Dollar will be the winner when the EU volcano erupts
Dollar will be the winner when the EU volcano erupts ·CNBC
Dr. Michael Ivanovitch
Updated
Europe's apparent inability to secure its monetary union leaves the world without any credible dollar alternatives. Those who were expecting that a legal tender of an economic system nearly matching the size of the American economy would offer an effective instrument of portfolio diversification have to accept a simple reality: The dollar remains an irreplaceable global transactions currency and, by far, the world's most important reserve asset.
The pious hopes of the French President François Mitterrand and the German Chancellor Helmut Kohl that a common currency would bond their countries and the rest of Europe into a peaceful and prosperous union could soon be dashed. Their political offspring has become a symbol of European discord and a cause of seemingly irreconcilable French-German economic and political divisions.
These historical divides are now aggravated by violent street demonstrations and frightening civil war rhetoric in France, where the country's mainstream politicians are trying to fight off extreme right and left parties, commanding nearly half of the popular vote and demanding an immediate exit from the EU and the euro.
Investors would be well advised to take this seriously. Even if relatively moderate French center-right forces were able to keep the anti-EU parties at bay, a long-brewing clash with Germany appears inevitable. For many French politicians of all stripes, Germany has gone too far in bossing the rest of Europe around, and in causing a huge economic, social and political damage to France, Italy, Spain, Portugal and Greece with the imposition of its mean-spirited and misguided fiscal austerity.
Unbridgeable divide
That German behavior was bound to backfire. The philosopher Jürgen Habermas warned his country's leaders that they were "dozing on a volcano."
So, watch your portfolio because the economic and financial implications of the current wave of European animosities erupting into a political earthquake could be very serious. With its 20 percent share in world reserve assets, the euro is still an official or de facto transactions currency in one-fifth of the world economy.
And here is why the euro demolition job by Germany and France will continue.
Both countries have known all along that the proper functioning of the monetary union, and the credibility of the euro, require common fiscal policies and a unified regulation of labor and product markets (broadly defined as structural policies). That's what is needed to complete the European economic and monetary union (aka the "European project").
But the leaders did not dare tell the truth to their people. And the truth is that such an arrangement is only feasible in a political union, with the administrative structure of a federal state.
Brexit followers correctly call that the European super state. They want no part of it because they know that this would turn the revered Palace of Westminster into a museum of parliamentary democracy.
The Germans also know what they want. Having been architects of the euro area monetary system and of the European Central Bank (ECB), they want the fiscal union on their own terms, too. Germany is asking for a euro area finance minister (most certainly hand-picked by Berlin), who would manage a common budget and the joint public debt financing.
But the Germans are (intentionally?) making an offer they know the French cannot accept. And the French are making a counter-offer they know Germans are sure to refuse: Paris insists on inter-governmental negotiations of fiscal issues, allowing an intrusive (but negotiable) oversight by the EU Commission and a (negotiable) threat of sanctions. That's what we have now.
Germans were the first to violate the euro area fiscal rules with budget deficits above 3 percent of GDP for three consecutive years (between 2001 and 2003), and they refused to even talk, let alone negotiate, about it. But they are now allegedly pushing the EU Commission to sanction (with penalties) France, Spain and Portugal for repeatedly missing their budget deficit targets. And the brave and poor Greeks are suffocating under general strikes as Germany refuses to let little oxygen in by accepting the IMF-proposed flexible debt management.
"Don't leave me"
Knowing all this, I jumped last week on articles in the French media talking about measures that France and Germany should undertake to strengthen the euro. The big idea there was a constitution of a euro area parliament to oversee monetary and fiscal management, and to promptly implement public debt write-offs in excess of 60 percent of GDP.
These are, of course, non-starters, but they show how much the French distrust Germans, and vice versa, and how much the French think that a parliamentary format would help them – with possible assists from Italy, Spain and Portugal -- to squeeze out Germany's excessive influence on euro area policies.
And that's precisely what the Germans fear. A prominent German businessman implored the UK last February during his speech in London not to leave his country alone with "the French and other European socialists."
The German finance minister said the same thing to a British audience earlier this month. Brexit, he said, would make Europe "less stable and more volatile," adding, allegedly tongue-in-cheek, that "we (Germans) would cry" if Britain left. It all sounded like the Broadway's rendition of Jacques Brell's desperately sad, iconic song "Ne me quitte pas" (Don't leave me).
Such appeals reinforce the view of a deeply corroded French-German relationship, where chances of a compromise over a genuine fiscal union and other measures to strengthen the euro are nil.
Indeed, unless election gains of far right and left parties a year from now force an early French exit from the EU and the euro, things will be left to limp along until the next crisis blows up the monetary union. That time bomb is ticking; it was set up by fiscal austerity that caused deep recessions (the euro area GDP is still below pre-crisis levels of 2007), high unemployment and political instabilities in countries that account for 53 percent of the euro area.
Investment thoughts
The euro is critically wounded by seemingly unbridgeable French-German differences over the management of their monetary union. That crisis will be further aggravated by the growing anti-EU, and anti-German, political parties in France, and by similar socio-political movements in Spain, Italy, Portugal and Greece.
Successors to great European statesmen such as Mitterrand and Kohl have gravely compromised the euro's finality. The political mantra that "the euro is here to stay" has become an empty slogan.
The dollar is a winner in all this. A strong dollar could also delay and moderate the Fed's widely anticipated rate hikes, because a strengthening greenback is technically equivalent to monetary tightening. At the moment, the dollar's trade-weighted value is exactly where it was a year ago, and we have yet to see the evidence of the Fed's large-scale liquidity withdrawals.
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