Sunday, May 30, 2010

On the euro crisis

Carry Trade is forex. If u want to play in it u can google fxcm. The reason more people are using the carry trade on euro is because they are expecting the euro to fall. There are other countries with lower interest rates, but the situation in the european union looks bad because of Greece's recent almost default, there are many other issues with the other countries in the european union as well. Read why the euro is falling.

Sovereign default
The whole issue on the Euro right now is that some of the countries in it are very heavily in debt, and they cannot afford to pay off their debt. AKA sovereign default, sovereign default is when a country defaults on its debt, essentially this is like the country going bankrupt... The main problem countries in euro right now are the PIIGS, Portugal, Ireland, Italy, Greece and Spain.

Typically, because countries are considered very safe investments(people feel that they will definitely get their money back), they are rated AAA or the highest rating available. This rating means that the debt that they issue(bonds etc) will have a very low interest rate. The problem with some of these PIIGS, is that their rating has been downgraded, so not only do they have a lot of debt that they cant pay off, the interest that they need to pay for new debt has also increased. So they cant pay off their existing debt, and any new debt that they want to issue, they will need to pay more for it.

Sovereign default is a very big big thing, because a country issues a lot of debt (bonds, treasury bills, debt securities) and these debts are bought by a lot of banks/other governments. There is a rippling effect if a country were to go bankrupt, because if the government goes bankrupt, the people who are holding the billions of the countries bonds/treasury will not be able to recover their debt. Which might cause them to go bankrupt as well. The government would also have to reduce their expenses by cutting budgets. Take away unemployment benefits, social security, reduce the government workforce etc. This means more people will become unemployed, there will be less money in the economy, less money around means less consumers for businesses. Certain businesses might have to close down, etc etc. Demand for imported products will fall.

Euro currency is flawed
The entire issue of the euro is that the currency is pretty flawed, because there are strong countries and then there are weak countries. But u have one currrency to govern them all! zz.. For example, if you have a low productivity country with a weak currency, because their currency is weak. They cannot buy a lot of stuff, they can just buy what their currency will allow them to buy. When these weaker, low productivity countries are given the euro, they are able to spend more than they ought to be able to. So they consume more than they produce, and over time their debt grows and grows until they implode, like what the PIIGS are doing now(They call this being fiscally irresponsible). The other side of this is the strong, export driven countries in the Euro union. Countries like Germany, benefit the most out of this euro union. About 50% of Germany's total exports go to other Euro countries.

A lot of the euro countries are unproductive
Bailing out countries like Greece is just a temporary solution, they either need to be kicked out of the euro, or they need to be more productive and produce more than they consume, but because their people are lazy assholes who only work 5 hours a day and get paid much higher than say.. countries like China which has cheaper labour, or countries like Germany, which has much more technology. They are not able to produce as many products to export, and they like to spend their money. Unless there are some real changes in either the way the people consume, or the way the government allocates resources, Greece is going nowhere, even after being bailed out by the IMF + some other countries. Hence, the "austerity measures" that u can read about if u were checking up on Greece when it happened, Greece will need to cut down a lot on government spending to pay off their debts . This applies not just to Greece, it applies to many of the other euro countries because there are many other countries in the euro which have similar characteristics as Greece, eg: the PIIGS, which are the most well known.

Why the euro is falling
So.. u might be asking... what does this have to do with the euro falling? It has to do with demand for the currency, if u want to do business with a euro country, u are going to need euros, or say, if u(big big big banks/other countries) want to put ur money somewhere safe, u are going to want to put it in a reputable currency, or a currency u think is going to rise. Demand for a countries currency will cause it to rise. Euro used to be a reputable currency. If u think euro is going to shit, and u want to make money off the euro coming down in value, u can do what the article is saying, u borrow the euro's and put it in another currency that u think is going appreciate. Any interest differential in these 2 countries, (eg: euro interest 3%, australian dollar interest rate 5%, u borrow euro's at 3% and buy ausd, then put the australian dollars in an australian bank to collect the 5% interest rates). will be ur's, in this case u make 2% of the money u borrowed per year. However if the euro drops 20% against the ausd, u can pocket the 20% difference and take ur money back to euro to pay off what u owe in euroes. The effect of this carry trade is that the AUSD will appreciate and euro will depreciate when u borrow money from euro to buy ausd, and when u take ur money back to euro, the opposite happens.

What is happening now is that, not only are the economies of a lot of the european countries doing badly, people are also losing confidence in the euro, which means they might be selling their euroes to buy other countries. To top it off they are also betting against it by carry trading, this makes the euro fall even harder.

The problem in the european union will affect the world
The problems in euro will affect the whole world because the western countries like the european union and the us are such big consumers, if demand from these huge countries were to fall. Demand for a lot of products would shrink, this would impact the big export countries like China and Germany, weakening in these countries will cause other countries who rely on it to weaken. EG: contagion, this country goes bankrupt, that country enters recession. The only question is how much the demand that will disappear from these countries will affect other countries.

not so sure if this is what u were looking for... but just for the record. There are ppl saying that it might go to par, which means 1 for 1. Some people are saying this is the bottom, and that it will go up after this.

Personally I think the euro is going to continue going down... but its gone down for some time right now, there might be a rally.