EUR.USD

Mattresses and Soup Lines in Europe’s Future

By John R. Taylor, Jr.

There is not one of us who has not done some pretty foolish things in the middle of the night, so most of us go to sleep, to avoid saddling ourselves with the results of those ill-conceived actions when the sun rises the next morning. Not the Eurozone leaders and their friends in the ECB and the IMF. They sure did throw a hell of a party last week, but what a hangover! As the old saying goes, power corrupts and absolute power corrupts absolutely, and every ounce of it was in the Troika’s hands, especially since the victim was a tiny country, Cyprus, less than one-tenth the size of Greece. The Cypriot President was there too – it was his first meeting with this august group – but we doubt  anyone paid him much mind. The decision to confiscate (whoops), I mean take 6.75% from the checking and savings accounts of the poor Cypriot stiffs who work all the time and can’t make ends meet, was unanimous. Rich people with over €100,000 in their accounts would ‘give’ 9.9% to the bullies from that midnight soiree. This ‘tax’, as they called it, would save the other 330 million plus inhabitants in the Eurozone €5.8 billion by not adding it to the roughly €8.7 trillion they already owe. Seemed like a good plan in the smoke-filled haze after dinner and drinks. Anyone could see, by the light of day, this would infuriate absolutely everyone in the country. But then again there are only 800,000 plus of them, so no one seemed to care.

The callousness and the unthinking nature of this decision is obvious, but we would like to point
out that this is more important than another gaffe from the Eurozone leaders, bowing to Germany’s hard money wishes. This is very likely to have been a momentous decision that just might impact the future of Europe for the next few decades. The sanctity of bank deposits is something that, with great effort, has been developed into a critical underpinning of the modern financial system, something that did not exist in the Great Depression. Without it, governments find it very difficult to increase the velocity of high powered money needed to create optimism and growth. Remember, the Troika has ‘taxed’ deposits, not equity, not senior debt, nor junior debt. If your bank can take your money at will, the mattress is your best choice. Withdraw your cash in €500 and €100 notes and bury them at home. You will kill the economy, but protect yourself and your family. That is the way it was in the old days. It seems those days are coming back, at least in Europe. With interest rates near zero you are  much better off. A country like Slovenia, with a major banking problem and a population of only two million, is next on the firing line with commercial bank assets at 147% of GDP; the highest in Eastern Europe. Although Slovenia is far behind Cyprus in its gearing, a similar analysis would show a ‘tax’ of this sort as the most efficient way for the Eurozone to rescue this economy from itself. More important perhaps will be the impact on Spanish and Italian savers, both depending on banking organizations that any neutral observer would view as bankrupt. Why should Germany recapitalize those banks? The more money that moves into mattresses, the deeper the Eurozone’s recession and the less likely it will pull out of it. The Troika is breeding fear. The Cypriots seem to be cornered. They have followed a freer banking structure with low taxes, much like Ireland, but the Germans and French don’t like that – it smells Anglo-Saxon. Thanks to the bullies’ deposit ‘tax,’ a major pillar of their economy has been smashed forever. What can Cyprus do? There are some options. Although they are dramatic, the Cypriots have been put in a horrible place. Who needs Europe? The Russian Navy needs a base south of the Bosporus and Gazprom might find the Aphrodite gas field to its liking. Cyprus is about 100 kilometers from the Lebanese/Israeli coast. By controlling it militarily and economically, one would dominate the Eastern Mediterranean. The UK has a base now, but that is at risk. Russia controls the natural gas flow into parts of Europe, and with Aphrodite it will grow. This midnight decision could make Europe politically and economically weaker, while strengthening Russia. Good move Angela!

EUR - Draghi, Growth or Bust 

By Jonathan Clark

During the past eight months it can be argued that the two most important factors impacting European currencies have been efforts by European officials to support the euro and the interest rate at which European banks are willing to lend. The rally in the euro began in late July of last year when ECB President Mario Draghi made his pledge "to do whatever it takes to preserve the euro." This caused money to pour into Europe to buy sovereign debt. Yields in even the most fiscally troubled countries declined dramatically. Despite the recent flare up in Cyprus, yields have not risen significantly in Europe, arguing that so far it hasn’t actually impacted the euro (but it could if the situation deteriorates). During the past four months Eurozone interbank lending rates (EURIBOR) have started to reassert their power to impact capital flows. Since they also reflect expectations about future economic growth they tend to act as a sentiment gauge for Europe. Although interest rate differentials are also important US short-term interbank lending rates (LIBOR) are stable and don’t exert much impact on the differential. If the euro is to make a significant rally it’s unlikely to be due to a Cyprus ‘solution’ as there is none possible. Cyprus’ future as a banking center is significantly compromised and money will leave the country. If the euro is to make a significant rally then either growth expectations for the Eurozone must improve, causing EURIBOR yields to rise, or European officials must show an increased willingness to support Eurozone member countries.

The cycles argue the first half of April should see the European currencies strengthen, but are then likely to make a further decline into May and up to several months longer. EUR/USD may have just formed the medium-term low expected around this time, but it is more likely the low is reached between Friday and early next week. There is a risk it spikes to as low as 1.2725 before bottoming, but we are starting to doubt it will prove that weak.

Following this low the euro should turn higher. Now, it will only take a close above 1.3020 to turn the outlook positive. The euro is then headed higher into the week of April 8 or the following week and our target for this upmove will become the 1.3225 area. Provided this target area holds the downtrend will resume into early May and this overall weakness could last up to several months longer. Our further objective for the downtrend is the 1.2425 area. There is a risk the strength expected into the middle of April proves aggressive, which would signal the start of a sustained rally
lasting through the fall, but at this point it is our less likely scenario.