Euro shock will come with parity to the dollar
By David DeRosa
NEW YORK (Bloomberg): One is a sad number. I don't mean "one" as in not having a date for the Memorial Day barbecue. I mean it as in the euro trading at or below parity to the dollar.
Practically speaking, the euro today is only about four percent away from its date with foreign-exchange destiny.
Parity looks more likely than ever before. What has gotten my attention is the old guard of European finance has finally started to voice concern about the level of the euro. Benign neglect became a scarce commodity when Bundesbank President Hans Tietmeyer last Saturday said he "would not be happy if there would be any further decline" in the euro.
Tietmeyer and the all the rest of the Euroland currency overlords continue to maintain they have no target zone for the euro. Yet I believe they see 1-to-1 parity in their worst nightmares.
There was a similar incidence of parity to the dollar in 1985, only then the object of foreign-exchange scorn was sterling.
What I remember most about those days is the sterling trader I worked with at an investment bank (which no longer exists) in Kuwait, who kept a black armband in the top drawer of his desk. This sterling patriot planned to strap the band on the moment his national currency dropped below parity to the dollar.
The armband never saw the light of day because sterling never broke parity with the buck -- the low was around 1.05.
The dollar peaked in February 1985. Then in September the Group of Five industrial nations (which later became the G-7) opened fire on the dollar in what is now known as the Plaza intervention.
So what I want to know is this: Does the prospect of parity make intervention in the foreign exchange market any more likely? I don't mean a Plaza-style intervention because I doubt the U.S. and Japan really care if the euro dips below $1.
If there is an intervention, it will come from the European Central Bank (ECB). This could be very educational to watch. The ECB has yet to intervene in the foreign exchange market. The first time out will probably be a solo flight, except that the ECB might get some help from the Bank of England.
The UK might be willing to go along with a euro intervention because the strength of the pound has already been identified as a public menace to British export industries. Plus sterling is an official euro-groupie -- the prime worry is that it might end up joining the euro at too high a level than is good for the UK.
Yet all talk of intervention is complete speculation. What we do know is that Euroland has at least four strikes against it.
While the war in Yugoslavia has been negative for the single currency, its influence has been greatly exaggerated. Many Europeans think that it was Kosovo that sank the euro. The Kosovo troubles have had a kind of narcotic effect on the Eurocrats in the sense that it dulled their appreciation for the true causes of the currency's weakness.
The truth is the euro had already fallen seven percent when the conflict started and continued to drop because of fundamental economics and political forces.
And those aren't hard to pinpoint. The 11-nation euro-zone's growth is sluggish. The ECB isn't going to raise interest rates anytime soon, yet the U.S. Federal Reserve is now officially in a tightening stance.
The most damaging of all may be the ill-advised acceptance of a larger-than previously forecast Italian budget deficit. This is just what europhobes have been waiting for -- clear evidence that adherence to the much-touted Stability Pact, which outlines economic and monetary union, is not a priority.
The credibility of the euro depends more than anything else on member-nations controlling their budget deficits.
Still that is a bit of an overstatement. The revised target for Italy of a deficit of 2.4 percent of gross domestic product (from the previous two percent) is still within the Maastricht Treaty guideline of three percent. The shocker is how fast the Europeans accepted Italy's revision, seemingly with a wink and nod of complicity.
It will be interesting to see how much of a shock that breaching parity will give the Eurocrats if their currency continues to fall. Get those black armbands ready at the ECB. Still, I hope nobody believes that intervention can save the euro from its rotten fundamentals.
The writer is president of DeRosa Research and Trading and an Adjunct Finance Professor at Yale School of Management. The opinions expressed here are his own and don't necessarily represent the judgment of Bloomberg LP or Bloomberg News.