Currency traders are a brave breed. They invest in trades based on moves of tenths of a point. It doesn’t sound like much, but when leverage of 100 to 1 is involved every move is magnified by a hundred times on the upside…and on the downside.
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Right now there are a lot of traders who are feeling very good and many who are probably looking for a window in a high building. Last week the Swiss hit the panic button. Their currency, the Franc, has been appreciating wildly in the past couple of years as investors looked to it as a safe haven. They have good reason to look to the Franc. While Switzerland is a small country, it has a lot of money – over $300 billion in reserves. It’s a global financial center and it has an economy that is fine tuned and, in business parlance, perpetually profitable. But, there comes a time when profits are threatened. Last week that time came. Swiss companies like Nestle warned of lower profits due to currency translation. Imagine a sting of 25% to your profits because your home currency is worth more than the places that you sell to. Of course you have ways to mitigate currency translation, but not enough to sway such a sharp move in a short period of time. The Swiss had to do something and they did.
In an announcement last week, the Swiss said they would peg their currency to the Euro at $1.20 Francs to the Euro. And, not only would they buy the Euro to maintain the peg, they emphasized that they would do so at all costs. This will put a temporary floor under the Swiss/Euro ratio, but in the longer term, the Swiss had better hope that the Euro actually survives or they will go down with it.
The problems in the Euro zone, which I have been writing about extensively in these pages, are not getting better. In fact they are getting worse. The Euro broke below $1.40 to the US Dollar last week, dropping under the current trading range of $1.40 to $1.45. As I remarked before, any move above $1.45 is a shorting opportunity.
The only legitimate country in the Euro zone with the effective power to solve this mess is Germany. What mess? The mess created by over leveraging economies, poor fiscal and tax policies and rampant public sector spending that could not be supported by tax revenues. The resulting deficits would have not surfaced for years if not for the collapse in the global economies in 2007/2008 which put even greater pressure on government spending yet decreased inflows from taxes.
Bottom-line it’s only the Germans that have the fiscal and political strength, as Europe’s largest and most sound economy, to pull the Euro zone together and put forth a massive TARP type of package for both banks and countries. European banks are now suffering the same types of rampant speculation that hit the US Banks in 2008 after the collapse of Bear Stearns and Lehman Brothers. Except then the US Government debt was not under attack, so the problem was more manageable.
Today, it is government debt of countries like Greece and Portugal that is being assailed as not creditworthy. The backstop is the European Union. However, the Union itself is not a true Union in that they share a common currency but vastly different laws governing individual country tax and spending policies. The Germans in the meantime are being asked by the weaker nations to inject money into the system to buy their debt because no one else will. But, the fly in the ointment here is the people of Germany. They’re balking. They don’t want to spend any more money bailing out their weak southern neighbors because in the end that means they are debasing their currency. As well as reducing their standard of living and increasing their individual debt – for a bunch of people with whom they don’t even share a common language… let alone a culture.
Politically, Angel Merkel, Germany’s Chancellor, is being pilloried across the country and faces the prospect of being thrown out of office in the next elections. Germany is the lynch pin and in the coming months it is they who will decide the fate of Europe and the fate of the Euro. Odds are that they will cave and open their wallets, but those odds are changing daily. The Swiss might have upped the odds of success by giving the Euro a vote of confidence. However, the problems in the region are not going to be solved by currency theatrics. They will only be solved when the Euro’s weak sisters are jettisoned from the Union in order to save it… an option that I believe will soon be on the table.
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