Is the Flight to the Dollar about to End?

An article on Zerohedge.com speculates on how the consequences of the dissolution of the European Union on the value of the Euro. An interesting scenario at the bottom of the article offers a prediction if a partial North-South split occurs. If the EU gets rids of its “deadwood” in the South, then the Euro will rise in value to $1.60. Under this scenario, the dollar will depreciate in two ways:

  1. The new Euro will have a higher value compared to the rest of the world’s currencies.
  2. The dollar’s recent rise based on its perceived safety in relation to the rest of the world’s currencies will be gone.

Of course this is just speculation on the part of Zerohedge. The massive depth still incurred in the Northern portion of the European Union is not manageable even in this scenario. Fortunately for the United States, we can print money in the wink of Bernanke’s eye. Or at least until the people realize that they are no longer working for themselves. Redistribution, excessive taxes at all levels of government and inflation will only be tolerated until the price of gasoline hits $5.00 per gallon.

David DeGerolamo

Boom!

The point on legacy currencies made by S&P is actually an old one. Many have insisted that monetary union between north and south was a mistake. But for S&P to have put it on the table is very confrontational to existing EU thinking regarding the need for a breakup. European leaders have all along ignored the blogs and various MSM commentators. Their line has always been, “A breakup is unthinkable”. Not any longer.

I don’t expect “Merkozy” to change their stance on the single currency issue anytime soon. But others will. The message in the S&P FAQ will not be ignored. We’re going to see it in the MSM, and we’re going to hear about it from both the political and the financial sides of governments (and of course, the blogs).

The thought process of a resumption of legacy currencies won’t start on Monday. Before this can be accepted as a viable option, things have to first get worse. Much worse. Liquidity has to dry up further. Bond spreads for Italy and Spain have to widen. Funding conditions for the banks have to get worse. Equities (especially bank stocks) have to be broadly declining. The economies of the region need to be in recession coupled with very high rates of unemployment. Declines would be most severe in Spain and Italy. Social disturbance would be on the rise.

Reading the S&P FAQ, you have to conclude that the conditions that would force a return of the legacy currencies will happen, and they will happen in the next twelve months.

There are some very substantial currency implications built into this line of reasoning. If you believe, as I do, that things have to get (much) worse before we see Pesetas and Liras again, then you might logically conclude that the Euro is first headed south against the crosses. EURUSD at 1.100 would not be out of the cards in this scenario.

But consider the end game for this. What’s the value of a Euro if Spain, Italy, Ireland and Portugal were no longer part of the monetary union?

That price starts at EURUSD 1.6000.

I look at this and wonder if the currency trade of the new millennium is taking shape.

      
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