The biggest threat to the euro – and how to profit from it

Europe’s problems go a lot deeper than Greece.

If you didn’t already know that, it became pretty plain yesterday.

Germany, France and Italy all saw their economies shrink in the final quarter of 2012, compared to the third quarter. Overall, the eurozone economy shrunk by 0.6%, a bigger drop than expected.

It’s all pretty grim. It also puts even more pressure on the most important relationship in the eurozone – the one between Germany and France…

Why Greece didn’t leave the euro…

For most of last year, the biggest threat to the euro was the ‘Grexit’ – the danger that Greece would drop out (or be kicked out) of the zone, resulting in a chain reaction of fellow members leaving.

That threat receded as the Greeks voted to stick with the status quo, and the European Central Bank (ECB) stepped in to promise unlimited government bond-buying, if necessary. Markets strengthened, along with the euro.

Now Greece is hardly out of the woods yet. Between the fourth quarter of 2011 and the fourth quarter of 2012, the economy shrank by 6%. The Greeks may yet get sick of this.

But I’m rapidly coming to the conclusion that by far the greatest risk to the euro is an exit by Germany, not Greece, or one of the other peripheral countries.

Let’s think about this for a moment. The peripheral nations are in a lot of pain. That’s why pundits argue that they will vote to leave the eurozone: simply because the populations can’t stand it any longer.

But it’s not that simple. The first problem is this: people in the peripheral nations are only too aware that they are suffering. But they don’t necessarily link that suffering to the euro in itself. They’re more likely to link it to the intransigence of their fellow members – the Germans in particular.

So there’s no direct link in the average voter’s mind between the single currency and their economic woes. That’s why we haven’t really seen any major anti-euro political movement yet. There’s a hint of it in Italy, but I suspect that’s more about blackmailing other members to gain influence: Italy knows it’s too big to fail, so the European Central Bank had better fall into line, or else.

Secondly, for the peripheral economies, the euro represents a major advance for them. Many of the ‘Club Med’ countries have only recently (in historical terms) become democracies. Being able to join the euro and the ranks of the firmly developed economies is quite an achievement. Leaving again would feel like a step back. Nobody wants that.

And thirdly, ditching the euro is hardly an easy option. It’s not as though these economies will recover the morning after they return to the drachma or peseta or escudo. Inflation will rocket, savers will be ruined, and you’ll have a lot of potential for unrest and unpredictable side-effects. That’s not something you vote for lightly. 

… and why Germany just might

So, thinking about it like that, the fragile countries are not in a good position to leave the euro. They might need a weaker currency, but they’d much rather have a weaker euro, not a return to their old currencies.

And the peripheral nations now have a champion, in the form of France. French president François Hollande is agitating for a weaker euro. But the Germans are not so keen.

Jens Weidmann, head of the German central bank, told Bloomberg: “I fear a politicisation of the exchange rate”. Other German officials may not be quite as ‘hard money’ as Weidmann, but with a German election up ahead this year, Angela Merkel has to tread a line between creating more eurozone upheaval, and being seen as bowing to the demands of other nations.

So we’ve got a situation whereby France and a majority of the other eurozone nations need and want a weaker currency. None of them are prepared to take the consequences of actively marching out of the euro. Germany on the other hand, is having its arm twisted to bail these countries out (as it sees it), at the risk of inflicting higher inflation on its own citizens.

If Germany were to leave the euro, its new currency wouldn’t collapse. If anything, it would soar. We might see that as a big problem for an export-dependent nation, but estimates by various investment banks suggest that Germany could tolerate a much higher exchange rate before it caused it real pain.

So here are the choices: if you are Greek, you have a choice of doom by deflation, or doom by rampant inflation. Your best hope of a more moderate path is to get a far weaker euro. Given the options, throwing your lot in with the French and pressurising the ECB to weaken the single currency, looks the best of a bad bunch.

If you’re German though, your choice is: bail out all these other countries and put up with inflation. Or leave them to it, get the strong currency you desire, and keep pumping out top-class export goods that other nations will buy anyway. The only thing keeping you onside is an emotional attachment to the eurozone ‘project’.

So what does it all mean investment-wise? A German exit would take ages to play out. It’s not going to happen soon. But the Germans are not going to get the kind of euro they want.

Indeed, I’d be surprised if the euro gets much stronger this year from here. Given the litany of whining that has already started up, I hate to imagine the reaction if it actually gets to $1.40 or more, from where it is now. The ECB will come under pressure to act, or to at least keep talking it down.

So if you are the spread betting type, you might want to have a punt (bearing in mind it’s highly risky). Our expert trader John C Burford regularly covers the euro in his free email, MoneyWeek Trader – you can sign up for it here.

For those who aren’t so keen to spread bet, a weaker euro would be good news for European stocks: those in the periphery particularly. Markets have taken a bit of a hit recently as the currency has strengthened, but I’d still be happy to buy. Peripheral markets aren’t as cheap as they were, but if you keep drip-feeding money into them, I don’t think you’ll regret it in the long-run.

