Euro: Rock star of the year?
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Axel Merk is president and chief investment officer of Merk Investments, a US-based currency manager.
It is no longer taboo to be bullish on the euro, but in our 2013 outlook we took it a step further, predicting the euro will be a "rock star". Despite the recent run-up, we may not have seen anything yet. Let me explain.
First, for some background, we were positive on the euro in 2010, when the currency was tumbling towards 1.18, arguing that the issues in the eurozone were rather serious, but should primarily be expressed in the spreads in the bond markets.
The euro, we argued, was sold as a proxy as it was easier to short than peripheral eurozone bonds. Sure enough, the euro recovered to the high 1.40s while spreads were blowing out.
We then turned gradually negative in the fall of 2011, noting that the processes to adjust the crisis were increasingly dysfunctional. If you don't know what direction management is taking a business in, investors stay away from buying shares in the company as they cannot price the risks.
Similarly, a bad process is better than no process when it comes to dealing with the challenges in the eurozone crisis. In the spring of 2012, European Central Bank (ECB) president Draghi implored policy makers to define roles, set deadlines, hold people accountable - in good political fashion, nothing happened. Then Draghi gave his we will "do whatever it takes and, believe me, it will be enough" speech.
What got us positive on the euro, though, was Draghi's announcement that the ECB would buy peripheral eurozone bonds should such countries: a) ask for help; and b) other countries agree to help. The move was ingenious for a number of reasons, including:
- It provided a process to move forward. One may or may not like the details of the process, but it is a process nonetheless. For all the naysayers, keep in mind that the processes in the US, UK and Japan aren't particularly good, either;
- The euro took great strides to becoming "yet another currency". That's very good news for a currency that has been treated like a contagious disease;
- The process imposed requires that weak countries would give up sovereign control over their budgeting. That was the de facto outcome of previous bailout requests as well, but a defined process is replacing chaotic action. Crises will always happen, but they are less stressful when well-defined processes are in place;
- The fact that other eurozone countries have to agree to help weak ones throws the ball into the court of politicians. The ECB is not supposed to be a political body and has squared the circle on this one. Many disagree with us that the ECB is truly able to stay outside of politics, but in our assessment, the ECB is better positioned to deal with political pressure to finance deficits than the Federal Reserve, Bank of England or Bank of Japan;
- Not to be ignored, Draghi did remove significant "tail risk," making it much less likely that we will see liquidity-driven defaults. I'm treading carefully here in how to express this, as I believe the essence of many of the eurozone policies is to eventually have markets strong enough to stomach sovereign restructurings. As such, I'm not ruling out defaults in the eurozone but when the time comes, the market fallout may be rather limited; and
- In brief, the ECB promised to act more like other central banks if eurozone countries acted more like a United States of Europe.