Will the Euro Collapse in 2010?

Eric Rosenbaum
May 4, 2010

Covering the Greek debt crisis and the slide in the euro in 2010 has been like monitoring a schizophrenic's state of mind from minute to minute.

One day, a bailout package is a "sure thing" and fears that Europe is sinking deeper into its debt mess ease. Then the next day, political resistance makes a bailout package for Greece look "unlikely" and sends the markets tumbling. The European debt Chicken Little has had its head cut off and reattached so many times during 2010 that even if it were free range it wouldn't be a very happy poultry ambassador of the economic apocalypse.

The equity markets lost $1 trillion in value on a single day last week, Wednesday on fears that the European debt crisis would derail a recovery in Europe and edge the global markets back into a second recession.

Noted market prognosticator Nouriel Roubini -- who predicted the U.S. recession a year ahead of its actual occurrence -- stoked fears of a global contagion stemming from the European debt crisis when he said last week at the Milken Institute Global Conference, "Greece is just the tip of the iceberg, or the canary in the coal mine, for a much broader range of fiscal problems."

Day to day it's hard to keep track of all the noise related to Europe's woes. Greek labor unions balk at a bailout; German politicians dilly-dally on their big role in approving a bailout based on domestic political pressures; and some market economists argue in favor of allowing Greece to default rather than seeing through an expensive bailout package.

The crests of optimism followed by fears of the economic apocalypse are carrying over to this week, as well. On Monday, a Greek bailout package was "in place." Yet on Tuesday, fears that the Greek bailout package might fall apart -- due to Greece's inability to receive support for its austerity measures and the trick of receiving approval country by country in Europe for the lending -- led the euro to sink to a new low in European trading, just above $1.30. The European Union and the International Monetary Fund had agreed to a $145 billion bailout package over the weekend, but investors remained skeptical.

Greek workers began a two-day strike on Tuesday. The looming debt crises in Spain and Portugal have not helped, either. It's still an open question this week whether -- after months of back and forth over the road forward for Greece -- the European Union will be able to pull together and bring Greece back from what has been an unplanned-for odyssey in 2010. If a deal is completed this week -- and many in the markets are still hopeful of that outcome -- Greek would have until May 19 to make its next debt payment.

Short-term fortunes may have been made in fast money trading on stocks like the National Bank of Greece (NYSE: NBG - News), but a larger and more critical question lingers: will the euro collapse in 2010?

Roubini, for example, told Bloomberg that Greece "could eventually be forced to get out" of the European Union, which would put more pressure on the euro.

Standard & Poor's cut Greece's credit rating below investment grade on Tuesday, and lowered Portugal's credit rating also. On Wednesday, S&P downgraded Spain's debt. The Greek debt crisis has been described as the economic "ebola virus," spreading far and wide and triggering the euro's slide.

There are specific fears that the exposure held by European banks to Greek debt, as well as debt of other stressed European nations, will cause another credit-triggered global markets crisis.

Overall, French banks have the greatest exposure to Greek debt among European lenders, according to the Bank for International Settlements (BIS) -- $78.8 billion of the $193.1 billion of total claims European banks have on Greece. Credit Agricole and Societe Generale are among individual European banks most exposed to Greece's financial crisis.

France's banking sector has the second-largest exposure to Portugal and Spain debt loads, after Germany, according to the BIS.

European banks have more at-risk assets in Portugal and Spain than in Greece. European lenders are holding Portugal debt issues of $240.5 billion -- including $47.4 billion by German banks and $44.9 billion by French firms, according to BIS figures from the end of 2009 quoted in a Bloomberg report.

Overall, European exposure to Spanish debt stands at $832.3 billion.

Amid all the market noise related to European debt, though, on Thursday the markets were back up, buoyed by positive earnings in the U.S., even as the situation in Europe remained a cloud hanging over a sustained global market recovery.

Greek Prime Minister George Papandreou began trying to persuade labor unions to accept further austerity measures as the European Union worked to finish a bailout package to avoid a Greek bond default.

The Greek Prime Minister was meeting on Thursday with the heads of the largest unions as Greek, European Union and International Monetary Fund officials discussed a bailout package that would allow Greece to tap emergency loans.

The Greek budget deficit had soared to 13.6% of GDP in 2009, four times above the maximum threshold allowed by EU rules.

The euro has lost about 7% against the dollar this year. Institutional investors sold euros this month at the fastest pace since the second half of 2008, when the euro fell more than 25% versus the dollar, according to Bank of New York Mellon Corp. data.

Yet, lo and behold, on Thursday the euro gained off a one-year low reached on Wednesday, rallying back above the $1.32 mark after having fallen below that level -- considered an important psychological threshold -- which it had fallen below after S&P's downgrade of Spain on Wednesday.

All the up-and-down action in the markets related to the euro and the Greek debt crisis may be far from over, too, even though the EU is talking in terms of the "finishing touches" on a bailout package. Those finishing touches have been in place, before being stuck in place, throughout 2010.

Barclays Capital wrote in a report on Thursday, "We believe the move toward a Greek rescue package will remain a slow grind and a weight on the euro," and the securities firm specifically cited the political situation in Germany as a reason to expect more ups and downs in the outlook on a resolution to the Greek debt crisis.