Euro solution provides quick fix but basic long-term problems remain

But according to analysis carried out by financial consulting firm Oxford Metrica the current solution still fails to solve some fundamental shortcomings that were not tackled at the currency’s launch and which meant that actually the ‘currency’ has been little more than a grandly named fixed rate mechanism. Oxford Metrica states that based on current negotiations the solution delivers the following significant risks: - It fails to deal with extant debt - Big legal and political hurdles still lie ahead - It remains unclear how European banks will be recapitalised - The recent progress is good news but the euro will remain in crisis for 18 months, and - Fiscal integration will remain ‘elusive’ as Europe will continue to be two-tiered.hideIndeed, one of the key findings of the Oxford Metrica study is that there is ‘clear, unambiguous’ evidence of a two-tier Europe since the launch of the euro in terms of growth, fiscal arrangements, inflation, unemployment, trade and finance. According to the consulting firm, the two tiers are: the creditor nations represented by Germany and Finland and the debtor nations represented by Greece, Italy and Spain. The analysis also identifies a fast-rising disparity in the national claims to be lodged with the European Central Bank (ECB) across the euro area. “Germany and Finland are shown to be building massive claims with the ECB whilst the ECB has increasing claims on debtor national central banks,” stated the firm. Oxford Metrica believes that the fixed exchange rate regime has ‘run its course’. “The recent crisis, the report argues, emphatically illustrates that the euro in its present incarnation is little more than a fixed exchange rate regime, not a true single currency,” stated the firm this week. “In times of growth this distinction may be academic but in times of potential sovereign debt default and bank failure it is crucial,” it added. The consulting firm pointed out that fixed exchange rate regimes have been used frequently in various regions of the world but rarely survive economic crises. One example was the ERM (exchange rate mechanism) that preceded the creation of the euro and the ‘ignominious’ manner in which sterling was forced to exit on ‘Black Wednesday’. “In fact fixed exchange rate regimes are often a contributory cause to financial crises as is the case currently in the euro area,” stated the firm. Returning to the present, Oxford Metrica stated this week that the recent announcements about the euro can be seen as a ‘strong signal’ from the troika in support of the system. These are represented by a resolution for the ECB to implement the Open Monetary Transactions (OMT) system, a commitment to the Single Supervisory Mechanism (SSM) to be handled by the ECB, a commitment to the development of a deposit insurance scheme and finally an intention to recapitalise banks when necessary. “These collectively go some way to completing the architecture of the euro. However, several issues need to be borne in mind when considering the likely near-term future for the euro: The arrangements do not deal with extant debt, there are significant legal and political hurdles ahead, it is not clear how European banks will be recapitalised, progress is good but the euro will remain in crisis for 18 months and fiscal integration will remain elusive as Europe will be two tiered. The firm said these initiatives should have been set up when the euro was created and that ‘retro-fitting’ may not work. “In retrospect [this was] a massive gamble to proceed without a complete architecture,” stated the firm. “The problem now is that the ‘retro fit’ approach to the architecture may be sowing the seeds of future weakness. Most fundamentally it needs to be understood that very few of these measures will be implemented fast enough to save the euro. The euro must survive the next 18 months without the benefit of these proposals being implemented. But will good intentions be enough to tide it over the current crisis?” asked the firm. Oxford Metrica identifies three possible scenarios for the future of the euro. The first is what it terms the ‘muddle through’ scenario under which there are no exits from the euro system. This scenario is the most likely but still has a less than 50% chance of happening. Europe muddles through without any country exiting during the forecast period and many of the causes of the problems remain, it said. Scenario two, which sees the exit of one or more debtor nations, is the next likely. “This is probably the best long-term outcome for the world and Europe in particular. Although there will be little room for non euro EU members,” stated the firm. Scenario three—termed fragmentation—would herald the demise of the strong euro. Under this scenario Germany exits and joins the UK as an additional currency area within the EU. Oxford Metrica points out that, to date, the value of the euro in dollar terms has been protected by the weak economics of the US currency. But this would change if the US economy improves and US investors are exposed to a big devaluation of their euro investments. That said, there will still be value opportunities in Europe, said the firm. “There are undervalued equities, although the wrapper of an expensive euro is a premium,” it stated. Finally, Oxford Metrica said that the idea of a ‘safe haven’ should be highlighted. It pointed out that the Swiss central bank (SNB) has announced a policy of supporting the euro at CHF1.20 by buying euros. As a result, the SNB is now the largest foreign holder of euros. Its foreign reserve holding now tops $400bn which makes it the fifth largest in the world, stated the firm. “This represents over $50,000 per capita. It is unlikely that the SNB can sustain this strategy and it may represent a useful hedge for international investors, contrary to their intentions,” concluded the firm.

Euro solution provides quick fix but basic long-term problems remain

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