The currency is now more likely to fail, but immediate action will protect us

If the new President of France lives up to his rhetoric and attempts to stimulate growth through further borrowing, then the death of the euro may be closer than even the most bearish of us feared.

The economics of issuing government debt to stimulate growth is a dangerous game for any country, and not just because the money is often wasted on hopelessly unproductive political projects. The risk is that markets lose faith in the state's ability to repay its debt. If this happens, then borrowing costs for the whole economy go up as investors seek a premium to cover the additional risk. At the same time, the exchange rate is likely to fall, as overseas investors sell risky assets in the overindebted state.

Now you might think that France, being in the euro, would be protected from the punishing judgment of the foreign exchange markets. Up to a point you would be right, but there's a catch.

The effect of France's borrowing would have implications for all eurozone countries, not least Germany. For in as much as German creditworthiness supports its more profligate European partners, their profligacy undermines the financial stability of Germany and indeed all other responsible members of the club.

That is why northern European leaders required Spain, Italy, Portugal and Greece to stabilise their national debt. And this leads to many in the southern European states feeling (not unfairly) that austerity has been forced upon them by an over-mighty Franco-German axis.

How will the unemployed of Spain (a staggering 25 per cent) feel about their financial straitjacket when the French Government decides its own population cannot bear a far smaller dose of austerity? The current rise of anti-austerity parties in Greece is testament to the risk. Some countries might simply decide to abandon austerity themselves and with that we would have an implosion, the end of the euro.

Of course President Hollande's victory does not guarantee the demise of the euro, but it nudges it closer to the precipice. We need to start thinking about what we should do.

Nobody knows exactly how the euro will be unwound, which is why I set up an economics prize to discover how this might best be done. However, the most likely scenario would appear to be the exit and concurrent devaluation of one or more of the weaker southern European countries.

David Fuller's view If only it were not true. This whole euro saga over the last twelve years would make a great novel for catastrophist theory policy wonks. In the right hands it would also make a great, edgy film - perhaps James Cameron of Titanic fame.

The stressful and boring bit (the latter being preferable to the former) is living through this event, even from a distance. We knew that last Sunday's elections in Greece and France were likely to roil markets and they certainly have. We still have the Irish vote on the European Stability Mechanism (sic!) later this month and it is by no means certain that it will pass. Additionally, Greece will almost certainly require another election in early June and the country currently looks ungovernable.


Turkeys do not vote for Christmas and in a democratic election people are unlikely to vote for austerity, especially once they have experienced it. Meanwhile, investors are looking at Europe and continuing to vote with their feet.

One of the more worrying charts, often cited in Fullermoney, is the Euro STOXX Banks Index (monthly, weekly & daily) where this year's entire rally has been retraced and then some. It shows some loss of downward momentum near the historic lows but requires more than a 2-day rally to check the downward bias beyond a brief pause. Anyone reading the rest of Simon Wolfson's article above will understand why investors remain wary of European banks, despite the ECB's Long-Term Refinancing Operations (LTRO).

The Euro Stoxx 50 Index (monthly, weekly & daily) is also under pressure. It currently requires a close above 2380 to check the short-term downward bias and a sustained break above the March high just over 2600 to reaffirm prior support from the historic lows. Spanish 10-year bond yields (weekly & daily) are another reason for the concern. Anything above 6% is an increasing headwind for Eurozone stock markets.

The performance of Southern European Indices remains dire because investors are concerned about deep recession, currency losses via the euro and much worse if these countries eventually vote to abandon the single currency. The best that can be said for the stock market indices of Greece (weekly & daily), Portugal (weekly & daily), Spain (weekly & daily) and Italy (weekly & daily) is that the declines are becoming overextended once again, increasing scope for temporary short-covering rallies. This may require a catalyst, most likely from the ECB. The other country on Europe's periphery, Ireland (weekly & daily) has done far better although it has lost upside momentum since the mid-March high and potential support near the 200-day MA is likely to be tested.

Given all this Eurozone muck you may be wondering if there are also some attractive ponies in there as well. You would be correct and they are the European Autonomies such as BMW (weekly & daily) which currently yields 3.4%. Today's downward break by EUR/USD (weekly & daily), if maintained, would indicate that European shares were about to become cheaper for those holding stronger currencies. However, it would do no harm to the likes of BMW in terms of exports and consolidated earnings. Regarding EUR, I would like to see it maintain the break beneath $1.30 before being convinced that this long awaited renewed decline in line with the medium-term trend is actually underway.

(See also Eoin's comments on Europe below.)