• This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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  • David Morgan

    Interesting and insightful stuff, as ever from Mr Stepek. It will indeed need a lot more pain for Germany to give up what it sees as its European commitment (for better or worse…). The other issue is that Germany isn’t the only northern ‘goody’ country in the Euro. What would the others do in the event of a ‘Gerexit’? It could rapidly become a collapse.

    No easy answers (or exit routes), I fear. So John’s conclusion about where the Euro is likely to go from here has to right.

  • Peter Lindsay

    Dear John, You are in good company suggesting a possible German exit from the Eurozone(Gerxit?) Roger Bootle – the only man who in 2009 predicted five years of 1/2% bank rate – also thinks Gerxit is possible and desirable. Gerxit would be a mainly political decision – the eurozone is clearly going to be very expensive for Germany in terms of bailouts , yet there is no way Germany will ever get political control in return: there is the rub. Germany now has an alternative “zone” however : Poland and Eastern Europe, or “Mitteleuropa” as it was once called.

  • Cesare Avanzini

    I dont comment that letter, but many i have received from your organization about fantastic opportunity before end 2012 to buy GOLD (buy, buy..) since it will go up at least to usd 2.000 or even 5.000 in a short time, whilst in same period all big Hedge fund ( see Soros and others) sold from 50% to 100% in their Gold stakes. And now Gold dropped from as high as 1.800 to today 1.630 so who was right You or Soros and all others who solde gold? Looks like you advised to buy gold to help gold price not to loose too much during selling from big Hedge Founds….
    Would like to have a comment, best regards

  • Mark

    I think a close to zero per cent chance of Germany leaving the Euro – the german population moan about their bailing out of club med, but Europe is encoded in their DNA now – leaving the Euro would be completely unacceptable – they would only leave if they were forced out – there’s a thought.

  • HL

    However beneficial it might be for the German economy, it is hard to envision a majority of Germans wishing to leave the eurozone.

    Why ? Because the whole “idea” of Europe and the near-religious devotion to concepts like “counterbalancing the USA” and “punching above one’s weight” have become to deeply embedded in the European psyche–including the German psyche–to be easily neutralised, let alone swiftly removed.

    No, Germany will slog on. Its hardworking people will mutter under their breath and make their cars and pay for the profligacy of others, perhaps for a generation.

  • SteveH

    German property though, upside if they exit, hard to see a downside if they don’t. Mind you I still haven’t found the best vehicle, anybody got any suggestions?

  • Jay

    Talk of Greece and Germany leaving the Eurozone is journalism trying to invent a crisis? EU Treaty law does not permit the expulsion of any nation from the Euro or EU. A State can only leave voluntarily. Greece has a veto over any Treaty change. No political party in Greece wants to leave, even Syriza would stay in and simply default on the debt.

    Default is the best solution. The current economic depression is caused not by the Euro but by Socialism and its entitlement-redistribution philosophy leading to governments running up exponentially increasing debt as the way to bribe voters and stay in power. That, the regulatory burden and too high commercial rents, is the real cause of the decline.

    Germany makes a profit on the bail-outs… it charges interest on the loans, keeps the Euro low helping its exports, its banks profit from safe haven transfers, and as industry in the peripheral countries collapse so German firms pick up the business. Why leave the gravy train?

  • Roger

    Germany has no fear of high currency, China has no fear of higher currency, why? Because they export capital goods, high end, where price is no prime concern, economic outlook is. You should be impressed by China that now more than 60% export is high end (it has made a series turn since 2007, it is tsill on going but hope is high). In face of western weakness, China exports reached historical highs and gaining momentum. Moneyweek editors will find their sorror two years down the road.

  • SW

    What’s happened to gold this afternoon. MW have been touting buying gold for months and ever since I bought, its gone down !! I’d like to know what your advice is now ??

  • Johan Voss-Schrader

    cultural differences), but also constantly being yelled at for inflicting the pain associated with necessary structural reform.
    Leaving, on the other hand, is impossible for three reasons: Although some calculations may show that the new D-mark would NOT soar to unbearable levels for the German export industry (which I personally doubt, see the example of Switzerland), it would be against their mercantilist heritage.
    (continues below)

  • Johan Voss-Schrader

    Even if that would not stop them, there are two more obstacles: While slightly off the highs seen last fall, Germany is still creditor in the European payments system TARGET2 to the tune of EUR600bn ( and German banks have outstanding debt to the garlic belt of easily the same amount (see BIS report). Even with the relaxed time table of BaselIII, the German financial sector could not withstand the losses resulting from that exposure. Assuming a 30% exchange rate move of the new DEM vs EUR, would cause losses of some EUR360bn to a EUR11.5trn financial sector and with a leverage of some 20x would wipe out more than half of that sector’s equity. And this is without neither counting any snowball effects on the German Corporate sector, nor the political price…

  • Johan Voss-Schrader

    No, just as impossible it is to see the German public accepting to continue to carry Europe on its shoulders, just as impossible is it to see Germany leave. And in the meantime the fault between the North and the South is only widening in most respects. The euro is really the tragedy of our times and a disaster for a whole generation of its population!

