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People keep wondering why the euro retains as much strength as it does.

Recently, I have argued that the value of the United States dollar against the euro has been the only (semi-) bright spot for the dollar in an investment world that has seen the dollar's value decline against most major currencies for much of the past forty years.

It is amazing to me that American economic policy is so bad that the euro can actually be competitive against the U.S. dollar. That is, if Europe were not so screwed up, it appears as if the value of the dollar would actually be declining against the euro much as it is declining against other major currencies in the world.

The only argument I believe that can be made for the relative strength in the euro is that, ultimately, the "solution" to the European crisis rests with Germany. Germany is seen as having sufficient economic power to lead the European Union and the German government is seen as sufficiently conservative in a fiscal sense to dominate any financial pact that is finally achieved within the European Union. This financial pact will include both a European banking union and a European fiscal union. There is a growing consensus that "Berlin is increasingly the de facto capital of the EU." This comes from Gideon Rachman of the Financial Times.

Of course the EU's main institutions-the commission and the council-are based in Brussels. But the key decisions are increasingly made in Berlin.

This shift in power from Brussels to Berlin has been accelerated by the Euro crisis…Ms. Merkel is now incomparably the most important leader at the table.

Although Germany has not overtly sought this position, the position has fallen to Germany as

exasperation with rule-breaking and fiscal incontinence elsewhere in Europe is making the Germans less shy about insisting on the need for a more 'German' Europe.

As a consequence of this,

[T]he price of German financial assistance is, increasingly, going to be the acceptance of rules and laws designed in Berlin.

I believe that this possibility is what is holding up the value of the euro against the United States dollar. When events in Europe seem to be spinning out of control the value of the euro falls against the United States dollar. When Germany seems to be gaining in influence in discussions within the European Union, the value of the euro rises against the United States dollar. This is why over the past three years the euro has fluctuated within a relatively stable range against the U.S. dollar in spite of all the bad news coming out of Europe, particularly from southern Europe and Greece.

If the European Union can establish a banking union and a fiscal union using the strength of the German economy as its foundation then "Europe" will hold together and become a more important economic force in the world. And, the value of the euro will rise once again relative to the value of the U.S. dollar. Then, the United States dollar will become even weaker within the global economy than it now is.

The bottom line: Investors seem to be basing their hopes for a stable and economically feasible European Union on Germany and the economic strength and fiscal prudence it brings to others within the European Union.

Economic strength combined with fiscal prudence does pay off over time. Economic strength and fiscal prudence results in a strong currency and a strong currency makes a nation a more relevant player in the world economic community.

The United States does not seem to understand this. The United States, with two short exceptions, has generally pursued economic policies over the past fifty years that have inflated the credit of the country to such an extent that it resulted in the breakup of the post-World War II exchange rate system and then produced forty years of a declining value of the United States dollar.

The current economic policies of the U.S. government will only continue this secular trend of decline. If Germany and the European community are able to pull themselves together, it will only put more downward pressure on value of the dollar.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: German Strength Holds Up The Euro