The Eurozone’s Chaotic Future
By John R. Taylor, Jr.
Dictionary.com defines chaos as “a state of utter confusion or disorder; a total lack of organization or order,” but that definition is old-fashioned. We would use something more quantitative and more scientific. We want to know how chaos develops and works. A chaotic system is one in which the future cannot be predicted by knowing the past. Systems are not totally predictable and have chaotic elements. Chaos is totally unpredictable and occurs when previous organization collapses. An old folk saying, “the straw that broke the camel’s back,” illustrates this principle – and the implications around it – beautifully. The arrival of chaos cannot be predicted. Each straw that is placed on the camel’s back is insignificant and thousands of straws can be placed there. Eventually one almost infinitesimally-light piece of straw will cause the back of the six-hundred kilo camel to break. It is impossible to predict which straw will cause the system to break. Clearly it will not be the first straw, but it is impossible to predict which straw will be the ‘one’. Science has recently recognized that there are many chaotic events that are essentially unpredictable, and – most importantly – once the chaos begins, the internal progression of the process and the final outcome is even less predictable. Chaos is chaotic. In Ubiquity, one of our favorite books, Mark Buchanan describes the “bewildering and unruly rhythms” of the chaotic events that often rule us. His examples run from forest fires to the 1987 crash and include the outbreak of World War I.
That gets us to the topic at hand. What is next for Europe and the euro? The currency picture looks great. Short-term fundamentals could hardly be better. For a start, the ECB’s balance sheet is shrinking. There are fewer euros now than there were at the beginning of the year, while there are many more dollars, yen and pounds, so the euro should be in short supply. Also the current account balance of the Eurozone is at an all-time high, now running at a €300 billion annual rate (about 3% of GDP) – lots of foreigners must buy those euros to pay their bills. Even the long-term capital flows are more positive than in any other country over the past few months. Topping it all, Draghi recently said that there is no chance the ECB will ease rates. The positioning side is also positive for the euro, as most market participants are short and most of them have been losing money. Since the start of 2012 – almost 370 trading days – the euro has closed higher than its current level on only 28 days. How long will investors tolerate these losses? Currency fundamentals say buy euros, but the political and social situation says something very different. Merkel, Draghi, the Germans, and some others support this very restrictive stance, despite the 7-quarter recession in the entire Eurozone, and the multi-year recessions in some individual countries. However, only Germany of the EU-17 has a healthy economy. Let’s get back to the camel. If we argue that the Eurozone’s back is loaded with straw – the Euro-area jobless rate at 12.2%, with Spain at 26.8%, youth jobless in several countries over 50%, radical political parties growing fast, and poverty levels doubling to over 30% in several countries – the question has to be when and where will the chaotic event occur? We don’t know, but it will occur, probably in some street somewhere. In August, 1914, it was in Sarajevo. No rational formula could describe the course of events that followed. When the Thai baht began its decline in 1997, calculations showed that a 15% move would be correct, but the 60% drop dragged in all of Asia.
The Commodity Wind Blows Cold
By Jonathan Clark
The Australian dollar has witnessed an aggressive decline during the past two months, falling to its lowest level since September, 2010. There have been other declines of similar magnitude in 2011 and 2012, but after those, the Aussie came roaring back. This time is different: we are not expecting another death-defying recovery this time. The country has gone 22 years without a recession, largely fueled by expanding exports of raw materials (increasingly to Asia) and a growing population. During the past four decades, the population has grown by nearly 2% per year, although the growth has slowed recently to less than half of that rate. The long period of growth has created areas of vulnerability, including an extremely large and expensive housing sector, large foreign ownership of government debt, and a relatively weak economy in areas not related to the commodities industry. Australia has increasingly grown to rely on exports to China, another large vulnerability for the country, with mining-dominated Western Australia export volumes declining 4% during the most recent quarter. Commodity exports have been the wind behind the sail of the Australian economy, and they are now blowing cold due to slowing global growth and increasing production, significantly increasing the risk of an Australian recession, plus a further decline in interest rates and a very weak Australian dollar. The cycles argue that the European currencies will decline into the middle of July before forming a significant low and strengthening into the final two months of the year. We are getting quite different readings from the cycles in the Australian and New Zealand dollars, which call for weakness into the fall. This isn’t surprising, as the cycles between these two geographic regions vary significantly at times. Europe has many positives at this time, and Australia is in danger of entering a recession.
AUD/USD should end its recent recovery by early next week, then resume its downtrend, and this should help to further alleviate its oversold condition. It is unlikely to surpass resistance between .9660 and .9680 and, if seen, this should be a good place to sell for the next leg of the downtrend. There is a medium-term low due during the week of July 1 or the following week. Our initial target is the .9125 area. Following this low, the Aussie should turn higher and recover into the end of July before the downtrend resumes. The longer-term cycles are negative into September and possibly early October. Our objective for this downtrend is the .8425 area, and we cannot rule out a further decline to the .8050 area before a major low is reached.
