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Generational Dynamics Web Log for 15-Aug-04
Will the Euro currency collapse?

Web Log - August, 2004

Will the Euro currency collapse?

International investment firm Morgan Stanley is warning that it's a real possibility, which shouldn't be surprising in view of the weakness of the European economy (see next item).

Euro currency

Euro currency

The Morgan Stanley report (PDF) originally came out in January, but the company publicized it this week in a highly visible full page ad in the Wall Street Journal. When a company is willing to pay tens of thousands of dollars to publicize such a controversial finding, it captures one's attention.

Here is a summary of the the report's reasoning:

Many of the small countries (plus Spain) that have pursued a more virtuous budgetary policy in the past several years are seriously angered by the slippage in budget deficits in large countries such as Germany and France. This is because rising budget deficits in the large countries, due to their sheer size, are seen as raising the borrowing costs for all governments within EMU, irrespective of the consolidation efforts that the smaller countries have made.

The new EU Constitution is unlikely to be agreed upon in 2004, and therefore unlikely to be agreed upon at all.

Bond yields are liable to differ significantly between the "more and less [fiscally] virtuous countries." In fact, thanks to the provisions of the Maastricht treaty that formed the EU, "the credit quality of a fiscally profligate country could deteriorate quite significantly." Thus, instead of converging to a single market, the EU may diverge further into separate markets for bonds and even for equities.

There is nothing really to prevent a country from seceding from the EU and issuing its own currency again, in order to depreciate it. There would be costs, since existing contracts would have to be honored in more expensive Euros, but devaluation might save more money in the long run.

On the other hand, if political pressures force the ECB (European Central Bank) to weaken the Euro currency, then a country could secede and issue its own less deflationary currency. In this case, it would save money on existing cross-border contracts, since they would have to be honored in cheaper Euros.

Individual central banks are still fully operational, making secession relatively easy for any country that wants to do it. Ironically, even the Euro coins and notes are still issued on a country by country basis, and can easily be distinguished by country of origin, so a country could use its local Euros as a national currency until the new national currency is available.

Based on this analysis, the Morgan Stanley report forecasts that the euro will weaken considerably in the next 6-12 months, and long-term investors "should allow for the possibility of the euro falling apart" at some time in the future.

From the point of view of Generational Dynamics, a serious split in the European Union is very likely. There have been numerous wars between France, Germany and England for a millennium, and Generational Dynamics predicts that we have not seen the last of them. A splitup of the euro zone is something that we should be expecting. (15-Aug-04) Permanent Link
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Generational Dynamics Web Log for 15-Aug-04 Will the Euro currency collapse?

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Generational Dynamics Web Log for 15-Aug-04
Will the Euro currency collapse?