Tags: Dollar | Rise | Europe | Walks | Financial | High-Wire

Dollar Holds Its Breath as Europe Walks High-Wire

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Tuesday, 30 Nov 2010 10:32 AM Current | Bio | Archive

Don’t be surprised that the European Union sovereign solvency crisis might get quite a bit worse before it gets better (and it probably will).

Everything in the near future will be about how Germany (which represents one-third of the eurozone GDP) is going to continue to support the other weak eurozone members and at what price the German government will be able to sell the EU bailout costs to the German electorate as there remains less than two years to go before there are new national elections in Germany.

In the aftermath of the Irish bailout, the German proposal for a future sovereign and/or senior bank-debt restructuring mechanism within the eurozone makes complete political sense to the electorate in “stronger” eurozone countries.

We know the Germans don’t want to write blank checks to weaker countries and to out-of-control financial institutions going forward. Creditors to countries that run into trouble may face losses.

In this context, I can’t agree with both France Finance Minister Christine Lagarde and the German Finance Wolfgang Scheuble, who accused yesterday “sheep-like” financial markets of acting “irrationally” in pricing down eurozone debt.

Maybe they must have been deeply perplexed by developments since Sunday’s established bailout of Ireland as we see further sharp widening of the Portuguese (and more importantly of the Spanish and even the Italian and Belgian spreads) over the German Bunds.

The EU politicians’ “Maginot Line Illusion” is apparently circumvented by the markets and the situation is looking more like wishful thinking than anything else. After WWI, the French established the “Maginot Line” fortification to provide time for their army to mobilize in the event of a German attack and/or to entice Germany to attack neutral Belgium to avoid a direct assault on their own defense “line.”

The success of static, defensive combat in World War I was a key influence on French thinking. And yes, the fortification system successfully dissuaded a direct German attack.

However, it was strategically ineffective, as the Germans did indeed invade Belgium, flanked the “Maginot Line,” and allowed the German invasion of France.

When I think at all these historical events and at the extremely costly “Maginot Line,” today’s EU/IMF and others bailout (defense) actions now seem no more than a “Maginot Line”-like illusion that will probably be ignored by the markets. How far the weaker eurozone sovereign bonds values could tumble and their yields rise remains an open question.

Nevertheless, it is now clear that the markets are well aware of the tightrope that “peripheral” (and some other) eurozone governments are walking.

Yesterday, Olli Rehn, the EU Economic Commissioner himself recognized that degree of difficulty they face when he stated that Italy might need further measures to comply with its targets and acknowledged the difficulties that Greece faces given that its economy isn’t expected to grow until 2012.

Indeed, things worsened after the latest EU Commission forecasts were released wherein the EU Commission predicts that Spanish GDP will contract by 0.2 percent this year and only grow 0.7 percent in 2011 with a broadly similar picture painted for Ireland.

Clearly there is little room for error. Ireland is expected to be facing a deficit totaling 10.3 percent in 2011-2012 and the draconian measures designed to bring it down from this year’s 32 percent undoubtedly will put that total — and next year’s Irish GDP growth — at risk of being “significantly” undershot.

Perhaps most worrying of all because of the domino effect it could cause is that whilst Greece is expected to have a deficit of 7.4 percent in 2011 this is expected to rise back to 7.6 percent in 2012. No doubts at all, the EU scary statistics are set to haunt the eurozone debt market for quite some time and probable more than most of us can imagine.

Meanwhile, the single currency’s downtrend now can easily move back to the summer lows around $1.2580 and beyond. German exporters, who have thrived when the euro was at $1.40, will undoubtedly be rubbing their hands.

More seriously, we could — I repeat could — be on our way to the new “Neue Deutsche Mark” (New German Mark), or NDM, that would include Germany, the Netherlands, Austria, Finland, Luxembourg and a few other smaller countries. Italy shouldn’t be taken into account for the NDM as Northern Italy would remain part of Italy and two currency zones within the same country probably doesn’t make sense.

Unfortunately, that same situation applies to Catalonia in Spain. Yes, there could be interesting times in the making in Euroland.

All this, of course if it happens, would be supportive for the dollar.

No, the dollar isn’t out, at least not for now.

If the evidence of an improving U.S. economy continues to combine with an uncertain European Monetary Union, then it is tough to see anything other than a weaker euro and a stronger dollar.

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HansParisis
Don t be surprised that the European Union sovereign solvency crisis might get quite a bit worse before it gets better (and it probably will). Everything in the near future will be about how Germany (which represents one-third of the eurozone GDP) is going to continue to...
Dollar,Rise,Europe,Walks,Financial,High-Wire
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2010-32-30
Tuesday, 30 Nov 2010 10:32 AM
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