Euro crisis and Europe By ASAD RIZVI

ARTICLE (May 20 2010): In 1991, after the successful gathering of the European leaders in Maastricht, Netherlands, the launch of euro became a strong possibility. Those days, the then German Chancellor, Helmut Kohl, must be feeling very proud as Germany's dream of European monetary integration started looking like a reality.

About two decades later, however, Germany said that 'Europe faces historic test in Euro crisis'. On May 19, 2010, Chancellor Angela was telling the German lawmakers that Europe faces an "existential" test as it works to shore up euro.

It was initially thought that the introduction of euro would bring a meaningful change in world's monetary landscape, bring transparency and lower transaction cost. As in past when US dollar was in trouble the global shift in currency was towards German mark and Swiss franc. The presence of euro also helped in shielding third currencies from too much volatility caused by a turbulent dollar. As the time passed it all started proving to be true.

But the cost of birth and monetary integration is proving to be too high, as it came into existence due to some political reasons. After fighting two World Wars, the Germans were desperately looking for European economic integration, as they wanted to become part of the European family.

Bundesbank, which is one of the most reputed central banks and known for its tougher stance, also learnt lessons from 1920s' hyperinflation. It had to compromise on many weak issues. Germany eased qualification rules to the 16-European nations to increase its exports.

The integration of a larger group of countries with high deficits became possible after Italian PM Romano Prodi's visit to Germany in 1996. He offered Kohl to lay pipeline and buy milk in exchange of support to Italy for euro membership that was having a budget deficit of over 10 percent. It also paved way for countries with weak economies.

The most difficult part for Euro is that there is no ownership of this currency or one would not be wrong to say that euro is without a state as the European member countries commonly use single currency, but every country has its own economic policy and each country's policy differs from other's. There is no back up available for the failing countries. ECB only manages inflation.

Since the birth of euro, the recent crisis is the worst economic condition faced by the Euro-zone. Quite a few countries have breached three percent deficit limits and the biggest problem is that instead of finding a permanent solution, Europe is entangled in a web of debt and therefore, debt is created to settle debt. This is why the market has lost confidence despite announcement of a USD 1 trillion Euro-zone rescue package.

Hence, ECB's independence is now being questioned, as it is not supposed to lend to junk grade. It is not supposed to purchase bonds directly and can only buy bonds from secondary market. Euro zone rules do not allow assistance to governments to finance deficit. The purchase of bonds by ECB also means it is likely to push inflation higher.

Euro that dived to a crucial 1.2145 levels, its lowest since April 16, 2006 after the announcement by Germany's market regulator BaFin to apply ban on naked short selling of Euro zone government bonds and shares in Germany's 10 biggest financial institutions. It has also banned naked default swap on Euro-zone government bonds. However, France said it was not considering a ban on European debt. It also said that it had not been consulted. Short selling is a trade that bets a price will fall. Naked short selling is when a trader sells a financial instrument without first borrowing the instrument or ensuring that it can be borrowed, as would be done in a conventional short sell.

The timing of a halt to sale of naked short sell is very crucial for two reasons as the dumping of euro is thought to be executed by the speculators and this could be a message for to the speculators. The other factor could be that it is the German government's response to speculators and to convince its parliament to allow bail package, as it is ready to defend Euro. But what could be more concerning for the market is the timing to ban naked short selling, which could also mean that there is more trouble in the pipeline.

However, based on above arguments, euro could witness a roller coaster journey, a possibility of a dip to 1.2080 cannot be ruled out, but our research suggests that Friday's New York closing will be the key to watch. If euro manages to close above 1.2280, a correction may occur, which could see Euro raring towards 1.2850. Or else test and break of 1.1910 cannot be ruled out.

Source: http://www.brecorder.com/index.php?id=1059411&currPageNo=1&query=&search=&term=&supDate=