The Euro Remains Strong: Germany Is Winning

Includes: EWG, FXE, UDN, UUP
by: John M. Mason

German Chancellor Angela Merkel has … so far … stayed the course. She has, in her own under-played way, stuck to her guns and has led Europe to the brink of economic progress.

One still needs to be careful. The cow is not fully in the barn yet and the door of the barn has not been closed. But, step-by-step, the European Union seems to be convincing the world investment community that it is on the way back.

The evidence: the strength of the euro, which closed at a two-year high of $1.3768 against the dollar.

Additional evidence: the flow of funds that are returning to Europe from the United States. These funds had earlier fled Europe as investors had sought a "safe-haven" for their funds as confidence in European leaders' ability to resolve their financial problems reached a near-term low.

Now, with the eurozone on the brink of a new banking union where member countries will give up the largest amount of sovereignty since the creation of the euro, confidence in what European officials are doing is at a new high. And, the feeling seems to be that once this banking union is achieved a new political union will follow.

And, behind these developments … in the shadow … stands Chancellor Merkel. She has been heavily criticized. She has been called a Nazi in some eurozone countries. She has been accused of many things. But, she has remained true to her vision … a stronger Europe.

Now, she seems to be on the verge of seeing this come to pass. But, in the case of exchange rates, it takes at least two parties to determine a price. In the case of the euro/dollar exchange, the other party is the United States.

The eurozone has seemed to achieve some common success in getting its act together. With Spain pulling out of recession and Ireland leaving its international bailout program, with Greece and Italy showing some stability, with financial markets stabilizing and "risk averse" money flowing back to the continent, and with discussions on a bank union progressing, confidence in what is going on in Europe has risen.

The opposite has been true in the United States over the past two years or so … in spite of Mr. Obama's re-election.

The United States Congress has shown its worst side and Mr. Obama has not had the leadership skills to bring it into line as other presidents have done. There has been the budget sequester and the shutdown of the government. Weakness has also been shown in foreign affairs with Syria, Iraq and Afghanistan topping the list of international shortfalls. And, then there has been the disaster connected with the introduction of the new healthcare program. The United States economy is extremely weak and there seems to be no coherent effort to resolve the structural issues that dominate the situation. In fact, there seems to be no leadership at all

In such a situation, the evolving situation in Europe is dominating the one taking place in the United States and this has resulted in the strength of the euro.

In the longer-run, financial strength trumps financial weakness and uncertainty! And, in the current case, the effort to secure solutions that make for a stronger financial and political union in Europe are trumping the lack of leadership and confusion that exists within the United States.

I continue to quote the words of Paul Volcker in such instances: "A nation's exchange rate is the single most important price in its economy."

A nation's exchange rate captures the relative strengths or weaknesses of a government's monetary and fiscal policies. A nation's exchange rate is the scorecard for how a country is doing relative to what other countries are doing.

In the case of the euro/dollar exchange rate, the move to become more financially sound on the part of Europe is winning over the mess that is coming out of Washington, D. C.

But, in the case of the United States, this performance is not really new. The value of the United States dollar has declined by almost 30 percent against the major currencies of the world since it was floated in August 1971. Both Republican and Democratic administrations have contributed to this fall. In essence, the United States, over the past forty years or so, has taken advantage of the fact that it is the primary currency in the world and created an extended period of credit inflation that has almost continually made the dollar weaker in world markets.

In this sense, the Obama administration has just followed its predecessors in creating credit inflation policies that continue to depreciate the value of the currency.

Europe seems to be on the opposite track right now. The recovery in Europe could still collapse and financial problems could still take place, but, for now, events seem to be moving in the right direction. It is my belief that the euro will continue to strengthen against the dollar. There will be corrections from time-to-time. Over the next year or so, however, I see the value of the euro strengthening and the value of the dollar weakening.

Financial strength trumps financial weakness.

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.