Saturday, February 6, 2010

Testing the Euro

It may be time for a little summary of how I see the fundamentals situation right now.

This past week has been a rich one in event on the EUR/USD front, we first saw the EUR rebounding from 1.385 to over 1.403, then back down to 1.365, all these moves being fed by news from the ECB supporting Greece, and worrying about Portugal, Italy and Spain.
The rebound has been discounted as a speculative action to the news of the ECB support to Greece, and the bubble has deflated as fast as it did inflate.
There was no real surprise in that, but the drop signals something bigger at play. This is the first big test ever for the Euro, and the fundamental question is: Will the ECB be able to impose a strict budget and economic policy to its member nations?

The way this question is answered will be important in the sense of establishing the status of the EUR as a serious reserve currency. As of now, this status is far from obtained yet, indeed, why didn't the EUR replace the USD as a safe haven currency?
Clearly, the social and political situation of Europe is relatively stable, the EUR currency is supported by the largest economy in the world, but the basic problem of the EUR is about sovereignty, political authority. If a single country had gathered the objective parameters that are behind the EUR, its currency would be the safe haven currency of the world. However, in the EU, there is not one single political voice, there is actually no clear warranty that all member countries will maintain their participation to the European framework if things turn bad. This ambiguity about the EUR is what, in my view, explains that it is, so far, not even considered as a potential reserve currency.
If something goes wrong with the USD, the US government is able to act upon it in a sovereign way, it can raise taxes or lower them as it deems fit. Nothing, within USA will oppose these decisions if they are clearly motivated by the defense of national interest, and the USD is doubtlessly considered as such.

The current crisis, in Greece, Portugal, Italy and especially Spain, will be the test for that. If it fails, if one of these countries strays away from abiding by the ECB recommendations, and somehow displays a lack of responsibility towards the other EU members, the EUR may not survive in its current form. On the other hand, if it succeeds, the EUR will have made a great leap towards being considered a reserve currency.

Meanwhile and according to the news about the troubled european countries and their interpretation, the EUR/USD pair should display high volatility with a medium-term down-trend, where I see the EUR retesting the low 20s.


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