The Euro Under Attack

Avi Tiomkin has a provocative article in the latest Forbes on "the demise of the euro". His thesis is not only that the euro will fall against the dollar, but that the entire currency will fall apart, and that Europe will go back to francs and lire and marks.

There’s no doubt that tensions are running high in euroland.

What will undo the euro: the mounting tension between the inflation-obsessed German bloc (including Austria, Luxembourg and the Netherlands) and the Latin bloc of France, Italy and Spain…

Spain’s worsening real estate slump dramatically illustrates the problem faced by the Latin bloc. For years Spanish home building and buying outstripped that of Germany, Italy and France combined. Now that the boom has turned to bust, the Spanish central bank cannot lower interest rates. Nor can the treasury devalue the currency. Bound to the euro, Spain can only complain to the ECB, while watching its economy circle the drain.

European heads of state and the European business press are making their discontent public in stark language. "We cannot continue to cope with the autism of some bankers who do not understand that the priority is not fighting inflation, which is nonexistent, but fighting for more growth," declared French President Nicolas Sarkozy last year. In October, in response to German Finance Minister Peer Steinbrueck’s comment that he "loves a strong euro," leading Italian business newspaper Il Sole ran a headline labeling the remark "a declaration of war." "Italy has lost the ability to grow," the Italian finance minister, himself one of the founding members of the ECB, admitted recently.

I think that Tiomkin overstates his case, however. I don’t know when exactly Sarkozy made his "autism" remark, but I suspect it was while he was campaigning for the presidency rather than after he had won it. And there are many reasons why Italy isn’t growing; frankly the strong euro is far from being the greatest of that country’s problems. Tiomkin also fails to recognise that exiting the euro would be economically and financially disastrous for Italy, which would probably be forced to default on its debt at the same time.

It’s weird too that Tiomkin advises investors to short the euro, since the departure of a Latin state or two from the eurozone would only serve to reinforce the ECB’s ability to fight inflation and maintain a strong currency. Tiomkin seems to think there’s a zero probability that Italy or Spain could leave the euro without the whole currency being abandoned and Germany going back to the Deutschmark. But that’s far from obvious.

Still, the base case is for no exits from the euro, and a continued hawkish stance from the ECB. The central bank might be unpopular, but that doesn’t mean it’s going to be abolished. After all, it’s worth remembering that the ridiculously high interest rate everyone’s complaining about is actually set at just 4%: what’s considered high in Germany would be considered low in Italy. So really there’s no sense in Italy leaving the euro.

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