By William L. Watts, MarketWatch
LONDON (MarketWatch) — The euro is damaged goods, laid low by a debt crisis that has revealed the shortcomings of European economic and monetary union, economists say.
But while the episode raises questions about whether the single currency can survive without major changes, others say it’s too early to dismiss the single currency’s role as one of the world’s premier reserve currencies — and alternative to the U.S. dollar.
“It is clear the euro is a tarnished currency,” said Neil Mellor, currency strategist at Bank of New York Mellon.
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The euro’s problems, however, come in the wake of a wider, global financial crisis that has served as a “reminder to reserve managers that actually having just one currency or even two currencies is bad for the majority of their portfolios,” he said.
The euro (CUR_EURUSD 1.36, +0.01, +0.56%) has suffered a huge plunge versus its major rivals and has dropped from more than $1.50 versus the U.S. dollar in November to trade below the $1.36 level Friday. Last week, it changed hands at a nine-month low of $1.3440.
Pressure stems from fears heavily-indebted Greece could see further downgrades to its credit rating or could potentially default on its debt. European Union leaders earlier this month offered a vague pledge to do whatever is necessary to support Greece, but market participants have been unsatisfied by the lack of detail.
To some strategists, however, Greece’s woes merely amplify other bearish factors for the euro.
“All the Greek story does is reinforce the idea that in the context of the three major central banks (the European Central Bank, the Federal Reserve and the Bank of Japan), the ECB will probably be the last to hike rates,” said Marc Ostwald, strategist at Monument Securities. See related story on how to fix euro.
The crisis has “done some damage” to the euro’s reputation, but investors still must ask themselves what other deep, liquid alternatives are there to the dollar and the yen, Ostwald said.
And with burgeoning debt levels of their own, neither the United States nor Japan outshine the euro to a blinding degree, he said.
But euroskeptics say that the episode has demonstrated nothing less than the impracticality of the union.
They have long argued that a one-size-fits-all monetary policy and a lack of fiscal union means debt woes, such as those now seen in Greece and elsewhere in the euro zone, could eventually split asunder the single currency.
“Any ‘help’ given to Greece merely delays the inevitable breakup of the euro zone,” Societe Generale strategist Albert Edwards argued earlier this month in a research note. Read about Edwards’ warning.
There’s little question the euro’s selloff “is being characterized as a question over its durability as an entity,” said Daragh Maher, currency strategist at Credit Agricole.
In other words, traders aren’t selling the euro for cyclical reasons, such as fears of weak euro-zone growth or expectations the European Central Bank is set to cut interest rates.
“It’s not that kind of driver. It’s actually nervousness over the euro experiment for want of a better word,” said Maher, who thinks the euro will survive.
Euro bears see the potential for much bigger declines.
Hedge fund managers have piled into massive bets against the single currency, with some targeting parity — or equal value — with the dollar, The Wall Street Journal reported Friday.
Political commitment to the euro by European Union leaders, however, is likely to ensure ultimately that the single currency doesn’t fail, say some economists.
“But if it survives this crisis, there will need to be much greater progress on structural reform and internal cost flexibility than (before), and the systems of fiscal transfers between members and crisis management will need to be significantly embellished,” wrote Russell Jones, global currency strategist at RBC Captial Markets.
And for now there appears to be little appetite for tighter political or fiscal integration, noted Paul De Grauwe, a senior fellow at the Brussels-based Center for European Policy, in a recent paper.
“One is led to the conclusion that the inability to create a more intense political union in the euro zone will continue to make it a fragile construction, prone to crises and great turbulence each time such a crisis must be resolved,” he said.
While more rough sledding may be in store, BNY Mellon’s Mellor contends calls for euro parity with the dollar or a euro break-up are overdone.
Credit Agricole’s Maher said the sovereign concerns will eventually be viewed as overplayed.
“I think the euro will remain a very important reserve currency, but it is a difficult time because it’s not just a cyclical perception, people are wondering if this is the first test of monetary union,” he said.
William L. Watts is a reporter for MarketWatch in London.