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November 12, 2004

Is the US Killing the Euro?
by Alex Wallenwein

Fighting an opponent doesn't always mean opposing his force. When faced with overwhelming power, good fighters often use their attacker's force to their advantage, like in Judo, for example. There are better examples in martial arts, but Judo is probably the most commonly known and understood.

It looks like the US strategy in this transcontinental currency battle is to give the euro's masters what they want - except way too much of it, way too quickly, in order to overload the euro system and make it collapse.

The ECB was instituted by the euro's creators to preside over an orderly transition away from a dollar-dependent world to a more versatile arrangement wherein the euro fulfills a quasi-reserve function that will eventually give way to gold being the ultimate international currency reserve, with all the fiats freely floating against gold instead of against each other.

But the road there is a long and winding one, and not even all of those currently "in charge" (international central bankers) are fully aware that this is the ultimate goal. Rather, that unstated goal was wrapped up implicitly in the ECB's role of guaranteeing price-stability, rather than using interest rates to jump-start an otherwise faltering economy like the Fed does over here.

"Price-stability" mans that the currency is intentionally not used as a means for gunning Euroland's economic engines. This goal is designed as a precaution to avoid the excesses caused by overprinting, which has been the US' main tool for papering-over any possible recessions, or even looming depressions - so far.

So far, the US model has "worked" - but only to the point where the resulting trade and investment imbalances are about to do the dollar in altogether.

To provide a life-line to keep the world from falling into that same pit together with the dollar was the very reason for the euro's creation and launch.

We now find ourselves at a juncture where the US (in its efforts to continue to paper-over its excesses and their consequences) absolutely MUST have a lower dollar to even survive. A lower dollar has the twin benefits of (a) lowering the monstrous current account deficit (reflecting trade plus investment-flow imbalances), and (b) propping up the competitiveness of US exporters, hopefully leading to more investment by these firms, and eventually to increased employment.

The Fed and Bush administration know that the euro's ultimate aim is by necessity to slowly attract foreign investors and central banks to the euro and away from the dollar. But they also know that an explosively upward rocketing euro will wreck the Europeans' major economies in a heartbeat. As a result, the US game is to allow the dollar to drop lower - and faster than the Europeans' fragile economies can tolerate!

What the newspapers and financial commentators call a policy of "benign neglect" turns out not to be so benign at all: by pursuing its current strategy, the dollar-establishment is killing three birds with one stone: they get the benefit of (1) higher US export-competitiveness and better economic performance, (2) simultaneously lower EU export competitiveness resulting in economic stagnation, and (3) shifting the entire burden of smoothing out the dollar's forex movements onto the Europeans' backs.

The dollar-faction knows that it has nothing to resist the world's slow but steady, molasses-like run to the dollar-exit doors. It will happen. Nothing can prevent it - except ...

The dollar-faction's best chances at regaining control, they believe, lie in speeding up that very process - way past the ECB's tolerance level - in an attempt to utterly destabilize the euro system, hoping for an eventual complete breakdown.

In essence, the dollar faction is playing a game of "chicken" with the Europeans.

So far, the ECB hasn't blinked. It was able to get away with purely verbal intervention earlier this year. It will be very interesting to watch what happens now that the purely verbal attempts have proven to be of very little effect, so far.

My personal guess is that the ECB will try some covert actual intervention before they'ill drop their interest rates. Maybe some friendly arm-twisting of certain Asian nations will do the trick? Who knows?

In the meantime, China and the Muslim nations are playing another game, altogether. Every time the dollar drops, they are buying gold. It certainly isn't the Europeans who are buying gold. Most individual European investors know as little about gold (and value gold as little) as their American counterparts. When the US financial media utter their textbook mantra for explaining gold's powerful rise in dollar terms (i.e., "a lower dollar makes gold more affordable for buyers paying in euros") they are not saying that Europeans are on a buying binge.

As a side note: Whoever is out there doing this buying of gold for euros is a heck of a lot smarter than American gold investors. Americans collectively lose their pants every time COMEX gold takes a dip. "They" (whoever "they" are) are doing it right: they are buying gold when it gets cheaper instead of when it gets more expensive. If only Americans could learn from them!

So, who is winning? Is the US winning by figuratively letting go of the rope the ECB is pulling on in order to make them fall on their collective behinds? Or is it the ECB and the rest of the world, by having the last laugh because they hold in their hands the key to blowing the US economy sky-high?

Remember that the Asians, particularly China and Japan, hold huge amounts of dollar-claims in the form of Treasury debt. If they decide to accelerate their selling, US debt prices will collapse and long term rates will explode past the US' point of tolerance. The certain consequences of that have been discussed in these essays ad nauseam and need not be repeated here.

The German saying "Wer im Glashaus sitzt, soll nicht mit Steinen werfen." (He who sits in a house of glass shouldn't be throwing rocks) comes to mind.

The lower the US lets its currency fall, the more temptation the Asians feel to dump their US debt holdings, as they see their US "assets" depreciate with every tick lower by the dollar on its journey into forex "Hades." At some point, this temptation will become overwhelming. The US is currently betting that the Asians' point of no return comes after that of the Europeans. I don't think that's a safe bet to make.

No matter which way this battle turns out, if you put a good portion of your assets in gold, you can afford to sit on the sidelines and simply "watch the game." Whoever wins or loses, you will be (economically, at least) safe from the carnage on the playing field. While the euro's rise against the dollar certainly gives US gold investors a boost, even a total collapse of the euro system will be good for gold.

Why? Because the international move away from the dollar has become a do-or-die necessity. If there is no euro, that move will be directly into gold as the ultimate currency reserve. The euro was just interposed to make that transition less painful.

Either way, it will be nice to own some gold before that comes to pass.

Got gold?

TWO CASES IN POINT: (Headlines from Friday morning, November 12, 2004):
Bloomberg/Japan
Bloomberg/Europe
(These news reports came out after this article was submitted to publishers late last night, confirming my suspicions.)

Alex Wallenwein
Editor, Publisher
The Euro vs Dollar Monitor

Just like driving your car, investing only makes sense if you can see where you are going. The Euro vs Dollar Monitor is your golden windshield wiper that removes the media's greasy film of financial misinformation from your investment outlook. Don't drive your investment vehicle without it!

Copyright © 2003-2008 Alex Wallenwein

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