Would A New Deutsche Mark Reach U.S. Dollar Parity?

Includes: FXE
by: Richard Bloch

According to Forbes, a report by Nomura suggests that a breakup of the Eurozone would mean a whole new set of floating currencies, most of which would depreciate against the old Euro. The lone exception? A new Deutsche Mark, which would likely appreciate slightly.

In a report released Monday, Nomura’s fixed income research team analyzes the potential depreciation of new Eurozone currencies in the case of a break-up and sees the Greek drachma falling almost 60% over 5 years; the group of PIIGS plus Belgium would suffer a 25% to 35% depreciation, while Germany’s hypothetical new mark would gain marginally.

I thought I’d take a look at the history of a couple of these old currencies, the Deutsche Mark and Italian Lira. Here’s a chart showing the U.S. dollar exchange rate against the Deutsche Mark. The blue line shows the DM as it traded when it was on its own, so to speak. The purple line shows the theoretical exchange rate based on the performance of the euro since the conversion back in 1999.

It’s hard to imagine a Deutsche Mark at parity to the U.S. dollar, but it could happen. The currency was certainly gaining strength against the dollar prior to the introduction of the Euro. And while it may not be a fair comparison, it was hard to imagine the Swiss Franc reaching parity to the U.S. Dollar –until it did.

The Italian Lira, on the other hand, was growing weaker prior to 1999. Italy’s participation in the Euro may have masked further weakness, which could easily continue in a eurozone breakup.

Disassembling the Euro: “Messy at best”

Is a Euro breakup likely? According the Wall Street Journal, some central banks are “weighing contingency plans”.

Before the formal launch of the euro in January 2002, an army of planners spent years choreographing the logistics of the currency's debut, including the minting of billions of bank notes and coins and the distribution of the new currency to banks and businesses across the Continent.

Disassembling the bloc would be messy at best. Among the many challenges, loans and deposits currently denominated in euros would have to be switched to new currencies. And individual countries would need to decide whether to dust off their old currencies and, if so, how to quickly produce large quantities of paper money.

The last time a major currency fell apart, it was 1971, and it was the U.S. dollar. That was when President Richard Nixon “closed the gold window.” The dollar, once fixed to gold with relatively fixed pegs to other currencies, was allowed to “float.” That was pretty messy. This could be a lot worse.

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