By John R. Taylor, Jr.
Dictionary.com defines chaos as “a state of utter confusion or disorder; a total lack of organization or order,” but that definition is old-fashioned. We would use something more quantitative and more scientific. We want to know how chaos develops and works. A chaotic system is one in which the future cannot be predicted by knowing the past. Systems are not totally predictable and have chaotic elements. Chaos is totally unpredictable and occurs when previous organization collapses. An old folk saying, “the straw that broke the camel’s back,” illustrates this principle – and the implications around it – beautifully. The arrival of chaos cannot be predicted. Each straw that is placed on the camel’s back is insignificant and thousands of straws can be placed there. Eventually one almost infinitesimally-light piece of straw will cause the back of the six-hundred kilo camel to break. It is impossible to predict which straw will cause the system to break. Clearly it will not be the first straw, but it is impossible to predict which straw will be the ‘one’. Science has recently recognized that there are many chaotic events that are essentially unpredictable, and – most importantly – once the chaos begins, the internal progression of the process and the final outcome is even less predictable. Chaos is chaotic. In Ubiquity, one of our favorite books, Mark Buchanan describes the “bewildering and unruly rhythms” of the chaotic events that often rule us. His examples run from forest fires to the 1987 crash and include the outbreak of World War I.
That gets us to the topic at hand. What is next for Europe and the euro? The currency picture looks great. Short-term fundamentals could hardly be better. For a start, the ECB’s balance sheet is shrinking. There are fewer euros now than there were at the beginning of the year, while there are many more dollars, yen and pounds, so the euro should be in short supply. Also the current account balance of the Eurozone is at an all-time high, now running at a €300 billion annual rate (about 3% of GDP) – lots of foreigners must buy those euros to pay their bills. Even the long-term capital flows are more positive than in any other country over the past few months. Topping it all, Draghi recently said that there is no chance the ECB will ease rates. The positioning side is also positive for the euro, as most market participants are short and most of them have been losing money. Since the start of 2012 – almost 370 trading days – the euro has closed higher than its current level on only 28 days. How long will investors tolerate these losses? Currency fundamentals say buy euros, but the political and social situation says something very different. Merkel, Draghi, the Germans, and some others support this very restrictive stance, despite the 7-quarter recession in the entire Eurozone, and the multi-year recessions in some individual countries. However, only Germany of the EU-17 has a healthy economy. Let’s get back to the camel. If we argue that the Eurozone’s back is loaded with straw – the Euro-area jobless rate at 12.2%, with Spain at 26.8%, youth jobless in several countries over 50%, radical political parties growing fast, and poverty levels doubling to over 30% in several countries – the question has to be when and where will the chaotic event occur? We don’t know, but it will occur, probably in some street somewhere. In August, 1914, it was in Sarajevo. No rational formula could describe the course of events that followed. When the Thai baht began its decline in 1997, calculations showed that a 15% move would be correct, but the 60% drop dragged in all of Asia.
The Commodity Wind Blows Cold
By Jonathan Clark
The Australian dollar has witnessed an aggressive decline during the past two months, falling to its lowest level since September, 2010. There have been other declines of similar magnitude in 2011 and 2012, but after those, the Aussie came roaring back. This time is different: we are not expecting another death-defying recovery this time. The country has gone 22 years without a recession, largely fueled by expanding exports of raw materials (increasingly to Asia) and a growing population. During the past four decades, the population has grown by nearly 2% per year, although the growth has slowed recently to less than half of that rate. The long period of growth has created areas of vulnerability, including an extremely large and expensive housing sector, large foreign ownership of government debt, and a relatively weak economy in areas not related to the commodities industry. Australia has increasingly grown to rely on exports to China, another large vulnerability for the country, with mining-dominated Western Australia export volumes declining 4% during the most recent quarter. Commodity exports have been the wind behind the sail of the Australian economy, and they are now blowing cold due to slowing global growth and increasing production, significantly increasing the risk of an Australian recession, plus a further decline in interest rates and a very weak Australian dollar. The cycles argue that the European currencies will decline into the middle of July before forming a significant low and strengthening into the final two months of the year. We are getting quite different readings from the cycles in the Australian and New Zealand dollars, which call for weakness into the fall. This isn’t surprising, as the cycles between these two geographic regions vary significantly at times. Europe has many positives at this time, and Australia is in danger of entering a recession.
AUD/USD should end its recent recovery by early next week, then resume its downtrend, and this should help to further alleviate its oversold condition. It is unlikely to surpass resistance between .9660 and .9680 and, if seen, this should be a good place to sell for the next leg of the downtrend. There is a medium-term low due during the week of July 1 or the following week. Our initial target is the .9125 area. Following this low, the Aussie should turn higher and recover into the end of July before the downtrend resumes. The longer-term cycles are negative into September and possibly early October. Our objective for this downtrend is the .8425 area, and we cannot rule out a further decline to the .8050 area before a major low is reached.
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