Thursday, November 17, 2011

Do I think the Euro will still be around in 5 years?

by Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

The short answer is yes.  And this is due to self-interest, particularly for Germany.  The Euro has certainly been a weaker currency for Germany than a stand-alone Deutschemark would have been.  At the same time it has been a stronger currency for many other Eurozone countries than stand-alone currencies would have been.  This might have been expected to force the latter countries to become more productive and remove some compulsion for Germany to become so.  In fact, Germany has improved productivity substantially over the life of the Euro and produced very strong export performance helped by a weaker Euro.  At the same time, other countries, notably Italy have not restructured, or notably improved productivity, and fallen behind.  However, their borrowing costs, until recently, have been low.  Germany has in effect been benefiting from a weak currency policy (like China has) relative to its economic strength, under cover of the common currency. 

 

If weak Eurozone countries left the Euro, their currencies would likely plunge dramatically making it even more difficult to repay debts that would still be denominated in Euros.  This would apply not only to sovereign debt, but also to corporate debt.  Large bankruptcies and default s would follow resulting in massive losses for German banks that are hugely exposed to these countries.  As import costs for these weak countries would soar, German companies would also lose significant export markets.  Also German goods internationally would be more expensive with a stronger Deutschemark

 

Conversely, if Germany left the Euro, a new Deutschemark, would soar compared to the new weaker Euro and other currencies hitting German exports globally.  German banks would incur large losses as their Euro exposures lost value against the Mark.

 

In short, there is certainly going to be large cost for Germany arising out of all this one way or the other.  They have benefitted from the Euro for over 10 years and now will have been shown to have squandered part of the surplus generated by providing liquidity to unreformed weak economies.  Ensuring survival of the Euro is probably the least bad course, which is why I think the Euro will still be around in something like its present form in 5 years.

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