Wednesday, June 01, 2005

Euro Pop?

WaPo on the Euro's decline:

The euro slid to its lowest level against the dollar in eight months on Wednesday, as expectations the Netherlands would reject the EU constitution in a referendum intensified doubts about European integration.

Economists said the euro likely would recover in the medium term as persistent worries about the U.S. trade and budget deficits return to haunt the dollar.

The currency was pushed down in part by an unsourced report in the German weekly Stern that a possible failure of the monetary union was discussed at a meeting last week attended by Germany's finance minister and central bank chief.

The article highlights two different econometric forecasting models:

1. A Continuous model, which holds that the twin US deficits drive the $/Euro rate and as the US gets its house in order, the rate will progressively change.

2. A Discontinuous one, which says the Euro may just collapse.

Markets are completely ineffective at predicting discontinuities.Yet discontinuities occur all the time - this is why the performance of Mutual Funds (Unit Trusts) can't be predicted from their past performance, and why professionals are worse at picking stocks than simple Index Trackers. Hence the sensitivity to rumors.

I'm no better at forecasting discontinuities than the professionals. But a Euro collapse seems plausible: Germany & France have abandoned the Stability Pact that was supposedly essential to underpin the Euro. All the big Euro-based economies are in severe trouble. The bond rates that governments need to set to raise loans are diverging across the Euro zone.

So I'm glad to have dollar-denominated assets.

As ever, this is not investment advice, currencies can go down as well as up, etc etc.