Greenspan's Top Tick

“It is absolutely conceivable that the Euro will replace the dollar as the reserve currency, or will be traded as an equally important reserve currency.”

-Alan Greenspan, Late 2007

As tremors of sovereign default concerns continue in Europe, it is worthwhile looking at the history of the Euro and the Eurozone to put this current crisis in context.  For starters, the Euro and Eurozone are far from established and historic institutions. 

The origin of the Euro can be traced back to the 1992 Maastricht Treaty, which obliged most European Union member states to adopt the Euro upon meeting specific budget and monetary requirements.  These requirements included: budget deficits of less than 3% of GDP, debt to GDP ratios of less than 60%, low inflation, and interest rates close to the EU average.

Technically, the Euro was introduced in non-physical form on January 1st, 1999, just over eleven years ago, and began to be used as legal tender on January 1, 2002.  Currently, roughly 330 million Europeans use the currency on a daily basis and almost 175 million people globally (primarily in Africa) use currencies that are pegged to the Euro.  The Euro is the sole currency of 16 EU Member States: Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Irelenad, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain.

While it has a short history, the Euro has established scale.  In fact, there are currently $790 billion Euros in circulation.  According to estimates, the Euro has become the second largest reserve currency in the world.  Currently its share of total global reserve currency is 27% versus 64% for the U.S. dollar and 3% for the Yen. 

Not surprisingly, the Former Fed Chairman basically top ticked (Greenspan’s Top Tick) the Euro with his aforementioned statement in 2007. Since then, the Euro’s share of global reserves has flat lined and it’s price has declined.  We’ve highlighted this in terms of the price of the Euro in the chart below.

After serving the United States as Chairman of the Federal Reserve for nineteen years, Chairman Greenspan admitted in a congressional hearing in 2008 that he had “a flaw” in the model with which he analyzes markets.  Thus, we are pretty comfortable taking the other side of his market calls.

We have one of the top young European Strategists in the business in Matt Hedrick and he has written widely about the issues facing the Eurozone.  On March 26th , he wrote a note titled Politics versus Pragmatism, which highlighted the following:

“To return to Barroso’s quote above, Eurozone skeptics exists. And one could argue that the decision by Eurozone leaders to support Greece in a coordinated fashion—rather than a unilateral IMF-led loan—is born out of the desire of the European community to further substantiate the existence of the Eurozone as an entity. While Barroso as President of the European Commission will put his best foot forward in confirming that the Eurozone has a sound governing body, the fact remains that the Eurozone is young, only 10-years old, and still working through honing policy to benefit the whole.

Clearly, finding consensus on policy from country members with vast histories, and divergent economies and cultures, will remain a challenge. Countries will differ on stance; having a unified currency will put additional challenges (handcuffs) on exercising monetary and fiscal policy measures with such issues like debt restructuring and default.

Equally, imbalances in terms of economic weight and political influence will continue to weigh on decision making. These points were put on center stage with German Chancellor Angela Merkel’s full support of a unilateral IMF-led bailout for Greece. The fiscally conservative Chancellor wasn’t questioning the validity of the Eurozone, but suggesting that Greece continue to work to clean up its own “house” (budget deficit) before monies were placed on the table so as to not reducing Greece’s incentive to issue austerity measures to shave its imbalances.”

Herein is the dilemma with a regional currency such as the Euro.  In times of crises, will nations choose to support weaker member nations with fiscal issues? In a world of realism, this support will occur to a point.  The reality is, Germany on some levels would be much stronger without its weaker Eurozone counterparts.  And, in fact, has been reluctant to dedicate its or the European Union’s resources to support Greece.

Moreover, on a longer term basis, is it at all sustainable to have the same currency for rich and technology-driven nations like Germany and more agrarian nations like Portugal and Spain.  The very nature of these economies is inherently at conflict.  Poor and agrarian nations need weak currencies because price is their competitive advantage.  Conversely, nations like Germany would prefer higher interest rates and strong currencies to attract investment.

We would be naïve to believe that any nation state, whether a member of the Eurozone or not, will not ultimately act in its own self interest.  As Sun Tzu famously wrote in the Art of War:

“The good fighters of old first put themselves beyond the possibility of defeat, and then waited for an opportunity of defeating the enemy.”

As we enter into the second quarter of 2010, it is clear that winners and losers will emerge out of the current crisis in Europe.  Those countries and companies that are positioned “beyond defeat” will ultimately prevail.  And, in contrast to the fine Chairman Greenspan’s quote, the ultimately loser could be the Euro itself.

Keep your head up and stick on the ice,

Daryl G. Jones

Managing Director

Greenspan's Top Tick - Greenspans Top Tick