Since the beginning of May, the euro has lost around 5% of its value on a trade-weighted basis. Against the U.S. dollar, it has lost as much as 8%. This is a clear signal that the eurozone debt crisis has reached the currency markets. The euro threatens to fall further, possibly leading to serious concerns about a devaluation spiral.
In view of the way events have escalated in the eurozone over the last few years, what is surprising is not so much that the euro has shed its fundamental overvaluation, but rather that this correction did not happen sooner and was not a great deal more pronounced.
The answer lies in the pattern of this crisis, which is essentially a global debt crisis whose symptoms have been spreading for years – starting with the U.S. subprime sector, moving on to the banking sector, then to public finances – typically from the weakest link to a stronger one.
A similar process is at work in the eurozone: During the first phase of the euro crisis, substantial volumes of private capital flowed out of the “peripheral” countries. However, these capital outflows had no adverse impact on the euro’s exchange rate, because they merely represented shifts of capital within the eurozone – from Spain to Germany, for example. (Figure 1 shows private capital outflows from Spain.) Several months ago, these capital outflows from the periphery prompted a worldwide debate about the significance of the balances of the European payments system known as Target2, as the Eurosystem – particularly the Deutsche Bundesbank – took over the financing of these private capital outflows.
Now there are growing signs that the crisis of confidence in the eurozone has assumed a new dimension. For some weeks, it has been apparent that capital is no longer simply flowing from the southern countries to the core countries of the eurozone, particularly Germany. Rather, the falling euro is a sign that the eurozone as a whole is experiencing a net outflow of capital. Whereas initially investors fled to the safety of the eurozone’s core, now they are taking their capital out of the eurozone altogether.
In this context, it is worth noting that, since May, the Swiss National Bank (SNB) has been actively selling Swiss francs in exchange for euros on the Swiss currency market to maintain the maximum rate of 1.2 Swiss francs against the euro, which it set last September. According to SNB statistics, in May and June, Switzerland accumulated currency reserves of more than CHF 60 billion, so that the SNB’s currency reserves excluding gold are now equivalent to more than 60% of Swiss GDP, as Figure 2 shows.
The currency market interventions by the Swiss National Bank reinforce the downward pressure on the euro, as the SNB puts some of the purchased euros back on the foreign exchange market, offering them in exchange for dollars, yen and other hard currencies, to keep the composition of its currency reserves stable. In addition, the SNB invests the purchased euros mainly in high-quality eurozone government bonds, which tends to accentuate the downward pressure on yields in the eurozone core countries that still have triple-A ratings. The SNB is not the only institution that has been forced to take extraordinary measures: In July, the Danish central bank lowered the interest rate on its deposit facility to a negative level – minus 0.2 percent – to counter the upward pressure on the Danish krone. In other words, banks must now pay for the “privilege” of depositing money with the Danish central bank.
Domestic and foreign investors seem to be steadily losing confidence in the Economic and Monetary Union (EMU), and so are increasingly looking for safe havens for their money outside the eurozone. In the interest of safety, i.e., preserving capital, they are even prepared to accept negative interest rates. And with confidence in the EMU shaken, there is the danger of this capital outflow turning into a self-perpetuating process, further accelerating the tension within the system.
When storm clouds gathered over “little” Greece at the end of 2009, it seemed unthinkable that the debt crisis and the flight of capital would shake European monetary union – once proclaimed as “irreversible” – to its very foundations. Now, though, another storm could be about to break.