A few months ago I wrote a popular article called “The Path to EURUSD 1.1000“. The premise: A new consensus was forming for the euro, where nearly every possible scenario leads to a lower EURUSD and FXE.
This consensus is widespread today. It’s widely recognized there must be drastic steps to save the Euro from total destruction. It’s also recognized any possible Eurozone scenario means a lower EURUSD.
The scenarios fall into two broad categories, breakup and continuation. I will use the new GIPSI acronym to refer to the problem countries of Greece, Ireland, Portugal, Spain, and Italy.
In any continuation scenario, the EURUSD is lower:
- Debt writedowns for GIPSI
- More loans for the GIPSI countries
- Continued ECB purchased of GIPSI debt
- Continued austerity for GIPSI countries
Every single one of these scenarios causes a weaker EURUSD. There is no scenario where the Eurozone retains all of the members and the EURUSD is stable in price.
A large capital repatriation into the Eurozone will get swamped by the increases in net financial assets required to stabilize the GIPSI economies, or get swamped by massively lower economic activity. Either way, the EURUSD is lower than it is today.
The breakup scenario is one where many people today are beginning to change their minds. The old consensus scenario for a Euro breakup was the euro would skyrocket once it cuts away the dead weight.
The idea is the current price of the EURUSD is an average of the strong Euro of the north and the weak Euro of the GIPSI countries.
I’ve changed my mind completely on this. I now firmly believe a Eurozone breakup causes a weaker EURUSD. This is the crucial part of the new consensus which needs to take hold for the EURUSD to really dive.
How does a Eurozone breakup cause a weaker EURUSD? The German export machine gets crushed as soon as any country leaves the euro.
This was pointed out to me in a comment by reader Emme on my article “Capital Inflows vs. Spain Problems“. He points out any country leaving the euro cuts off importing German goods, which depresses Germany’s export machine.
This is a huge point. The most likely consequence for Greece leaving the Euro would be an immediate termination of any trade credit to Greece, and a complete shutoff of any German exports to that country.
Even a slight slowdown in exports for Germany would have huge negative consequences for the entire Eurozone economy.
It’s not a long shot to say a Greek exit could trigger other countries leaving too. Ireland and Portugal could leave, and Spain would be tempted to leave too. This exit does not need to happen overnight – once Greece leaves, the other countries have a massive incentive to play for the best deals from Germany.
So there are many paths to EURUSD 1.1000- it’s just a matter of which of these paths the Eurozone will choose.