Is The Euro Currency Experiment Over?

David Frost // Blog


September 29  

One of the looming questions being asked is “what happens when Greece defaults.”  Some believe that European policy makers will continue the bail out charade of Greece, but it not longer is a matter of if and when, but how, and maybe more important – What will it look like?

Let’s take a gander at what may seem like a crazy and unbelievable idea, but maybe not out of the question –

First, the obvious occurs, Greece defaults.  Ouch!  Those that want to minimize the potential damage of a Greek default are most likely underestimating the potential long term effects and structural changes to the European economy.  Don’t forget, this is certainly at least one degree larger than Lehman Bros.  That was a company, this is a country.

The next order of business is for each country to make an attempt at protecting their respective banking system.  However, the only Euro zone country that may be able to build a moat around themselves is Germany.  They have the money, the economy and the political prowess to put their blinders on and save themselves rather than to go down with the entire European shipwreck.

As Germany decides to protect their banks through legislation or temporary nationalization, the Euro currency begins to fall, and fall precipitously against several other currencies, namely the US Dollar.  Then comes the bombshell.  Germany announces they are reinstating the Deutschmark and leaving the Euro currency.  The likely scenario is that Euro would fall even farther, pushing the US Dollar back toward par.

The media and politicians all around Europe and the US begin to speculate on the far reaching impact this can cause on the global financial system.  The legal proceedings that follow can and most likely will last for years to come.   Germany will maintain that leaving the Euro will not have a negative effect on other countries and the currency will survive and thrive.  (Of course, they will be fibbing)

The main focus is misplaced.  Each and every day the market participants are focused on an imminent Greek default, but the real underlying risk is Germany leaving the Euro currency and directly causing a collapse of the Euro forcing it back toward par or 100 against the US Dollar.  This is a direct devaluation of the rest of Europe.

Germany may realize that further bail outs for Greece, while certainly possible, would set a precedent of other countries to come with hat in hand for more of the same.  They must begin to protect their homeland from the financial ruin and contagion this is persistently spreading throughout the Eurozone.  From a political and financial standpoint, they are not capable of supporting Greece, Italy, Portugal, Spain and others who are already leaning over the cliff of financial insolvency.

Here is an example of some of the discussions that have begun (more like arguments)


Restore the Deutschmark – Trichet in angry tirade over Idea

EUROPEAN Central Bank president Jean-Claude Trichet yesterday launched a blistering attack on German proponents of a return to the deutschmark, insisting that the ECB had delivered “impeccably” on its mandate.

The comments came as Sigmar Gabriel, leader of Germany’s opposition Social Democratic Party, lashed out at the ECB’s purchases of bonds from troubled economies.

Asked to respond, Mr Trichet launched into a six-minute tirade.

“I would very much like to hear the congratulations for an institution that has delivered price stability in Germany for almost 13 years,” he thundered, adding that the inflation control the ECB had achieved was “better than what has been obtained in this country over the last 50 years”.

The ECB, he continued, had succeeded in its mandate despite “the worst crisis since World War Two” because “we decided very frequently not to do things that were recommended by various governments” — referencing French and German calls to cut rates in 2004.

“In 2004 and 2005, some important governments in Europe were asking for the weakening of the stability and growth pacts,” he said, asking: “Do you remember which governments? France, Germany and Italy.”

Any decision Germany makes will be in the interest of Germany and thus from this point forward, cannot be good for the rest of the Eurozone.


OK, now what?  What would the immediate aftermath look like?

Through mainly imagination and common sense, we may first see another credit crisis, but this time of much larger proportion.  Most of the countries in Europe would experience an immediate widening of their credit spreads, downward pressure on bond prices, and a market induced increase in interest rates, putting the perception of further economic deterioration in the forefront, and as we know, perception becomes reality.

Greece will have defaulted, and Germany will have moved to secure their own banking system leaving everyone else to fend for themselves.  Now the spotlight will be on the UK and France.

From a market calming perspective, they of course will state that a rescue package is underway.  Everyone will question whether or not they have enough liquidity to do so.

Next scene shows the US Federal Reserve.  You can forget about a formal announcement of QE3, the market will do it for them and force their hand into providing unlimited liquidity.  The question will become, where is the money coming from? Our politicians, media and citizens at home will be enraged that we must fuel the world financial system with our tax dollars.  (even if we borrow the money, our income tax will pay the interest)

There will most likely be bank failures and other insolvency issues to contend with.  As for the ultimate outcome and blueprint, we’ll have to wait and see.  Get your popcorn and candy ready because there will be many a Sunday night announcements before the Asian markets open.  We’ve read this book before, only one or two degrees larger and more intense.

About the Author

Trading and investing in markets is second nature to some, but a mystery to others. The goal is to provide a forum where everyday people aspiring to be part time or full time traders will learn how view markets differently and profit beyond their wildest dreams.

David Frost