by a severe energy crisis should the situation with Russia escalate. US involvement in Eastern European countries will only increase the chances of Russia's will to turn off the lights.

Russia has already quietly begun selling oil in Rubles[v], and announced the Ruble is fully convertible (since 2006)[vi]. While by itself these actions are not market-shattering, combined with the potential conflict in Georgia, and Russia's aggressive policy to capitalize on their vast wealth in natural resources, a situation is brewing in Europe which can be potentially explosive. Any turmoil can be seen as bad for the Euro, regardless of the actual damage done. The disadvantage of Europe is it's history: Europe has been involved in wars and currency devaluations. As poor as the US economic numbers are, the US is involved in foreign wars at its leisure, there is no compelling reason the US should be involved in any war.

Russia can also affect emerging markets which it may be forced to trade with, such as India, China, and Brazil. Russian oil could help a growing Chinese economy and decrease Russia's dependence on European customers. In a complex environment a static forecast is not possible, but it is clear any instability or even the perception of instability close to Europe will be negative for the Euro. Elite E Services believes the next bubble to pop will be the Euro bubble.

Long term, this is a buying opportunity for hard commodities such as Wheat, Swiss Francs, Oil, and Gold. Whatever happens in this war, the supply side in the Oil market is controlled by unfriendly countries such as Venezuela and Iran. If Russia is now added to the list of unfriendly countries, we can expect Oil to increase long term, as Russia will use this as a bargaining chip in any negotiations.

This move has been excellent for CTA's trading momentum and trend-based strategies. For short term gains in the FX or Commodities markets, investors can seek CTA's with established track records or automated trading systems, which are performing very well in environments like this. In fact, desynchronized markets are ideal for systems that monitor and analyze discreet price data vs. fundamentals.

Disclosure: Long

Endnotes

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[iii]

[iv] 

[v] 

[vi] 

Comments

[Michael Fit...:]

interesting and thought provoking article joe, but i'd like to challenge you on a couple points. first, if europe gets involved in a war with russia, so will the US - both are members of NATO and per NATO rules an attack on one is an attack on all. secondly, i don't believe russia is as hostile to europe as it is to the US. after all, it was US involvement in georgia which was behind the present conflict, and now the US is at it in poland wrt "star wars". russia stood by and watched the US put troops over iraqi oil reserves...i am sure taking back control of the BTC pipeline in georgia is a response. longer term, russia needs europe (and vice-versa) more than either party needs the US. you say the Euro is a designer currency, which is valid i suppose...but the US dollar has been made a fiat currency by the present administration's lack of budgetary restraints, excessive plundering of the US Treasury, and an insane tax policy to boot. they are just printing US dollars as fast as they can, and most of these dollars go to the well-connected and wall street bailout plans (it's call socialism for the rich). that said, we both come to the same conclusion vis-a-vis hard commodities, oil, etc. etc. which i believe you are dead-on and i view the current "correction" as a short term phenomenon...albeit a painful one for me.

2008 Aug 17 07:00 PM

[CLH:]

Joe---Well written and factual. I never thought of this but I agree with you.

Fitz--I see no chance of a hot war however a new cold war has started and will continue. Russia is not about to go to war with the US. It wouldnt last a week. Russia is still very weak.

2008 Aug 17 08:14 PM

[Greg Pinelli:]

Russia is "forced" to deal with Europe?? I think it's largely the other way around. I don't know I'd be placing any currency bets based on the Russian-broader Caucasus developments..However, I definitely would expect every resource Russia has control over to be squeezed hard before let go...oil and nat gas (especially in the Euro-Asian region could cost much more VERY soon. $85 oil is really someones fantasy....

2008 Aug 17 08:38 PM

[rdr4:]

Russia wouldn't last a week? Afganistan and Iran lasted much longer without nukes. VietNam lasted years. The US has not proven capable of finishing a war with super-lightweights or of providing a level economic environment stateside, do you actually think our government could engage a heavyweight to our benefit?
Maybe the Dalai Lama will lend us some of the $15,000 a month he has gotten from the CIA for the last 40+ years.
Maybe the US will free Hawaii. Maybe the war with Russia would last only a week without dealing a crippling blow to the world economy.
Horsefeathers!

2008 Aug 18 08:41 AM

[pockyclips ...:]

It's not so much a physical war that's the threat, but economic war thanks that is the bigger worry. The threat of the Arabs, China, or even Russia dumping large amounts of their dollars could cause a meltdown much worse than the sub prime fiasco.

Also, since we have very limited access to Central Asia, it's very difficult to muster troops in that region, even if we had the reserves to do so. Additionally, most of our armor is tied down in Iraq. So we would have to draw down our divisions in Germany, which doesn't look to be a very good strategic move at this time.

2008 Aug 18 09:07 AM

[NOWHEREMAN:]

Wisdom, CLH, you are a modern day "grasshopper".

2008 Aug 18 10:16 AM

[whidbey:]

The real fear is that the EU will cease to be a viable political/military alliance. That would leave the eastern flank of the Western democracies open and without a functional NATO organization (it was never worth much except as a front for US military actions). The USA would once again become the principal power in Europe. We don't that just now. And yes the Euro could go away via a death of a thousand cuts. But the Ruble is not a substitute since it is Russian managed. The Putin Klepto-state has been looting the national treasury and it too is shell. There is no good out for the EU. That leaves the USD as some sort of a paragon of virtue. Think of that.

2008 Aug 18 04:14 PM

[Joe Gelet:]

The Russia we are facing is a new Russia, we have spent a lot of time reading intelligence reports since this situation began, from many sources. It is clear there exists a void of information in the administration, in finance, and in the general business community, about the new Russia. One excellent source that has this situation pinned down is Stratfor - see stratfor.com Other articles you can see on our blog eliteforexblog.com (just scroll back to previous posts about the situation and read the articles). While we are worried about Georgia, basically an irrelevant state, no one (except stratfor) noticed that Germany is negotiating a new security agreement with Russia. This new Russia is not a threat to anyone directly per se, it is a threat to the current global political framework. From the Russian perspective, they try to capitalize on high oil and a booming debt free economy. Isn't that what the west has been trying to convince them to do for the past 50 years? Now that the Russian's are capitalists, we can't complain that they are protecting their economic interests militarily, like the west has taught them.

2008 Aug 23 04:17 PM

[buyforeclos...:]

"The recent strength in the USD is not USD strength per se, but Euro weakness. The fear is that Europe will be involved in a war with Russia"...

Are you insane? Europe and Russia war? LOFL

and you get to write of SA?

Man I won't ever coem to an SA posting again

2008 Sep 02 02:28 PM

[buyforeclos...:]

Dollar will go to 130 Euro...Oil to $90

not sure when but it will happen at some point

the writing is on the wall

2008 Sep 02 02:32 PM

[Joe Gelet:]

""Are you insane? Europe and Russia war? LOFL

and you get to write of SA?

Man I won't ever coem to an SA posting again ""

Europe has been at war for the last 5,000 years.. if anyone notice the reason USD became reserve currency was because Europe was demolished after WW2 and US was untouched with manufacturing base intact and a strong political footing being a driving force in the winning of Alliance powers.

Secondly, if anyone was watching the news, Russia invaded Georgia. Israel had troops in Georgia and trained Georgian forces. If one doesn't call that a 'war' then what is it? Tanks were rolling from Russia to Georgia and 1/2 of the country was destroyed by bombings. I'm sorry if it's "insane" to call that a war..

2008 Oct 23 02:50 AM