Why the euro is headed to $1.10--politicians see it's the easy way out of the euro debt crisis

05/18/2010 10:30 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Why the endless downward pressure on the euro?

Despite a $1 trillion bailout euro debt rescue plan, despite tradition-smashing euro bond buying by the European Central Bank, despite expressions of support from the Euro Zone’s political and financial leaders, the currency keeps tumbling.

Yesterday the euro fell to its lowest level against the U.S. dollar since April 2006. And European and U.S. analysts are openly speculating that the euro could fall even further from the recent lows in the $1.22-$1.24 range. Analysts are saying that $1.10 is a real possibility. That’s another 10% decline from here.

And you can even find projections that the euro will hit parity at $1.00. That would roughly an 18% further drop in a currency that’s already down 14% against the dollar in the last 12 months.

Why so much pessimism about the euro? Is it just typical market over-reaction to a crisis?

I don’t think so. I think analysts and the currency markets understand that despite all the talk from politicians in support of the currency, a cheaper euro is the closest thing national governments in Europe have to a free lunch right now.

Here’s the choice confronting politicians, as the market sees it:

 On the one hand, end the euro debt crisis by cutting budget deficits and lowering economic growth, perhaps enough to send countries from Greece to France into prolonged recessions.

On the other hand, allow the euro to fall further giving European exports a boost, which would support growth, at the cost of somewhat higher inflation, which would, happily, have the effect of reducing the burden of debt for euro-borrower governments.

Gee, that’s a tough one. How long do you think it took government leaders from Paris to Athens to figure that one out?

The OECD (Organization for Economic Cooperation and Development) has even put some numbers to the trade off. For every 10% drop in the value of the euro, sustained over 12 months, the Euro Zone economies pick up 1 percentage point in growth at a cost of about 0.5 percentage points in higher inflation.

That’s a huge inducement to let the euro fall some more in an economic bloc that’s forecast to grow by just 1% in 2010 and only 1.4% in 2011.

The 14% decline in the euro over the last 12 months would add 1 percentage point to that anemic growth. A further 10% drop would bring the gain to 2 percentage points.

And more economic growth means higher tax revenues, which will make it easier for countries to reduce their budget deficits to the European Monetary Union’s target of 3% without the kind of draconian cuts to salaries and pensions that cost governments votes.

Seems to me like betting on further declines in the euro is just common sense.

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