We aren't infallible, but we can choose between the types of errors we might make. Think of it this way: It's like a driver right before he or she makes a blind turn. The driver can assume there is a vehicle out of sight just around the corner and slow down. If the driver is wrong and there is no car there, the worst that happens is that motorist slowed needlessly. If the driver assumes the alternative -- there is no car lurking out of sight -- he or she will keep the pedal to the metal. If wrong, well -- good night, Irene.
It's pretty clear which type of error is preferable.
The euro has fallen in 14 of the 16 months since its debut. The pace of decline has accelerated recently and the euro has lost about 12% of its value thus far this year. Conventional wisdom in the foreign exchange market is that the currency's weakness is structural in nature. Until Europe implements structural changes, including serious labor market reforms, the euro is at risk. This opinion has been widely cited and has been echoed by no less an authority than
U.S. Treasury Secretary Lawrence Summers
Nevertheless, a compelling case -- I think a more compelling case -- can be made that the bulk of the euro's weakness can be traced to cyclical factors.
Most of the official arguments contending that the euro is weak on structural grounds are better understood as part of long-running ideological debates. For example, for more than 20 years, various U.S. administrations have been arguing that Europe pursue policies that lead to stronger growth. Summers is simply using the weakness of the euro to push the point.
European officials who have been skeptical of the merits of monetary union from the start are using the recent price action to legitimize their positions. Others, like the
in Germany, who called for a summit on the euro, are seeking to embarrass the current government.
Investment houses and banks are well aware that many of their clients with longer-term views, such as U.S. corporations and portfolio managers, are being hurt by their long euro exposure. Analysts, like one quoted on
a few days ago saying that "below $0.9000, all hell breaks loose," are trying to encourage their clients to panic and seek the insurance that the banks sell.
The fact of the matter is the growth in the euro zone is accelerating, and important reforms have been implemented. Labor markets, for example, are much more flexible than they have been. There are fewer restrictions on firing people, and employment taxes have been lowered. Fixed-term employment contracts are exempt from social legislation. There has been a rise of such contract employees, which now account for 14% of the euro zone's work force and nearly three-quarters of the jobs created in the region over the past three years. The euro zone's unemployment rate for March stood at 9.4%, the lowest in seven years.
A compelling argument can be made that the real key to U.S. job creation has not been the much-touted mobility of U.S. labor so much as the flexibility of U.S. capital markets. The depth and breadth of U.S. capital markets effectively broke the monopoly that banks traditionally enjoyed over the distribution of capital.
Small and mid-sized businesses, which do the bulk of the hiring in the U.S., have access to capital that they previously did not have. The same is increasingly true in Europe. The advent of the euro has spurred the development of European capital markets. For example, there is a high-yielding corporate bond market now and a euro-denominated commercial paper market.
In addition to the labor and capital market reforms, governments are in better fiscal shape as deficits and debt generally have been reduced. Tax cuts have either been planned or enacted in most of the major countries in the region. Corporations also are embracing shareholder values. The bottom line: In many ways, the euro zone is less rigid now than it was in the spring of 1995, when the euro would have been trading at the equivalent of $1.40.
We cannot know for certain yet whether the euro's decline is cyclical or structural in nature. We probably won't know until the U.S. economy slows down appreciably from the recent heady levels. Only if the euro doesn't recover, then can it reasonably be concluded that a structural shift has taken place.
The fact that so many people are (prematurely) concluding the euro's weakness is rooted in structural rigidities says more about market psychology than the veracity of their claims. Sentiment is reaching an extreme and it ought not be surprising to see that the extreme in sentiment corresponds to a near-term extreme in prices. The fact that the euro's weakness may be part of a larger cycle in the currency markets does not, of course, rule out additional losses. It does caution, however, against panicking and would suggest the euro is closer to a bottom than a top.
Perhaps the Bible provides the most pertinent insight into the euro. When King Solomon asked the wise men to engrave a ring given by God with something that would always be true, they opted for, "This, too, shall pass."
Marc Chandler is the chief currency strategist for Mellon Bank. At the time of publication, he held no positions in the currencies or instruments discussed in this column, although holdings can change at any time. While he cannot provide investment advice or recommendations, he invites you to comment on his column at