A Reader Asks: Why is the Euro So Strong?

Mish

A reader from Brussels has questions regarding the strength of the Euro.

Reader Question

Why is the Euro currency so strong? It is not that everything is hunky dory here, because it definitely isn't. But this counterfeit currency was created with the one and only purpose: to benefit export driven Germany.

The euro is flawed. It's a currency too weak for Germany and too strong for the other countries allowing them to 'happily' buy German products.

Fatally Flawed

The Euro is indeed fatally flawed.  But what about the US dollar?

I am asked far more frequently "What's holding the US dollar up?"

Hated Dollar

The “dollar is so extremely oversold, over-hated, and over-shorted that it all but has to rally for a while at some point soon.”

Dollar Weakness is Structural 

Regarding the dollar, the Fed is set to print, and print, and print. If you prefer, it's QE until the cows come home. 

Right now those cows are somewhere over the moon. 

The US dollar index surged above 100 in belief the Fed was on a tightening cycle. 

Then it wasn't and now short-term treasury yields are back close to zero.

But at least they are above zero. 

Note that the yield on the 10-year treasury is +1.1%.

The yield on the 10-year German bond is -0.53%. Yes, that is a negative sign. 

And note there are no Euro bonds to speak of. It's every county for itself. that's part of the fatal flaws of the Euro.

Target2 Imbalances

Target2 Imbalances 20210-01

Chart from the ECB Statistical Warehouse.

What is Target2?

Target2 represents creditors and debtors in the EMU Eurozone Monetary Union.

It represents goods purchased by debtors in Spain, Italy, Portugal, and Greece owed to creditors in Germany, Luxembourg, etc. 

It is also a measure of capital flight. 

Some, me included, believe the -330.7 ECB number hides loans to Italy and Spain. 

Regardless of what the ECB is doing, it's an imbalance of some sort.

Do you really believe these debts will be paid back? I don't. 

And if Italy left the Eurozone as it once threatened, the whole mess cascades. Spain and even Greece would be responsible to make good on the default.

Mutualized Debt

Target2 is one of the biggest fundamental flaws in the Eurozone. The Euro founders were well aware of it. But it was the only way to get Germany to go along. 

The Maastricht Treaty that created the Euro excluded mutualized debt at Germany's instance. There are no Eurobonds. 

The debt of each county is supposed to be equally good. But the Euro crisis proved the debt of EMU countries is not equally solvent. If it were, German bonds, Greek bonds, and Portuguese bonds would all trade at the same interest rate.

Don't Be So Centric

Whenever I get asked "What's holding the dollar up?" I tend to reply don't be so US centric.

My response to "What's holding the Euro up?" is don't be so Euro centric.

ECB and Fed Balance Sheets 

ECB and Fed Balaqnce Sheets

The above Balance Sheet Chart is from Brookings.

The ECB is papering over Target2 imbalances, interest rate imbalances, etc., and is killing banks with negative interest rates, perhaps on purpose.

The Fed is more open in its mischief.

Structural Weakness vs Fatal Flaws

The dollar weakness is "structural" but the euro was "fatally flawed by design" as an appeasement to Germany.

Those are the competing forces. 

Meanwhile, we have an ECB out of control with negative interest rates and QE vs a Fed out of control with QE while pledging to ignore inflation and stock market bubbles.

Sentiment

Whether the dollar or euro is rising or falling is determined by sentiment at the moment.

Right now, the market is focused on US structural weaknesses including trillion dollar deficits and a Biden election.

At times, the market is more worried about Target2 imbalances, fatal flaws of the Euro, negative interest rates, or a eurozone breakup.

Take your pick. 

Tell me what the more important concern will be a year from now and I will tell you which one will be sinking faster. 

Currencies Don't Float

Meanwhile, please note that fiat currencies don't float. They sink at varying rates. Right now the dollar is sinking faster. 

Got Gold?

Mish

Comments (61)
No. 1-24
numike
numike

People who broke into the Capitol Wednesday are now learning they are on No-Fly lists pending the full investigation. They are not happy about this.

njbr
njbr

Isn't part of the issue that economically weaker countries periferal to the EU (Turkey lira, eg with an inflation of 11%) are buying into the EU currency at a high rate?

Realist
Realist

Got gold? Yep. 4% of my portfolio.

I have a tiny bit of bitcoin left over from a year ago (sold most of it). But I am going to make it a 1% allocation this year.

I dont want to go over 5% in non-productive assets.

Though I am up to 10% cash as well. Waiting for opportunities.

Currencies have been declining in value throughout my entire lifetime. Occasionally I hedge against some currencies, but mostly, I just diversify my investments geographically through out the world.

I will leave it to Mish to explain currency variations.

Doug78
Doug78

The Euro is highly flawed but for a country to leave it is just about operationally impossible but stranger things have happened so I can't rule it out. The MMT experiment is in its beginnings. I would say that the currency that prints less should get stronger.

Webej
Webej

According to the theory of floating currencies, trade deficits should eventually lead a currency being worth less, whereas export surpluses should strengthen the currency. The dynamic US economy has huge trade deficits, whereas the sclerotic European economies have huge export surpluses.

amigator
amigator

Good Stuff Mish Thank you!

