The euro is one of the most important political experiments in European history. Born with a huge democratic deficit, it is still a legal tender for 300 million people in 17 countries and accounts for about a quarter of world currency reserves.
Not a bad record for a new monetary unit, whose chief architect former German Chancellor Helmut recently admitted that he would have lost the referendum had he asked the voters twenty four years ago whether they wanted to abandon the German mark for a European currency.
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But the ambivalence remains. Being essentially an act of political faith, the euro is a unique example of an asset class with intrinsic investment features, at the same time ridden by quasi permanent spells of investor neurosis about its viability as a transaction currency and a reliable store of value.
To simplify things, both of these aspects of euro asset valuation can be considered as short-term and long-term investment issues.
Euro's Good Short-Term Outlook
In the short run (a time period of up to one year), intrinsic features dominate as expected risk-adjusted returns of euro-denominated assets are analyzed – and compared – with other outlets in the investment universe. In that context, the euro is doing quite well: it keeps rising against the dollar in spite of the widening interest rate differential favoring dollar assets (against German fixed-income instruments of comparable maturity) and is up about 4 percent since the beginning of the year in trade-weighted terms.
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The euro's gains are underpinned by a large – and continuing – improvement in the monetary union's external surpluses, its declining budget deficits (with a huge drop in structural deficits) and a slowing growth of public debt. Of particular importance is the euro area's fast increase of excess savings – currently approaching 2 percent of the gross domestic product (GDP) – because that makes it less vulnerable to vagaries of global capital flows.
From a short-term investment perspective, it is not a bad idea to buy euro area's bonds and equities. The region's economy seems to be bottoming out, and the likelihood of a weak and noninflationary recovery offers attractive investment values in both asset classes.