Comparing 'Core Euro' and 'Periphery Euro' Realities

Includes: FXE
by: Firat Ünlü

The folks at HSBC recently released some intriguing research regarding how a core-euro and a periphery-euro might have fared. They came up wih this.

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Even if those numbers are just close approximations, they give us a clue as to what countries would have to expect were they to leave the euro zone and re-introduce their own national currencies. Irrespective of the most recent deal, there is a real risk of a break-up of the euro zone. This is fascinating stuff as devalued currencies would have repercussions beyond merely affecting bondholders through currency loss. Companies with a heavy revenue stream in Germany and other core countries would see their value rise in line with their earnings. One of the many reasons behind the resurgence of Spanish football teams in Europe is that thanks to the euro, their purchasing power is strengthened vis-à-vis the past. If a nation such as Greece were to leave the euro zone, it is conceivable that the new drachma would take a devaluation of 50-70%.

In one fell swoop, the achievement of a lifetime of EU membership would be gone. Imagine the blow to the European idea if it turned out that Malaysia was about to overtake Greece economically, that Koreans were richer than Spaniards or Italians? The EU would have to deal with a fundamental legitimacy crisis once it was confronted with these developments. It would be a laughingstock amongst technocrats worldwide. Decades of EU funds, an ever-larger bureaucracy, and yet European countries are being left behind economically. The battle to save the euro is being fought fiercely, not only because European banks stand to lose a lot of money but also because the EU has a vested stake in the survival of all euro zone member states.

For the investor this means that whatever can be done will be done to gloss over structural problems of the euro; if it weren’t for German foot-dragging, eurobonds would be in place already. The EU will not give up on the euro lightly. But if there are signs that a break-up is likely to happen soon, and you own stock in companies whose main revenue streams come from periphery countries, sell as soon you can, for their income will be heavily impaired.

Source: EUR and CHF: where core EUR might have been, page 9.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.