For the first time since 2002, the euro trades at parity with the dollar. In the summer of 2008, one euro was worth as much as 1.6 dollars. But with the eurozone on the front line in the war in Ukraine and the ECB simultaneously cautious about raising interest rates because of fragmentation risks, the euro seems to have only one way to go and that is down. The rapid decline of the euro is a harbinger of the next euro crisis.
The eurozone is getting the full brunt of the sanctions against Russia. From this week, Nordstream 1 will be provisionally closed, the only major gas pipeline from Russia that is not near Ukraine. All other pipelines from Russia are likely to stop carrying gas soon because of the war. They will be destroyed by Ukraine or else the Russians will hit them with their not very subtle artillery.
German engine without energy
Because of Nordstream, Germany - until recently the engine of the European economy - is highly dependent on Russian gas. Without this gas, the German economy will suffer greatly. Moreover, this is not the only problem for the Germans. Germany is ageing rapidly. Until now, these relatively old workers with a lot of experience have been the most productive workers in the world, but this group will retire in the coming years. Furthermore, since the 1990s, Germany has also been bringing in many relatively cheap workers from Eastern Europe. The ageing of the population there is even faster than in Germany; on balance, even fewer children are being born per capita there than in Germany.
Finally, Germany is finding it more and more difficult as the Export World Minister, because every country in the world is striving more and more for autonomy and self-sufficiency. The Chinese now prefer to buy their own cars, and otherwise the Japanese, thanks to the cheap yen, can gain an excellent market share from the Germans. In the United States, too, the Germans› market share is shrinking. In the rest of Europe, it is the price of natural gas that is killing the economy. Compared to two years ago, the prices for European natural gas have gone up more than 12 times. Expressed in terms of the price of a barrel of oil, natural gas now costs $600 a barrel, more than enough for a deep recession.
Weak euro fuels inflation
In the years after the Great Financial Crisis, every country tried to bring down the value of its currency, but because they all implemented more or less the same unconventional monetary policies, this collective race to the bottom did not succeed. Now the Federal Reserve is in the process of raising interest rates, while the first ECB rate hike is yet to come. In June, prices in the eurozone rose by 8.6 percent. The weakness of the euro may cause inflation to rise even more sharply.
Reaching parity with the dollar works like breaking through a psychological barrier. When this is broken, the euro can quickly fall to 90 cents. Another problem for the euro is the increasing European trade deficit. In the past, many euros went to Russia and came back in the form of investments, savings accounts and to finance football clubs, houses and super yachts. Now energy has to be paid for in dollars, dollars that Europe has to earn first. Not easy with these high energy prices and relatively high wages.
Furthermore, there are doubts about the proposed interest rate increases by the ECB. Eurozone debts are high and even a hint that the ECB might raise interest rates caused Italian yields to rise rapidly to above 4 percent (for the first time since 2014). Since then, investors may seem reassured by the ECB›s anti-fragmentation mechanism, but in fact this system is a bomb under the euro. Monetary financing of only the southern member states is a bridge too far for the North.
Existential crisis for the euro
The first twenty years before the US dollar (1792 - 1812) were also very turbulent with uprisings and wars, but the United States of America at that time formed a convergent system. The federal government had sufficient power, including the fact that it could finance itself by collecting taxes. The euro remains a divergent system. Each crisis creates greater divergence, not less. France is just one recession away from Italy.
Draghi did promise in 2012 that he would do everything he could to preserve the euro. Ten years later, as Prime Minister of Italy, he will experience the consequences of that statement. France, Spain and Italy will eventually go bankrupt if the interest rate remains at 4% or higher for too long. For far too long, interest rates have remained artificially low to keep the weak and indebted eurozone countries afloat. Now that inflation is rising, interest rates have to go up. The ECB can keep interest rates low, but then the euro will fall further and inflation will skyrocket, probably resulting in the end of the euro.
ECB hike risks fuelling populism
If the ECB decides to raise interest rates anyway, the southern member states will end up in a debt/deflation spiral that gives plenty of room for populist parties. Next year there will be elections in Italy, among other countries. It is politics that is responsible for the introduction of the euro and probably only politics can seal the end. At a time when Italy is in the umpteenth recession since the introduction of the euro and tens of millions of people from Africa are crossing over as a result of high food prices, the right-wing populist parties have enough wind to gain a majority in parliament.
The end of the euro is therefore fast approaching. In every bear market, there is eventually a major institution, financial institution or country that gets into trouble. In 1997 it was several Asian countries, in 1998 it was LTCM and Russia, after the dotcom bubble it was a laundry list of companies, from Enron to Worldcom. In 2008, it was Lehman and perhaps this time the euro, and with it the European Union, will be the victim.
Han Dieperink is chief investment strategist at Auréus Asset Management. Earlier in his career, he was chief investment officer at Rabobank and Schretlen & Co.
This column originally appeared in Dutch on InvestmentOfficer.be.