  • FrostyA1

    John, A most excellent aticle!, putting into terms sensible all the the feelings we had collectively but with overall clarity of an intuitive vision. I can listen to your common-sense views all day, unlike some other commentators who are `away with the fairies` on ridiculous long-shots,doom & panic.
    A long-overdue `spring-clean` @ M/W, leaving you as Head of the Household, would do much to increase readership & respect…..F.

  • Alec

    Of course, the peripheral countries don’t want to leave the Euro. It’s been Christmas Day every day for them since they joined the currency. They now expect the Northern Euro countries to continue chucking money at them, it’s in their DNA. If they left the Euro, they would have to devalue by 75% . No wonder they are in denial.

  • jimtaylor

    Good article, but I think neither will happen.
    Greece etc cannot afford to leave the euro, but if Germany leaves, the NewDM will soar AND the euro will tank and the combination will mean that very few people in the eurozone will be able to buy German goods.
    Germany needs to be in the single currency and for the rest of the eurozone to be able to afford to buy its exports – so it will be “business as usual” for a long time yet.

  • IJ

    Alec says: “it’s in their DNA.” What is in their DNA exactly? Being lazy and greedy? Apparently it’s ok to make these sorts of slurs about Southern Europeans. Imagine if you made a comment like that about Africans. I don’t think it would make the cut. As for it being Christmas Day for “them”, as a matter of fact citizens of the periphery have taken real economic pain and made considerable progress in the much-needed adjustment towards living within their means. Just look at how they’ve reined in their current account and budget deficits. Unfortunately the same can’t be said of the UK. Maybe we’re the ones in denial?

  • sw

    Germany stays in in the EUR … Germany sets leaves and sets up it’s own currency …. there is a third option, you know …

    … Germany joins the GBP

    yes, laughable, but a great plot for a “Yes Minister” episode!

  • Boris MacDonut

    #14 Alec. I think a village must be missing it’s idiot. The Euro has caused nothing but grief to “peripheral” countries.You are simply repeating a pile of tripe you read in the Daily Mail,whose journalists can barely sit up straight. The best thing for the Euro would be for Germany to leave as everyone else has to reference Germany,it would be easier if Germany had it’s own currency, the GB Pound is a good shout from #17sw.

  • Colin Selig-Smith

    Germany isn’t leaving the Euro. You think it’s a financial decision? It’s not. It’s about peace.

    The Germans will moan about inflation, and put up with it.

  • Roberto Birquet

    don’t worry about Alec. He’s a moron; it’s in his DNA.

    The only ones who have been living in denial and spending every day like xmas day have been the banks, the over-inebted, BTL investors, and home owners. A huge proportion of those largely caused this global crisis by massive extensions of their debt, and are the ones who have been bailed out all along by, of course, the innocent. Those who did not take on vast quantities of debt and who now get zero interest on savings, and find that banks and govt are in cahoots to stop repossessions; the only remaining means of buying a home.

    The last in denial is the economics profession, which has yet to wake up from the implosion of its cosy consensus.

  • Boris MacDonut

    I feel the biggest threat to the Euro is Little Englander types with zero confidence

  • herr reemonkee

    Most non-Germans don’t realise that Germans have just gone through two decades of pain already. Did nobody notice that all the holiday villa’s in Spain were being sold by Germans, mostly to over-Mortgaged Brits, in the 90s and 2000s.
    First, they paid for re-unification – a VERY long process to bring a 1930s infrastructure and economy (East Germany) into the present day and future ready.
    Then they struggled to modernise the West, almost Thatcher-style, because they had very outdated industry..
    Then they had to pay, almost as a penance, for the Euro-project – the best chance for peace in Europe since the Roman Empire (and the same opportunity for a single currency trade system).
    No German I know likes the situation in Greece, Spain, Italy, even Belgium – and they are mighty offended as individuals when they hear what Greek/Italian politicians are saying about them. There is a real feeling that too many are biting the hand that is feeding them.
    But – leave the Euro?
    Not a chance!

  • Boris MacDonut

    #22 herrreemonkee. Not since the Roman Empire. Since 1815. After the Congress of Vienna and Waterloo there was 99 years of peace ineurope interrupted only by Italian and German unification wars and the collapse of the Ottoman Empire. I have struggled to find another 99 year period beteen 410AD and 1789 that was so peaceful.

  • Herr Reemonkee

    Boris – nice observation and, of course, most of Germany wasn’t in the Roman Empire. But the Romans did have a single currency.
    The idea of the Germans leaving the Euro is wonderful – especially to folk like me who bought property in Germany and would love to see a double-your-money exchange from DM to Sterling (And that would be a dead cert from day one of the new exchange).
    But it’s never going to happen. Germans will deal with another ten years of hard times – and though they will complain like hell, they won’t let go of the goal.
    You would be better putting your money in tulips than on Germany leaving the Euro.
    Personally, my new interest is internet TV – apparently, its superfast!

  • Supersol

    The only way this can end in anything other than chaos is for Germany to quit the euro; see


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