Euro - Toast?

By: Alex Wallenwein | Fri, Dec 12, 2003
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Is the euro now "toast" as well? Whatever happened to the European "Growth and Stability Pact" during the last two weeks of November week may have far-reaching implications for the future of the euro.

But then again, it may not.

So, what happened?

The centerpiece of the EU's and the euro-zone's monetary policy is supposed to be "price-stability."

This requirement of price-stability was initially contained in what is known as the EU's "Growth and Stability Pact." The "Pact" consists of three separate legally binding documents. Its requirements have found their way into the Draft Treaty for a European Constitution that is currently under debate and must be ratified by the fifteen member states and the ten soon to be added eastern European nations.

For the last two years, both Germany and France, which make up the two largest economies of the EU have been running deficits in excess of the three percent limit imposed by the Pact. They have also reported that they will continue to run such deficits for at least FY 2004.

The reason for the deficits were the dire economic situation they found themselves in, with both countries having run into recessions during 2003.

Under the Pact, the European Council of Ministers is supposed to punish repeated violations of the Pact by imposing legal fines. However, since the two offenders were the two "big guns" of the EU economy, all they received was a limp slap on the wrist. They were more or less just "admonished" to get in line.

The other members who tried really hard to live up to the pact's requirements - and succeeded - were understandably miffed. But the whole point is that the Council of Finance Ministers' decision not to punish this blatant violation of the most central mandate of EU monetary policy is seen as forever undermining the euro's stature as the world's future reserve currency. Gloomy forecasts of the world losing respect for the euro abound.

Two questions arise:

1. Is this the beginning of the end of the euro's desired status as the world's primary reserve currency?

2. What effect, if any, does this have on the long term prospects for gold - given the fact that the dollar's recent free-fall against the euro is largely seen as the main reason for gold's ascent?.

So far, the euro actually seems buoyed by the prospects of a breakdown of the euro-zone's fiscal discipline requirement. On Monday, November 24th, both gold and the euro were hit hard after Friday's advances. The very next day, both were seen climbing again. Then there was Thanksgiving in the US. A break. And on November 28th, the euro hit (at that time) all-time highs against the dollar of over $1.20 per euro, before settling in slightly off the day's highs, but way above 1.19. For every day of the following week, with one exception, both the euro and gold just kept on rising.

Apparently, at least short-term, the EU's total U-turnon the stability mandate hasn't hurt the euro any.

So, what happened to "the Pact"? The Growth and Stability Pact was previously the absolute cornerstone of the new euro currency. It decreed (and that mandate is still enshrined in the draft Constitution to be ratified next year) that price-stability is the primary objective. On the other hand, there are musings by the authorities involved in drafting the "euro-constitution" that indicate they'd just as soon drop this requirement.

The first sentence of Article III-77 of the Draft Treaty Establishing a Constitution for Europe therefore unambiguously states:

"The primary objective of the European System of Central Banks shall be to maintain price stability."

You can't really get any clearer than that.

The problem is, this is a draft treaty hat has not been ratified yet. And even if it is ratified in that form, and this language is adopted in the Constitution, that doesn't mean it won't be violated by member states again, and it doesn't mean that such violation won't be condoned again by the weak-kneed Finance Ministers in the European Commission, the executive body charged with supervision of member state compliance with the requirement.

A recent monthly report from the German Bundesbank even suggests that this "primary objective" has been scratched from the draft Constitution during a recent revision, and its clear and unambiguous pro-fiscal responsibility language replaced by a watered-down call for a "balanced" approach to budgetary discipline..

If that is the case, no legal impediment, not even a symbolic one, would restrain the natural propensity of member states to exceed their budgetary limitations. This, in turn, completely undermines the stability - and therefore desirability to foreign holders, of the euro currency.

In other words, if excessive budget deficits become as commonplace in Europe as they are in the United States, the "monetizing of the debt" (i.e., printing/borrowing of currency to pay for budget shortfalls) will wreak as much havoc on the euro as it has on the US dollar. It will lead to over-issuance of the currency, monetary inflation, exporting of that inflation to other countries via those countries holding of euros as forex reserves, and all of the associated problems that have finally come home to hurt the dollar.

Is this the death-knell to the uniqueness of the euro currency?

It could kill one-half of that uniqueness. It could lead to a shorter life-span of the euro than originally envisioned by the founders of the currency.

But that's all just in theory. The realities of the situation are that Europe has ben plagued by endemically slow growth since launch of the euro. (That goes to show that all fiat systems eventually lead to a situation where "growth" can only be achieved or maintained by deficit spending, which requires monetizing the debt by printing more currency, leading to inflation and all its associated evils - the very evils the euro planners tried to provide against by focusing on price stability.

Implied in the first question (whether the breakdown of the G&S pact is the proverbial "beginning of the end" for the euro) is the question whether the euro can even hope to fulfill its role as the challenger to the dollar if its member-states' economies are chronic under-performers?

On the other hand, one must ask if the euro can realistically fulfill its promise if it is structurally no better than the dollar, other than currently having a zero debt load (actually a surplus)?

The struggle between these two questions is what the Germans and French - and by extension the other member countries are currently wrestling with. For the time being, it looks as if the two bullies of the EU have won the debate.

