We’re approaching the 20th anniversary of an historic agreement, and its impact is roiling global markets today, with potentially profound effects by 2017.

That landmark move: The European Central Bank’s (ECB) decision in 1995 to establish a single, continent-wide currency. When the euro finally began circulating (replacing drachmas, guilders, marks, francs, pesetas and many other currencies) in 1999, it was worth exactly one U.S. dollar. The ECB’s goal: to eventually see the euro become a leading global currency that would attract more than its share of capital flows.

#-ad_banner-#That plan may have worked too well: by the spring of 2008, the euro was worth more than $1.50, which was arguably too rich an exchange rate for many weaker European economies, some of which became among the most expensive places in the world to do business. The Great Recession of 2008 put an end to all that.

The euro has been in freefall ever since, and a pair of economic research teams predict that the euro will keep on sliding until it gets all the way back to parity.

In August 2014, when the euro was already breaking down to the 1.30 level, economists at Goldman Sachs predicted that the move would continue for the foreseeable future, reasoning that a fall to 1.00 to the dollar would represent a sort of equilibrium to compensate for such factors as growth rate differentials and interest rate policy divergence.

These economists foresaw a steady — not rapid — decline that would leave the exchange rate at $1.25 to the euro by this coming June. We’ve already pierced that level, signifying that events on the ground are happening even faster than these euro bears anticipated.

Economists at Deutsche Bank also predict the euro and dollar will hit parity in 2017. They base that view on a steady drain of capital fleeing away from Europe as investment opportunities dry up.

Weakness Or Strength?
While you could look at this topic in the context of weak European economies, Goldman Sachs’ Robin Brooks looks at it in a different light. “The longer-term forecast to parity is a pure view that growth in the U.S. will outperform that that of the euro-zone,” Brooks told Bloomberg News last summer, adding that “in terms of our euro forecast, we’re clearly signaling growth will be better in the U.S.”

On the surface, that would suggest that you focus your investments in the United States. But investors should recall that U.S. stocks posted remarkable gains after the Great Recession of 2008, not because the economy was poised to quickly rebound, but instead because it would greatly benefit from enhanced central bank liquidity, a potentially necessary precursor to eventual economic strengthening.

In many respects, that scenario looks set to play out in Europe, which is a theme my colleague Tim Begany recently wrote about.

In fact, the weakening euro should help create a powerful tailwind as European factories start to become ever more competitive on the global stage.

Hedged Away?
At first blush, the strong dollar may not seem to be too broad an impediment to U.S.-based multinationals, as many of them enter into foreign exchange contracts to hedge their euro exposure. Trouble is, such hedging is expensive and only becomes even more expensive as the dollar rallies further. We’ve already seen major U.S. firms take big write-offs in small markets such as Venezuela and Russia, as the cost of doing business becomes too onerous. The coming year may lead many firms to also shrink their European sales presence.

On the flip side, firms that have a production presence in Europe are heaving a big sigh of relief. Auto makers such as Ford Motor Co. (NYSE: F) and General Motors Co. (NYSE: GM), for example, have posted massive losses in Europe since 2008. Now, with the euro tumbling, those European factories are becoming more competitive, right at a time when ECB stimulus may give a long-needed boost to European auto sales.

Stability, Please
Perhaps the greatest concern about the rapidly changing currency rates is the potential instability it invites. Many previous economic crises have begun when specific currencies fail to find any sort of bottom. Thus far, the euro’s slide has been seemingly orderly, and isn’t creating instability. But how long will that last?

Right now, we’re in the midst of a global “beggar thy neighbor” dogfight where Europe, Japan, China, Russia, Australia, etc. are all engaged in a battle to secure a very cheap currency. The dollar and Swiss franc are among the few currencies showing any sort of vitality these days. But how long will it be before the currency impacts start to swell our imports and cut our exports, pushing our trade balance unstably out of whack?

Indeed we’re already witnessing that move. The Commerce Department recently reported that an unexpectedly large $54 billion trade deficit in December is likely to blunt U.S. GDP growth. That massive trade gap is especially surprising in light of the fact that we now import a lot less oil than we had in the past.

Risks To Consider: As an upside risk, various currencies may stabilize at current levels and not weaken further, which would greatly assuage concerns about potential global economic instability.  

Action To Take –> A strong dollar’s impact on various sectors might seem to be the obvious lesson to be heeded in all this. Instead, it’s the increasing chances for global economic instability that can ensue from a rapid and ongoing depreciation of the world’s second-largest currency. The markets crave stability, and as we have already seen in the early going of 2015, an increasing number of cross-currents are leading to rapid market dips and rebounds. The fact that the United States appears headed for soaring trade deficits in 2015 is yet another concern.

On the margin, you should approach this bull market with more caution. Small caps, simply due to their higher domestic exposure, and lesser exposure to global currencies, can be something of a safe haven. Of course this asset class often falls out of favor during times of instability, but this asset class is most squarely focused on the resurgent U.S. economy. This is a good time to assess your specific portfolio holdings and identify how each investment is likely to fare in an environment of ever-weaker foreign currencies.

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