The August 2007 to July 2008 euro bubble ended spectacularly. In three months of trading, the united currency lost almost quarter of its value against the dollar. Valuations in bubble markets are divorced from reality, they are propelled higher by the internal logic of profit. As long as participants in the market can push prices higher then some will make money and the bubble is self-sustaining. But when the collapse comes, it is swift, deep and usually irreversible. Bubble markets do not recover.
Financial market bubbles are often accompanied by a theory that explains why the unusual valuations, so different than traditional measures, are consistent with good sense. For the euro bubble, the fashionable theory was ‘decoupling’; the idea that American banks were uniquely infected with the sub-prime virus and that the United States economy could drop into recession but Europe and the rest of the world would sustain moderate if not robust growth. Until quite recently, the European Central Bank (ECB) had ascribed to this idea, and used it to justify its July rate hike. But the bank endorsement did not give the idea any more credibility.
Peak to trough the euro lost 23% against the dollar from mid July to the end of October. It has recovered a scant 2.0% at Friday’s close. Its greatest recovery, which lasted less than one day, has been 6.0%.
Since the great fall, the euro has traded in a 500 point range around 1.2750. That range was last occupied between May of 2006 and the end of that November. In that period the Fed was just finishing a long series of rate hikes which halted at 5.25% in mid year. The ECB was also raising but would not finish until it reached 4.0% in the early part of 2007.
The current rate situation is similar but in reverse. The Fed has orchestrated a historic 4.25% reduction in the target Fed Funds rate since last September. But Mr. Bernanke and the board are almost finished cutting, regardless of whether rates are slashed at the December 16th meeting or not. At 1.0%, the Fed cannot realistically go much lower. Mr. Trichet and his bank are headed in the same direction and to a likely similar end. But, as in the 2006 period they are six months to a year behind the Fed. In 2006 the ECB rate hikes were the new factor; now the new consideration is the ECB cuts.
In 2006, the US economy grew at an annual rate of 2.7% in the 2nd quarter, 0.8 % in the third and 1.5% in the fourth. The Eurozone expanded at 2.9%, 2.8% and 3.2% respectively in its year to year measure. In the third quarter of this year the Eurozone was already in recession, having fallen 0.2% in second and third quarters. Even the most sanguine market observers expect at least two more negative periods. Though the US may not officially be recessionary, having scored 2.8% growth in the second quarter and -0.3% in the third, a dismal fourth quarter is predicted. Perhaps GDP will contract by as much as 3.0% annually or more with much gloom anticipated in the early quarters of 2009.
In 2006, the six month pause in the second half of the year was only a brief stay in the euro’s seven year rise against the dollar. But there is little reason to think that the dollar has begun a new long term advance against the euro with its run of the last four months. The economies of both the United States and the Eurozone are probably in for long comparable bouts of recession and low interest rates. Neither GDP growth nor central bank rate policy will provide the competing currencies with an advantage. But if we have not started a strong dollar period, there is also no reason to expect a substantial rebound in the value of the euro against the dollar. Bubbles do not recover.
The August 2007 to July 2008 rise in the euro was not part of the longer trend going back to the early years of the decade except in the sense that the prior trend gave traders confidence in the upward movement. The August inception was the product of two singular circumstances and the erroneous interpretation of one.
The first, of course, was the US sub-prime and asset backed securities debacle. The potential for disaster was correctly diagnosed by Mr. Bernanke and the Federal Reserve. It was a serious threat to the banking system and American economic growth. Even if the governors did not at the time know how it would play out, they clearly saw the danger and immediately began to support the economy with lower rates. The ECB did not sense the danger. Its spokesman continued to preach the anti-inflation gospel throughout this period even raising rates a final 0.25%. And it was this ECB confidence that gave the united currency such strong backing for the entire period. If further proof is needed of the effect of the false confidence of the ECB on its currency, we only need remember that it was Mr. Trichet’s statement in mid July that Eurozone growth was going to be much weaker than the bank had previously predicted, that set off the euro cascade.
The second circumstance was the easy credit in the early part of the decade which contributed a great deal to the boom and now bust in the housing market. It is harder to gauge its effect on the commodity and currency markets. But the appearance of price bubbles in many commodities and commodity currencies including euro and oil, at the same time speaks of, if nothing else, a willing suspension of rationality. It is no coincidence that the price of oil and the euro reversed within days of each other. This circumstance is now ended and the analysis that justified the rise of oil and the euro now seems slightly foolish.
The euro bubble is gone. It will not re-inflate. The dollar and the euro have begun a new relationship, or maybe just renewed an old one.
Related Articles
|
Top Rated Comment Streams:
-
1.Hedged In662
- 2.
-
3.Smarty_Pants417
-
4.axelrod608312
-
5.cos1000277
- Free E-Newsletters
- About Seeking Alpha
- About Us
- Contact Us
- What's New
- Readers Feedback
- Advertise With Us
- Contributors
- Contribute an Article
- Feature Your Book
- Our Contributors
- Anonymous Contributions
- Dispute an Article?