Effects on long-term prospects for gold.

What effects does this ongoing battle have on the long term prospects for gold? Isn't gold currently riding the euro's coattails to higher valuations? If the euro weakens over time, won't gold suffer as well?

Sure. From a purely "paper-centric" world view, that's how it looks. The rise of the euro has caused the decline of the dollar, and that has caused the price of gold (in dollars) to rise - or so it seems.

But look at the situation through the gold-perspective.

Gold has never stopped determining the true value of anything. After all, it was gold's very power that caused the dollar-forces to try and suppress its price by convincing the public that gold was "just a commodity", just a "barbarous relic", and essentially a dead, "non-performing" asset that the central banks of the world couldn't wait to dump in favor or "more lucrative" paper investments.

Now that the euro's challenge to the dollar has freed other world economies from the knee-jerk requirement of always supporting the dollar - and therefore the by extension the dollar's underlying anti-gold bias - gold has essentially been freed from its dollar-shackles.

Because of the dollar's unbelievable debt load and unsustainable current-account deficit, it is impossible for the dollar to fight off the euro's attack - even if the euro becomes structurally less stable and less distinguishable from the dollar in principle..

Whether the euro ultimately survives this crisis in the long term or not is no longer really that relevant. The point is: for the present, THE EURO EXISTS AS AN ALTERNATIVE TO THE DOLLAR.

That's all that the other economic powerhouses of the world needed. The dollar now can be allowed to subside in value and scope, and to quietly pass from the world's center stage. The euro now CAN be substituted for the dollar, even if it is no longer perceived as so ultimately "stable" as its planners had intended it to be.

The point is that the euro's short history and successful challenge to the dollar world-wide has already allowed all the other countries to rediscover - and most of all utilize - the power of gold.

Central bankers aren't stupid, really (just greedy for power). The euro's creators KNOW that no paper currency can exist forever. They KNOW that if a currency's perceived value depends on an artificially suppressed price of gold, then such a currency's life-span becomes even shorter. They thus realize the importance of gold - an importance which gold advocates very well know has not even escaped Mr. Greenspan.

It is not the euro, but gold that will "do the dollar in."

It is not the euro but gold that will become the world's ultimate currency reserve.

It is not the euro, but gold (or the dollar's structural adversity to it) that will ultimately cause the downfall of the dollar and therefore of US economic supremacy in the world. In other words, it's the dollar that is doing itself in)

That's one reason why a less stable euro in no way restrains the current upward vault of gold. Gold is no longer dependent on the euro's continued rise against the dollar. Gold is now free. The euro has just allowed everyone outside of the United States to shift their attention back toward gold.

In effect, the euro has already done its job. What happens to it from here on out no longer matters - as far as gold is concerned.

However, to the Europeans it does matter. The euro is still their primary currency. Gold is not. They do care what happens to the euro.

Why did the Council of Ministers fail to punish Germany and France?

The euro has done an extraordinary job in penetrating every major central bank's currency reserve position around the world. It has done an extrordinary job in rising against the dollar, all the way from its low-point in 2000, back up to its original launching point, and beyond - and that in spite of lagging EU area growth.

This success came at a high cost, though. During these last two quarters' phenomenal ascent against the dollar, the US has been able to engineer an incredible "second bubble" stock market rally by injecting unprecedented amounts of liquidity into the system, all the while the dollar was dropping against the euro. This has helped US exports, has severely undercut Europe's ability to export to other countries, and has contributed to Germany falling into, or getting very close to, a recession this year.

The Europeans saw they could not keep this up any longer. Germany is only now coming out of its recession. It was able to do so only as a result of the very deficit spending that has so outraged the other Europeans beside France. If they cannot get out of their hole economically speaking, the euro's rise would be only the result of speculators bidding the currency up versus the dollar because of the dollar's trade and current account deficit problems. As such, the euro itself would become a speculative bubble and could conceivably suffer a dramatic drop if the US was able to continue to deficit spend its way out of its recession while the two European draft horses Germany/France were prevented form doing likewise.

And that would happen even with the stability mandate in full force and effect - or rather, as a result of it.

For the European Council of Ministers, allowing those two members to keep violating the Growth and Stability Pact for now is a small price to pay for keeping the euro on the attack by giving the EU economy a chance to grow.

Another way of looking at it is implied by the very name of the Pact: Its Stability AND Growth. Without growth, the Pact would also have been violated, at least in spirit. The euro-creators' problem was that they were hoping that sufficient growth could be achieved without overspending in a fiat-currency environment. That was their mistake.

All the more reason to believe that gold will be the currency of choice of future generations -- unless our "fearless leaders" succeed in pushing an implanted-chip-in-your-hand "cashless society" on us.

In that case -- better watch out!

In that case, there will be no limits on the evil your rulers can perpetrate upon you. They can not only take all of your money, but destroy your entire life with a single keystroke. (More on that in the current and future issues of the 'Euro vs Dollar Currency War Monitor') But, even then, what would be the only viable counter-currency?

Yep. That same old yellow metal (and that white one, too, of course).

Got gold?


Author: Alex Wallenwein

Alex Wallenwein
Editor, Publisher
The Euro vs Dollar Monitor

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