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Taking Out the (Euro) Trash
(April 7, 2005) The value relationships amongst the dollar, euro, yen, and, most importantly these days, the Chinese renminbi effect the direction, size and trends of our global economy. Trading the sinking dollar for another currency merely shifts your risk across the ocean – and what would your possible winnings look like?
A common mistake is to consider the interrelationships among the world’s currencies as some sort of zero-sum game. True enough, foreign exchange trading often gives that illusion – one can keep a box-score as each day a currency either wins or loses against each other currency. League standings and rankings change in a closed circle, and it’s easy for the dedicated fan to be lulled into the lazy idea that this matrix of currencies somehow represents…all the money in the world.

Truth is, some forms of wealth are permanent (and, yes, we have our favorite), and others depend on the whims of politicians.

London’s Financial Times this past weekend (edition of April 2 and 3, 2005) headlined their lead editorial, “Cross-currents make currencies choppy – There are reasons to sell the dollar, euro, and the yen.”

“We live in a world of currency weaklings,” the FT editorial continued, “The dollar has the giant US trade deficit. But other big currencies have their troubles too.”

For instance, the strongest currency over the past few years has been the euro. Created by the European Union, the euro was launched as a cash currency on January 1, 2002 at a value pegged slightly above that of the US dollar. It then proceeded to fall to some 85 cents soon thereafter, yet its comeback in 2003 and 2004 has sent the euro as high as the $1.36 level.

Now, the euro is a marvelous invention. It was created from whole cloth, so to speak, without the legacy (or baggage)of having roots in the old days of the gold standard. No, the euro is the essence of a modern monetary unit, born of faith in the economic concept of fiat.

The trouble is, that faith has to be sustained by some dozen or so countries, including many with centuries-old histories of - how should we put this delicately? - violent disagreements.

For instance, Germany and France have consistently violated EU rules against allowing their deficits to exceed 3% of GDP, and debate in Brussels has been vigorous on the subject, with each European Union country having its own say as to whether the 3% rule should be hard and fast, or modified according to a proposed list of exceptions.

Austrian Chancellor Schuessel was quoted last month saying that he would have no truck with adopting situational ethics to justify a breach of the 3.0-percent rule.

"What we don't need is a list of exceptions with all the different national pecularities," Schuessel said. "We need precise rules of play that will guarantee the stability of the euro.”

On the other side of the argument, Bundesbank President and European Central Bank governing council member Axel Weber hinted in an article for the Sueddeutsche Zeitung that fiscal profligacy could even lead the ECB to raise its key interest rates.

"Unreliable fiscal policy makes its more difficult for monetary policy to guarantee price stability at a low level of interest rates," Weber wrote. "Pressure could be put on the central bank to finance public debt via higher inflation."

The euro, in short, is a product of the diverse European Union, a political sphere whose multi-polarity we in the US cannot even begin to fathom. While in America it seems that we have only Mr. Greenspan and Mr. Bernanke seriously pondering the direction and fitness of the dollar, Europe has literally hundreds of politicians of all stripes and persuasions, speaking various languages, each with a stake in, and an effect on, the fate of the euro.

Yet against this backdrop, the euro has risen, in lockstep with gold, as a hedge against the dollar. More and more central banks are replacing some of their dollar holdings with the euro. The current collective wisdom is that the dollar will continue to fall, and that the euro is the place to be.

Is that so?

The FT editorial continues, “In truth, there are good reasons for selling all three of the world’s main currencies…But could they all fall? Yes, against either gold or the Chinese renminbi.”

John Hathaway of Tocqueville Asset Management in his March 24th commentary, entitled “Euro Trash” (a phrase that was too irresistible not to pilfer), sees it this way:

“A likely side effect of the inevitable central bank migration away from the dollar will be further appreciation of the euro against the dollar. Let us see what European politicians have to say when one euro buys 1.40 or 1.50 US dollars. Their attempts to explain how further deviations from the Stability Pact and market interventions will not undermine the value of their beloved euro should make for highly entertaining comedy.”

“It is against such a backdrop that the euro price of gold should surpass the trading range of the past two years. A breakout in euros will serve notice to the market that gold is not a subset of the weak dollar play. Once it has crossed this threshold, gold will begin to attract capital from assets parked in all currencies and asset classes including commodities and high yield credits, the two most recent investment bubbles. The bull market in gold, which commenced in August of 1999, will shed its stealth mode. Its pace will quicken and become difficult to ignore. We stand at the end of the beginning of the first leg in a multi year bull market in the metal. The significant accumulation that has occurred during the past five years will not yield easily to the sharply higher prices that lie ahead, because those price gains will be spurred by financial market developments that make gold’s appeal quite obvious, even to its detractors.”


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