- Legal
- Terms of Use
- Privacy
- Copyright
This article has 6 comments:
-
drevno
-
6 Comments
Nov 26 10:35 AMBubbles are started by speculators who figured out where are willing punters (the British for 'gamblers' or anyone who's making a bet on something). Every bubble is a pyramid scheme, and as such, it will always collapse. Whether it is from the overinflation of the bubble to the point of losing coherency and the required opaqueness that makes it exciting to bet, or from running out of punters, or the inability of the operators to juggle the ever increasing number of participants and the ever increasing value of the thing associated with the bubble. From this perspective, ANYTHING that grows at anything greater than some mild linear fashion or stays put, is an explosion, and as such, it must reach its peak and than collapse on itself. In economics, not every bubble is the same in terms of duration or size. It is the irrational exuberance (aka an unusual and mostly ill-founded propensity) to buy a particular thing for some reason right NOW.
It is important to distinguish and separate the legitimate demand from the speculative one. For example, there's a real demand for houses from people who wish to live in them and are able to pay for them on mutually understood terms. And there is speculative demand from people who buy and flip them for profit to the next punter. Or a speculator (and here I hate using this terms, although it is a correct one), who bets that he/she can live in a house that is only marginally or actually not at all affordable, and acquires it with a mortgage from a willing pyramid scheme operator (e.g. a sub prime mortgage lender) against any reasonable odds.
The problem with these bubbles for a majority of people - including some working in responsible positions in the government - is that they come to them largely unnoticed and tend to become too large too quickly to deal with conveniently.
Fortunately, there's a possible way to identify and predict bubbles and the crises that they entail. It is possible to monitor from existing statistics and with existing resources the activities in all industries, all sectors, for deviations from a long-term average trend. A deviaton, say 2-sigma would automatically trigger a government, industry and public scrutiny as a MATTER OF POLICY. Representatives of the industry/activity, government and the consuming public - with equal 'voting' rights, would get together and discuss the matter with a full attendance of all sorts of media. The feedback is than rolled into legislative or regulatory actions and immediately implemented, if so agreed by the majority.
This suggestion has the added advantage that by including the 3 principal factors of economic coexistence - demand, supply, and rational governance, maximum degree of transparency is obtained.
Demand should always demand (in the lead), supply always supply as demanded, and the governance see to it that the common resources from taxation and the natural heritage (aka the social and public goods infrastructure, the land, the oceans of air and water) are fairly and effectively used to support the demand-supply equilibrium.
Yes, equilibrium. Even in the long term. Only that is sustainable, only that is democratic, and only that might offer a good and stable economic platform for the sustained presence of humans on this planet.
-
EUARTE
-
61 Comments
Nov 26 10:36 AMCitizens of various countries in the EU are well aware that they have little or no say in the direction of the EU - political or monetary. Remember, only Ireland, God Bless Her, was allowed to vote on the new faux constitution. There is a lot of resentment below the elites.
When the economies get even worse in the next four quarters there will be a rush to blame. Guess who will get the blame? The EU. Next, if not first, will be the €. The German people hate it. The Italians never liked it. There will be heavy preasure for member states to get out of the €. I am not saying they will succeed but the movement will be much stronger than the elites are foreseeing.
I am sadly proud. I predicted the demise of the € even as it was being forced down the European throat. If they are smart, they are not, the elites will either join in with the general population our find some alternative to the €. The only alternative is a return to EU as a community based on trade. They will not do this becasue of the jobs and titles the elite hold.
Good bye €!!
-
zanardm
-
42 Comments
Nov 26 04:17 PM-
zanardm
-
42 Comments
Nov 26 11:25 PMOn Nov 26 04:17 PM zanardm wrote:
> If the Euro dollar can have a bubble, then why not the U.S. dollar
> and treasuries, after VIX subsides? Are treasuries closer to a top
> or bottom? When everyone has bought in, and is safe in the treasury
> bubble, who's left to creat demand? One might not have a warning
> of a slow evolving yield curve, but rather in, our extreme volatile
> deleveraging environment, perhaps a stampeed of sellers for some
> retrospective reason; markets don't need an excuse to deflate; they're
> just top heavy; everyone is in. So plain old profit taking can snowball.
-
Ben Holdsworth
-
42 Comments
Nov 27 06:55 AMUK housing prices.
California housing prices.
Currencies....USD was at $1.45 per GBP in 2001, got to $2.11 in 2008 and "crashed"/ga... again to $1.45 in 2008. BPS "inflated" in between. Now what -- if the USD is trashed with $7.6 trillion in overhang -- what will happen vs. the GBP and EUR?
My take, EUR will become more a currency of "choice" in a multi-polar world.
-
analyste
-
6 Comments
Nov 28 10:21 PMIt's essential to remove emotion (and petulance) from your investing rationale, whatever the investment. Declared or undeclared 'loyalty to the Dollar,' OTOH, is as foolish as any other knee-jerk reaction.
The many currency ETFs now available provide excellent opportunities to diversify away from Uncle Buck, think of the alternatives!