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 And that’s before we consider the poor economic fundamentals, not to
mention the single currency’s new unpopularity with other central
banks seeking a safe place to store their reserves.
The euro fell to near nine-year lows on Monday, hurt by fears that a
push for vastly easier debt terms by a new Greek government,
expected after Jan. 25 elections, would lead not to agreement, but
to Germany opening the door to a euro exit.
A report in German media that leaders in Berlin see a euro exit by
Greece as “manageable” may qualify more as a negotiating tactic than
an analysis, especially given that no template for such a move
exits. Either way, that we find ourselves here can be nothing other
than negative for the euro, which would likely be in a cyclical
decline even if its structural future were not in doubt.
The immediate consequences for the euro from a fracture in its
line-up would probably be very negative, and certainly extremely
volatile.
By the time we learn what kind of government Greece has elected, we
will likely see important changes to monetary policy, with the ECB
widely expected to make a significant announcement involving
sovereign bond buying at its Jan. 22 monetary policy meeting. This
may be one of those rare events in which all news is bad news for
the single currency: if the ECB exceeds expectations with a large or
forceful funding program, the euro will fall almost as a matter of
policy; if the ECB disappoints, the euro will fall anyway.
The idea of buying up government bonds is more popular in Germany
than wholesale Greek debt forgiveness, but only just.
That German Finance Minister Wolfgang Schaeuble voiced concerns
about QE and lauded uber-skeptic Bundesbank President Jens
Weidmann's arguments against such moves recently implies that bond
buying is far from assured. It will be hard to deliver meaningful QE
while not appearing to stray into direct financing of euro zone
members, or at least the mutualization of risk.
“Any ECB decision to go ahead with QE, without substantial
modification, would now entail severe loss of face for the German
government, which might be obliged to abandon the condition which
has so far governed its participation in the single currency
arrangements,” Stephen Lewis, economist at ADM Investor Services in
London, wrote in a note to clients.
FACTS, THOSE PESKY THINGS
While few can agree about what the ECB should do or how Greek issues
should be handled, facts, of which there are many on the ground, are
not in dispute and not terribly encouraging.
Take deflation, the risk of which was illustrated by German
inflation falling to just 0.1 percent annually in December, from 0.5
percent in November. Data on Wednesday may show the first negative
such reading; that is, deflation.
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Remember, the price of energy continues to decline, and its impact
on inflation in the euro zone has yet to be fully felt. And while a
cheaper euro is stimulative - this is partly the point of bond
buying - business and consumer confidence is not helped by the way
in which the riven politics show up euro zone structural inadequacy.
Then there is interesting new data showing that global central banks
are no longer adding their support to the euro, something they have
generally done since its inception.
While central banks will usually buy a reserve currency as it falls
in order to keep their portfolios at the desired mix, that is not
happening with the euro. The euro’s share of global reserves fell to
22.6 percent in the third quarter, according to new IMF data, down
from 24.1 percent in the previous quarter, a decline of 122.9
billion euros.
“The euro has also become rather undesirable for central banks to
hold,” Stephen Jen of hedge fund SLJ Macro Partners wrote to
clients. “Nobody likes to hold a currency with a negative yield, and
with the central bank managing the currency explicitly wanting the
value of the currency to go down. “
Perhaps central banks are seeing the parallels between the euro and
Japanese yen, which though it represents the third- largest economy
in the world, accounts for only 4 percent of central bank reserves.
Both economies face not only deflation, but seemingly intractable
problems with making and implementing policy.
At some point, something will happen to arrest the fall of the euro.
But not, probably, in the next month.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be an
owner indirectly as an investor in a fund. You can email him at
jamessaft@jamessaft.com and find more columns at http://blogs.reuters.com/james-saft)
(Editing by Dan Grebler)
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