Would this be a conspiracy?
"Some, me included, believe the -330.7 ECB number hides loans to Italy and Spain"

LOL. No need to respond.

Not sure but a lot of people in this world still want to come to the good old USA. I guess they see it as a land of opportunity and really still a pretty safe place to live even after the "attack" on the Capitol. I thought the retreat of the forces was pretty calm and and have not heard much comments on the orderly exit.

God Bless America!

Lance Manly
Lance Manly

The real question is what holds the yen up? Talk about printing money.

AnotherJoe
AnotherJoe

"Right now, the market is focused on US structural weaknesses including trillion dollar deficits and a Biden election."

Euro has been climbing since April. How is this Biden's fault?

Also, if things get ugly in Europe, they will create the Euro bonds in short order and become more like the US. Most Euro haters fail to see that a European "USA" is the end game. Yes the EU moves at a glacial pace, however, they move in that direction every time there is a crises.

LawrenceBird
LawrenceBird

Disclaimer: In a galaxy far, far away in a time long forgotten, I was a market maker in FX at various money center banks. While there are other ways to view over/under valued, I just go back to 'what would USD/DEM be?' 1.55-1.90 captures the vast majority of the post Plaza Accord/Reagan range and is approximately 1.03-1.26 EUR/USD. So no, the euro isn't yet even out of the band - this is just noise. Wake me up at 0.93 or 1.40

Sechel
Sechel

considering the president of the united states just attempted a putsch i'm surprised the euro isn't up more

Casual_Observer
Casual_Observer

I agree. I also thought there would have been spike sent the Canadian and Australian currencies higher.

Scooot
Scooot

Doesn’t The Fed and the Government want a lower dollar? Wouldn’t it help achieve their inflation target and ultimately help with the trade deficit.

Eddie_T
Eddie_T

I’d say the Fed is pleased as punch that the USD in out of triple digits.

The Euro is perhaps relatively strong against the USD for other reasons than what have been mentioned so far.

The Euro was already strengthening against the dollar, up off fairly historic lows in 2015-2016...until this thing we call COVID hit, which reversed the trend for a while.
Now the prior trend has resumed.

COVID ravaged Europe first, before the US was hit. Both the Fed and the ECB took a variety of steps to deal with COVID, but the ECB started from a higher debt/GDP and printed a bit less than the Fed....and much more of the support the ECB is giving its member banks is quite complicated too understand and is opaque to the outside...while the Fed and the US Treasury get the headlines for printing trillions.

The ECB has more shells to hide the pea under.

Johnson1
Johnson1

All the financial engineering is amazing. It is hard to believe that Italy and Greece 10 year bonds have a lower rate than the U.S. Both of their 10 year bonds are at 0.54% or 0.58% while the U.S. 10 year is at 1.1%.

Long term which bond would you want to own?

German 10 year yield is negative at -0.7%

Hmm, do I want to lose money on a bond purchase or make 1.1%?

caradoc-again
caradoc-again

There could be opportunity here if the $ temporarily strengthens with a small market driven rate rise.

US stocks could crack and currently rising EM take a tumble.

Hold gold but have cansh ready too.
Timing is the great unknown but I suspect before May 2021.
Repercussions will be global.
When cracks appear, buy EM, buy miners.
Both will be sold off, temporarily.

caradoc-again
caradoc-again

The whole EU project is decidedly anti-US.

Biden et al won't/can't understand how disliked the US is in the EU elite. The one aim, failed to achieve so far, is to deseat the $ and take on the US in every sphere while American chumps pay to defend the parasites.

Look at the deal between EU-China, support for Russian energy exports and kow-towing to Iran.

On current form US is heading from #1 to #3 behind China and EU.
Wake-up.

FromBrussels
FromBrussels

Thanks Mish, for a, as usual, elaborate explanation ! As far as your gold question is concerned, the answer is yes. In a world though where common sense no longer prevails, and with hindsight, I wish I had invested in Bitcoin at one point...You too I guess... Well, at least we stick to our guns, don t we ? :-(

Mish
Mish

Editor

Thanks to @Eddie_T for the balance sheet chart.

Added to my post then filled in some missing pieces about the Maastricht Treaty

njbr
njbr

What would happen if we had a non-neutered Justice Department....

...The Treasury Department announced a new spate of sanctions on Monday targeting the “inner circle” of Andrii Derkach, the pro-Russian Ukrainian lawmaker who aided Rudy Giuliani’s efforts to probe unsubstantiated allegations of wrongdoing by President-elect Joe Biden and his family....

...Derkach met with Giuliani, President Donald Trump’s personal attorney, in Kyiv in December 2019. He is also suspected of sending packets of disinformation on the Bidens to prominent Trump allies around the same time. And in August 2020, the Office of the Director of National Intelligence accused Derkach of being part of the Russian government’s efforts to damage Biden’s presidential candidacy.

njbr
njbr

WTF is it with the "armed" protesters?

Are they scared?

Or is it intimidation?

My money is on intimidation--which is directly at odds with democracy.

It's a means of bypassing a vote which they may not win. And the snowflakes cannot stand that. So they threaten with weapons.

Bam_Man
Bam_Man

These garbage fiat currencies take turns getting dragged out to the woodshed for a beating. The Euro’s turn will come up shortly.

Doug78
Doug78

Don't you just love monopolies when you own them?


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