Thursday, January 21, 2010

Greece budget problems = end of Euro?

For long time observers of currency markets, current events in Greece seem eerily familiar.

In 1992 Britain exited the ERM (Exchange Rate Mechanism) after pressure on the sterling became unbearable for the government. It spent 6bn pounds trying to keep the currency within the narrow band of 2.25% versus the determined bilateral rate. The ERM was based on the principle of keeping European currencies within a narrow band against pre-determined bilateral rates. The ensuing crash of the pound on 16 of September 1992 was dubbed "black Wednesday" and some people argued that George Soros was behind it.

Events in Greece highlights the fragility of the Euro. Have investors lost faith in the value of Greek sovereign debt? Probably. The best litmus test is to see what happens when an attempt is made to restore confidence. Quoting Bundesbank member Hans Georg Fabritius "If Greece does not manage to get its budget problems under control, the discussion about a European bail-out will grow in vehemence and take its own dynamic. But the precedent which would result would hurt the credibility of the EUR and shake the foundations of the currency union".

Does it mean that Greece is on its own? This type of response may suggest that hard-liner Bundesbank members have no interest in saving their southern neighbour. It reminds us of the stance the Bundesbank took on monetary policy in the summer of 1992, that ultimately acted as the catalyst for the Pound's exit from the ERM.

We are not too keen on 'politically fabricated' currencies, such as the Euro. Ultimately the outcome of the Greek budget crisis may just signal the demise of the common European currency!

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