Monday, 6 August 2012

Why the Euro is still stable

When Britain dropped out of the ERM, some people got very rich. George Soros was one of those who  bet against the pound remaining in the ERM and the windfall from the decision of the British government (reportedly more than 1 billion dollars) made him a rich man for the rest of his life. The current crisis of the Euro should equally see plenty of hedge funds betting against the Euro but nothing similar to the ERM disaster has happened so far. The question is why is no one betting against the Euro? The answer is an interesting one and reveals why the Euro is not dead by any measure.

First, the Euro has remained stable in terms of currency fluctuations. The reason is that, while capital flight from Greece, Spain and Italy has certainly occurred, the surplus money has mainly been invested in German bonds, which balances out the Euro capital flows across the currency zone. Second, Spain and Italy have actually imposed bans on short-selling which prevents hedge funds to bet against Spanish and Italian bonds. With Greece the case is slightly different. Although credit default swaps are still in place, any heavy betting against them may trigger a large scale default of the country which in effect wipes out any chance of gaining a profit in the process. So there are limits to the profit you can make in a highly speculative market. Traders know that and hence stay away from an overheated Greek bond market.

But a look at some of the capital transfers within the Euro zone also indicate why the currency is still stable. Although there are some serious divisions between those countries that lose capital there are also winners such as Germany. In order to balance the loan commitments between individual national central banks and the ECB, the German Bundesbank has lend back much of the capital it gained through the bond market to the ECB. According to the New York Times, the Bundesbank lend the ECB over a 12 month period more than 730 billion euros up till June this year, double the amount it led in the previous 12 month period. So, while the Euro is internally riven with divisions, the overall capital transfer balance ensures that the Euro itself has not come under the onslaught of traders betting against a Euro collapse. However, as Moody has pointed out recently in its report on Germany's credit rating, Germany's ability to counteract some of the effects of this capital flight is not unlimited. So the picture can change very quickly and we may still see some people getting very rich indeed.


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