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March 18, 2005
Euro Bear
Confession - I’m a Euro bear ... fundamentally speaking.
And that flies in the face of the "conventional wisdom" one hears on almost every street corner these days. Not to mention from the lips of the likes of George Soros and Warren Buffett.
But lets not confuse issues. On long term fundamentals I’m a Euro bear, on short to medium-term "trades" I’d be foolish not to be a Dollar bear and Euro bull.
But it’s the fundamentals that interest me most. Of course the technicals are fine to enable one to eat, but its in the fundamentals - and I’m talking hear about the global economic picture – the BIG PICTURE - not just about "selective" fundamentals, plucked out to justify one position or another – that you’ll find where we’re ALL headed in the long term.
Sure, at the moment the euro is between a rock and a hard place. Eurocrats and perma-bears like to blame the US dollar’s decennial low against the euro for Europe’s currency and economic troubles. And when we talk here about "Europe", I’m referring to Continental Europe (Eurozone if you like) and not the UK, which is a relative economic oasis at the edge of it’s continental neighbour’s economic wasteland. The Ugly Americans, according to them, are importing more than they export and thus requiring the (allegedly ever-so-thrifty and prudent) foreigners to bankroll Yankee consumption.
But with every tiny soundbite emanating from Brussels, Tokyo or Seoul, the dollar drops a bit more. And with every decline, the relative value of European and Asian dollar-denominated currency reserves and company earnings drops as well. Unfortunately, due to insufficient economic reforms in the respective countries, domestic demand is stagnant or even recessive - and in no shape whatsoever to make up for falling US demand.
In Japan, where dollar reserves are estimated at US$820 billion, each cent the dollar loses in value means US$8.2 billion in unrealized losses. In 2004, the European Central Bank (ECB) recorded a tripling of its losses - to over 1.63 billion euros, due mainly to a devaluation of its dollar reserves by 2.1 billion euros.
And its no better in Germany where cash-strapped German finance minister Hans Eichel won't be expecting no check in the mail from the Bundesbank this year: experts forecast a break-even year for the German central bank, with a potential loss of 500 million euros.
Given this dynamic, it becomes quite obvious why China, for one, steadfastly refuses to float the dollar: any increase in the yuan would erode its central bank reserves while making Chinese exports more expensive. And internal demand in a country that still pays third-world wages for workers producing high-end goods is simply insufficient to make up the difference!
European firms, too, are feeling the pain. French defense contractor Thales just cut its forecast for 2005, which it had calculated at an exchange rate of US$1.15. (The dollar is trading at US$1.33 today.) Thales chairman Bernard Arnault was quoted as saying that the company "had to wipe 500m euros off our operating profit due to the decline in the dollar alone." Even the recently celebrated aerospace firm EADS indicated that the weak dollar is forcing it to build 300 of its new Airbus A380 super jumbos to break even. That’s a 20% increase over its previous forecast.
Each drop in profitability and each euro in non-realized central-bank profits translates into greater pressure on the respective domestic market and public debt level. And public debt, as a percentage of GDP, is already higher in Japan, China, Germany, Italy and France than it is in the US.
Did you get that? I’ll repeat for emphasis:
Public debt, as a percentage of GDP, is already higher in Japan, China, Germany, Italy and France than it is in the US.
Each high-level complaint about the weak dollar translates into a further fall in the value of the dollar. The euro’s valuation is choking off the already modest (read "negligible") growth rates in Europe (read "Continental Europe") - and is likely to do so until the central banks take active steps to depress its value.
These steps become even more likely considering that a correction of the US current account deficit would be even worse news. If the US were to restrict imports of foreign goods, for example, the miniscule economic growth rates in Europe and Japan would collapse.
Get it? Good!
But for the short term, and since traders have to eat too, let’s join the party, trade forex and get bearish on the dollar.
Posted by Tony at March 18, 2005 12:07 PM