Analyzing Hypothetical Cases: And What If There Was No Euro ?

About five weeks ago I wrote the first post in my “hypothetical case” series of articles in which I analyzed some of the possible effects a single world currency would have on the Forex market. Today I want to continue these series of posts with the analysis of a much closer hypothetical case involving potential changes on the Euro zone currency and the effects this would have on our Foreign Exchange trading activities. Within the following paragraphs I will give you my opinion about the current state of the EU and what I believe would happen with our trading if the EU dissolved into either many different smaller currencies (how it was before) or a couple of “block” currencies characterized by different country makeups.

Certainly many of you may have considered that the EUR is an impossible dream – especially within this past year – since it becomes obvious after looking at the 2008 economic crisis that there are many challenges ahead of countries who choose to have a common currency. The main problem is generated when the common currency is not tied to common fiscal policy something which  leads to countries having different debt and spending policies which in the end cause a need to adjust their central interest rates differently. For example during last year it was pretty obvious that Greece needed lower interest rates – to increase liquidity – while other countries like Germany were starting to need hikes – to ward off inflation.

With countries entering economic cycles at different rhythms and depths pressures will start to build across both sides (countries that need less money supply and countries which need more) something that in the end may cause the EUR to be an unsustainable project for some EU members. This could happen to either members who need much more liquidity or members who need much less. The problem here becomes to control the money supply across a region where money doesn’t need to be distributed in an homogeneous fashion.

Does this mean that the EUR is a doomed project ? I would say that this is not the case due to several important reasons. The first one is that the EUR was created as a mean to reduce trading costs across European countries and therefore the increase in trading costs as exchange commissions (bid/ask spread) for those countries that wanted to leave the union would be a  strong detriment towards any breakup since it would put them at a commercial disadvantage against other countries which stayed on the EU. The second reason is that this trade in effect acts as a distributor of money supply across the European Union and therefore the possibility to have a devastating crisis on one country eases as another reaches the other extreme. For example it would be hard to have very high inflations in Germany and deflation in Greece since businesses, people and banks would potentially move their money to buy cheaper greek goods, therefore shifting the money supply from the “over flowing buckets” to those in need.

There are another set of powerful reasons around why the EU won’t dissolve centered around the current commitment of the countries of the EU. The largest EU members – France and Germany – have all their debt issued in EUR and owe debt from other EU countries. Therefore it is not a good thing for anyone if the Euro ceases to exist as it would pose a massive catastrophe regarding the valuation of certain assets. For example if the EU dissolved today, how would you differentiate 100 EUR of German debt against 100 EUR of Spanish or Italian debt ? The problem here becomes that the system is already “too big to fail” so to speak, and probably the biggest members of the EU will never leave the project unless it was their only choice.

It is important to consider that it is “very easy” to go from many currencies to one but doing it the other way around is incredibly hard since everyone now has the possibility to exchange their old currency at the best new bidder. Imagine if the EUR ended today what would happen. People in all over Europe have EUR and if they had national currencies again probably everyone would go to the country with the most favorable EUR/New currency exchange rate to get the best out of their EUR. This would mean massive chaos in the sense that the EUR would become a sort of  “wild card” as it gets divided amongst many different national currencies.

However if the EUR dissolved or divided itself into two block currencies, it is obvious that the underlying trading that goes on through EUR denominated dual currency services (such as the EUR/USD) would still have to be made somehow and therefore if it was called EUR/USD or JUK/USD, it would still have the same underlying value. What this means is that the real trading being made behind the EUR/USD would still have to be made through some instrument and this instrument would have the same underlying price characteristics. This is something I showed quite clearly a few weeks ago when I studied a system developed from 1990-1999 on the DEM/USD on the EUR/USD. The system continued to work because the DEM->EUR conversion did not change the underlying economy and trade that caused all these movements.

Long story short, if Europe is still there and their trading volume remains similar, then there will be an instrument which would be equivalent to the current EUR. This probably means that EUR trading would be equivalent to the most liquid pair (for example the DEM/USD 12 years ago) but even if this is not the case you can always create synthetic instruments based on all the new European national currencies to simulate the trading of the EUR. In the end if the underlying volume is still there then the same inefficiencies are present because it is the trading activity – and not the name of a currency pair – what generates the action you see on your charts.

In the end I do not believe the EU will break but even if it does, I am certain that as long as there is volume being traded between Europeans and Americans there will be some instrument to trade in the same way as the EUR is being traded today. If you would like to learn more about my work in trading and how you too can design your own trading systems based on sound trading tactics  please consider joining, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach towards automated trading in general . I hope you enjoyed this article ! :o)

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