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Europhoria Already Wanes…

May 10th, 2010 Michael McDonough

Since the announcement of Europe’s unprecedented rescue package late last night, the Euro rallied to as high as almost 1.31/USD off of a low of 1.2529 on May 6th.  However, as the dust settles from Europe‘s nuclear option to address the continents widening debt crisis, lingering risks are reemerging as the Euro shows signs of weakness falling to 1.2780.  It’s akin to a classic monster movie where the government—out of options—decides to drop the ‘A-bomb’ as a last ditch effort to destroy the monster; as everyone begins to celebrate at the monster’s demise, hints of movement are noticed in the lingering debris cloud.  These movies typically end with some sort of mundane or natural force ending the monster’s rampage, and that might be what’s necessary for the European debt crisis.  While Europe’s bailout package may have weakened the monster it will take long-term fundamental change to truly end the crisis. 

The European experiment created a chimera that all EU nations were created equal, permitting member nations, despite their own domestic woes, to borrow far beyond their means, at irrationally low rates.    As reality is exposed for the European periphery, bailout or not, solvency cannot be guaranteed as tough, yet necessary, fiscal austerity could lead to wide-spread protests, and in a worst case scenario a double-dip recession for the continent.  The Euro’s late-in-the-day weakness is likely the first sign that investors have begun to see movement in the lingering cloud.

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