Nasty Experiment called EURO

Sorry if it is offending to anyone to call Euro nasty. But that is true. Because of Euro, many fund / portfolio managers and investors get sleepless nights. Who knows? Someone may even be getting heart attacks.

Second time this year (2010) the world's markets are rattled by Euro problems. Consequently, the values of stock and portfolios plunge, causing numerous issues of margin calls, leverage problems and crystallisation of derivatives. No wonder several portfolio managers and bankers watchover Euro with little bit of fear. A loss of confidence in Euro impacts liquidity and all risk assets. No one can rule out European (British banks are not immune) banks facing pressure.

First, it was Greece, who almost defaulted in April/May 2010. Greece is a very small player in the global economic scenario and its crisis would not have been of any major global impact. (Zimbabawe was in economic crisis, but hardly anyone noticed!!) Why did Greece issue become so magnified? Because of Euro. Media, investors, governments, bankers and across the world feared collapse of Euro. If it is the problem of Euro, it impacts entire Eurozone. And Eurozone economy is globally siginificant.

Second instance is now - Ireland in Nov 2010. Again Irish problems impact Euro and the global investors are worried. On a stand alone basis, Ireland is a very small player. But its problems are magnified through Euro. Markets get 'concerned' about these small Euro countries and fear the possibility of contagion and their impact on Euro and global markets.

Global investors, please brace up for more Eurozone problems. Your portfolio of stocks and commodities are at their mercy. Portugal, Spain and probably Poland are waiting in line to repeat the actions of Ireland or Greece.

Economic crisis due to heavy external debt sometimes happens and the best way to overcome is to depreciate its currency to encourage exports and earn enough foreign currency. For example, this was adopted by India in early 1990s and Brazil in 1980s. Had Greece had an independent currency, it could have devalued its currency. (Euro is not controlled by Greece but by Brussels, mostly influenced by Germany and France) This would have resulted in more export earnings through massive boom in tourism and exports through goods and services. In turn, this would have created more employment in the country.

Of the two choices, Greece was forced to have the German medicine of austerity instead of devaluation. Austerity also includes retrenchment, which means more unemployment. Latest press reports indicate that Greece is falling behind on its austerity promises and hence there is all likelihood that Greece problems may return in the future with vengenance. Bad news for global stock and finance markets.

As long as Euro exists, be ready for more problems ....

Let us hope for the best; but prepare for the worst.

Post QE2 Developments

As expected, after the announcement of the Fed’s new $600 billion bond purchase plan to boost the U.S. economy, the stocks and commodities were driven higher while Euro appreciated further partly reflecting European Central Bank decision to keep the interest rate unchanged. In fact the global stock indexes touched two-year highs while crude oil almost kissed $90/- per barrel and gold zoomed to record highs. Overall, the investors rejoiced the extra liquidity in the system.

And the dollar touched its 11 month low. Wow! that was too much, for China, who views the depreciation of dollar as indirect yuan appreciation. China came out with the most severe criticism and its 'government sponsored' rating agency downgraded US rating. That is China's way of thanking US companies who exported most of the manufacturing jobs to China, making millions of Americans unemployed.

But within a week's time, the dollar began to strengthen while commodities stagnated or dropped. Why? The major reasons are:

1. The market might have over adjusted to the anticipated announcement and now correcting itself.
2. One of the trader’s rules "Buy on rumour and sell on news" may be playing out.
3. Dollar is not only the currency of the US, but also the reserve currency of the world.
4. Many emerging economies have conducted studies and taking steps to control the dollar flow into their economies.
5. Unwinding of a portion of the USD based carry trade after the stock markets touched recent two year high.

However, in the long run, as more and more tranche of USD 600 bn hit the market, the possibility of depreciation of USD cannot be ruled out. One of the studies has indicated that over the next one year dollar can lose as much as 20% of its value.

But as economists say, this will happen ‘only if other things remain the same’. In this current volatile environment, we have to wait the reactions of other nations, who may view this as a step to weaken dollar. Moreover, the bad experiment called Euro is at the mercy of several fringe nations of the European Union. Any crisis for Euro will cause flight to safety causing USD to appreciate.