Vikram Saxena

Sell the Dollar, Buy the Euro? Think Again.

Mistrofan: The issues are:

i) The size of the debt compared to the total size of the economies both of the debtor nations and the bond holders; think Iceland.
www.investorsinsight.c...

ii) Currency Issue: A large amount of the debt is issued in Euros and not in local currencies. Investments in Eastern Europe were made in the hope that it will be the China for the Europe. With the slowdown, the exports have dried up, and the currencies have fallen. As a result not only have the assets underlying the debt have become less (or even non producing) but their real ability to service a debt in Euros has gone down.
www.investorsinsight.c...

iii) Legacy Issues: Some of the Eastern European countries also suffer from the challenge of their communist/socialist past. For example Hungary has a huge pension obligation which lies at the heart of its problem.
online.wsj.com/article...

Sell the Dollar, Buy the Euro? Think Again.

Some more thoughts:

1. I also wanted to add the Norwegian Krone (NOK) as one of the key currency to go long against the Euro. The Krone has a strong commodity link and the Norwegian economy is one of the best when it comes to fiscal discipline.

2. Among the long currencies I will under-weigh the Canadian Dollar with relation to the AUD, NZD and the NOK. The Canadian economy is too closely linked to the US, a correlation I would like to reduce in this trade.

Sell the Dollar, Buy the Euro? Think Again.

I do recognize that the USD is going to be under-pressure because of issues which are very well known. However my article's focus was that the rush to the Euro is unjustified.

Imagine, a dozen Treasury Secretaries, all with different political and economic compulsions, trying to come to a consensus. The ECB was clearly wrong last spring when they could not get off the inflation band-wagon leading to the rapid decline of the Dollar and the subsequent oil bubble, which weakened of the US consumer-base.The Germans, who are typically against bail-outs were the first in Europe to bail-out a major corporation!

The global economic picture will either worsen or get better. However the Euro is not positioned to benefit from either scenario.

In the positive scenario, the currencies which are likely to gain are the once which do not carry the baggage of a damaged financial system, have some organic domestically driven growth capability, and can participate in any upswing in the world economy. The commodity sensitive currencies fit the bill best.

In the negative scenario, where the global economy continues to worsen, major new shocks are much more likely to come from Europe than the US. If risk appetite decreases further, the bias will be to head towards the safest bets where the uncertainty element is the least. This includes the USDollar, and perhaps the Japanese Yen. The Euro will not be the safe-haven of choice, when it is not clear who is in control, what their plan is, which nations are next in line to join the union, or in some cases even thinking about leaving the Union.

And in times of crisis, the psychological significance of military strength should not be discounted. Europe has been getting a free-ride on the US Taxpayers via the NATO umbrella, when it comes to defense spending. If that situation changes, it will have a negative impact on European economies.

Inflation and the Declining Dollar

The emergence of the Euro as a viable alternative to the US Dollar has made the US not the only 'big country' around. Since the Euro is controlled be a large number of countries with different foreign policy objectives, it is seen as relatively immune to foreign policy based uncertainty. Since 9/11 US foreign policy has scared a number of countries which are big exporter of raw materials. These countries now convert their US Dollars to Euros right away; they are afraid that the US will use the US Dollar as a foreign policy tool (e.g. freezing assets held in the US).

The large federal budget shortfall, the trade gap and the low saving rate all require the rest of the world to buy our dollars. When there was no other alternative we could get away with it. However, the party is going to end, and it is doing so now as many other currencies now emerge; apart from the Euro, the currencies of the commodity producing countries like Australia and Brazil will continue to show strength.

The US has enjoyed very high wage rates and commodities form a very small percentage of its economy. In a globalized world this mismatch can not last forever. US wages will have to harmonize with the rest of the world, and the contribution of the commodities to the overall economy will gradually come in line with the rest of the world.

The only way we can maintain our lead in wages is by increasing productivity. That requires investment in fundamental engineering and science which will ensure that we drive the next big waves of high-value technological products. Our scientific base is our unique advantage and we need to invest to stengthen that to maintain our lead in real wages. Unfortunately the past two decades have seen private sector investments in fundamental research dwindle. With the compelling cause of the Cold War also not around, government spending too has not kept pace. We need to re-evaluate our priorities and keep up the investment in fundamental research. Kudos to Gov. Arnold who recognizes the value of high-tech and is trying his best to ensure that California remains the high-tech hub.