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February 11, 2002

The Leadership Battle to Run the European Central Bank
by William Thomson

The dour, hapless and colourless President of the European Central Bank, Wim Duisenberg, finally announced this week that he would be retiring from his position on July 9, 2005, three years before the end of his term. The battle to succeed him is expected to be an increasingly open and probably bitter one in the coming months. The French are expected to assert their droit de seigneur to the position by nominating Banque de France Governor Jean Claude Trichet, or whichever enarque emerges from their secretive internal processes.

Political horse trading along national lines and a case of 'Buggins turn' are likely to determine the process, rather than the interests of the institution and the 300 million consumers and producers who will have to live with its decisions. The institution's uncertain stature will not be enhanced.

Duisenberg, a Dutchman, the first President of the European Central Bank took the position in 1998 prior to the introduction of the Euro as a virtual currency in January 1999. His election was allegedly part of a Franco-German backroom deal whereby the ECB would be located in Frankfurt and the French would get the presidency, but only after a decent interval in order to make the stitch-up not too obvious. The Germans, who wanted the ECB to be a clone of their revered Bundesbank, saw Duisenberg as the closest thing they could get to a German without having the passport and someone who could build a reputation for the ECB in the markets. (He has built the reputation; unfortunately, it is the wrong one.)

The eighteen months period before the position becomes available is convenient for the French. M. Trichet is under investigation for his involvement in the scandals that rocked Credit Lyonnais in the early 1990s where he was a Senior Director. The period will give him time to clear his name. It would not be acceptable to have an incoming President with a cloud over his name as to his honestly and probity. In the event Trichet fails to make the grade the French will have a number of identikit candidates with a grande ecole education and experience in the French bureaucracy, including Jean Lemieux, the current President of the European Bank for Reconstruction and Development.

The French vice president of the ECB, Christian Noyer, will conveniently step down from the ECB Board in May 2002 and could therefore be another candidate should Trichet fail to make the grade. (The President and Vice President cannot be of the same nationality and the Vice President cannot be directly appointed to the Presidency.)

Franco-German relations may not be what they were but it is unlikely that the Germans will in the end not honour whatever understanding they had with the French. However, the other ten members of the ECB are unlikely to accept this axis without at least a symbolic fight. Candidates of other nationalities will undoubtedly emerge. They include the Finnish< Spanish and Italian board members. Intriguingly, Eddie George, Governor of the Bank of England would be available since he retires from the Old Lady on 1 July 2003.

But the undoubted infighting that lies ahead belies the greater question: what does the ECB need to establish its credibility in the markets. It is seen, fairly or unfairly, as an inflexible, undemocratic and unaccountable body that has presided over a decline in the Euro's exchange rate of almost 30 percent since the Euro was floated in January 1999. It is an unwieldy, inward looking, bureaucratic institution that is perpetually behind the curve in its policy responses.

Whilst it urgently needs to trim down and become more nimble, the internal contradictions about its mission make long term success unlikely. Whilst it enjoys autonomy on monetary affairs, the member states are unlikely to yield sufficient fiscal powers to Brussels to bring in common fiscal policies and make the Euro a success. Absent these fiscal balancing measures and flexible work practices and labour mobility, the one-size-fits-all interest rate policy is bound to create inflationary pressures in some parts of the union and deflationary pressures elsewhere. The Eurozone does not at this time classify as an optimal currency area. The entry of the Eastern European states will only distort this further and make the job of the ECB harder.

The Latin Monetary Union lasted 41 years from 1873 to 1914. Bretton Woods lasted twenty-five years from 1946 to 1971. The ECB and the Euro will be lucky to last as long.

Market implications
The Euro is, for good reasons, the Rodney Dangerfield of major currencies: 'it just don't get no respect'. Capital flight from Europe to North America has been massive in recent years accounting for much of the currency's weakness in the foreign exchange markets. But with the US dollar being managed like the Argentine Peso what about the future?

Well, every dog has its day and a broken clock tells the correct time twice in every 24 hours. We expect the USD to peak finally in the coming weeks as faith in the markets weakens and the economic recovery is weaker than the happy-clappy cheer leading consensus hopes. So long as the Euro can hold above its 2000 low of US 0.82 we would expect it to recover slowly during the course of 2002 and perhaps eventually reach close to a dollar.

However, the real story of 2002 may be the growing loss of faith in currencies generally. We see this in Japan currently where the populace frightened by the withdrawal of deposit insurance on bank deposits on 1 April is turning to holding gold in a major way.

Gold is after all the financial sector's equivalent of the miners' canary in the cage. It can produce a signal about the health - or lack thereof - of the system. It is the only asset that is no-ones liability. It has stood the test of time and, indeed, has performed credibly against all currencies except the USD in the last few years.

If Far Eastern buying continues after Chinese New Year then there could be a slow turn towards gold globally. After all, the gold mining sector was the best performing sector in 2001 and the sector is capitalised at less than USD 50 billion, less than many busted high tech US companies.

A small reallocation of global assets to this undervalued sector would have an explosive impact on valuations. We remain very positive medium term although there will be short-term profit taking. We maintain our position that, in these difficult times, most investors should have some exposure to this sector, at the very least as portfolio insurance.

William R. Thomson
Chairman of Private Capital Ltd.

William Thomson, Chairman of Private Capital Ltd., an advisory company in Hong Kong. He is also a senior adviser to Franklin Templeton in Hong Kong and Axiom Alternative Funds in London.

Mr. Thomson is not a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While he believes his statements to be true, they always depend on the reliability of his own credible sources. Of course, we recommend that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that, we encourage you confirm the facts on your own before making important investment commitments.

Copyright © 2001-2008 William R. Thomson

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