Short the Euro
The European economy has been struggling to survive these last five years. Debt issues and unemployment soared. Political measures to tackle problems have been slow and ineffective. The only big country in the union which seems to keep performing well is Germany.
Here’s an image that can describe what is going on there:
The welfare state has been very famous and loved by many of the most important economies in Europe; however, this system only works well when your population is young. Why? Because older people are supported by taxes the working population pays. What happens when the population grows old and the proportion of young people to old people declines? Structural crisis.
Many of the most indebted countries in Europe like Spain, Italy, Greece and France too, have been transferring lots of money from the active population to the passive population. In some cases, government expenditures became bigger than incomes due to all these subsidies to the idle. But they kept on spending relying on cheap money they received from the richest countries in the union such as Germany. Their debt grew until the point of unsustainability. Reforms were needed urgently.
Of course reforms cannot be done from one day to the next without consequences. People who receive state aid are not willing to accept cuts. Political stability is threatened and economic activity comes under stress. In addition to this, cuts are to be made in the middle of a crisis, affecting government spending and trailing down the economy even more.
This is the path Europe has chosen to walk and it’s a hard one. They are far from solving all of their problems but somehow I think they’ll get over the crisis with the help maybe of other regions of the world that are performing better like Asia, the U.S. — which is recovering economic momentum and Latin America which has performed very strongly.
Europe has resisted monetary easing for a very long time because members from the union with different economic interests caused the decision making process to be slow. When the U.S. and the UK were struggling with their economies, they acted quickly and boldly to lower key interest rates to historic lows of 0%. On the other hand, it took years for Europe to follow the same path and deliver a message to the markets assuring that all cash needed would be supplied by the Central Bank.
While Europe finally took the right decision, they are years behind those who acted fast, and as we have seen in Table 1 above, they may have to keep monetary easing up and running for a few more years if they want those economic indicators to get better.
The euro has been performing strongly lately against the U.S. dollar:
source: Google Finance.
I would not expect this to last for a very long time as the U.S. Fed has made it clear that they will cut monetary easing as soon as they can because their economy is getting healthier after the big 2008 crisis.
The euro is expensive at these values and what Europe needs is more productivity, especially in countries like Spain, Portugal and Greece. The fastest and most politically friendly way to achieve this is by devaluing the currency to make their products cheaper. With high political impact, spending cuts have been limited and have not had any good economic result. Gaining productivity through currency devaluation is the best way to compete, as there are no inflation threats ahead.
I would short the euro against the U.S. dollar as the U.S. is walking through a recovery phase in their economy and monetary tightening is expected to be seen in the following years. Europe has yet to overcome serious economic problems before they can afford their currency to strengthen.