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When the euro hit a low of $1.1917
against the US dollar on June 7th, 2010, the airwaves crackled with
assertions that the European common currency, beset by Greek debt problems
and intra-union discord, was destined to trade at parity with the greenback.
They were wrong. Since then, the euro has risen over 17% against the dollar, hitting
$1.3961 today. The current upswing, delivered courtesy of the Fed, has at
least temporarily silenced the euro's critics. It should also serve to impugn
the notion that the US dollar holds a permanent position as the world's
reserve currency.
To be clear, I have always felt that
the euro is just another flawed fiat currency. However, since its inception
in the 1990s, it has earned my begrudging respect. Most analysts have
reservations about the euro, but I see cause for some confidence.
Together, the 27 countries that
comprise the European Union represent the largest single market in the world.
Its GDP on a purchasing power parity (PPP) basis was $16.5 trillion in 2009,
which is greater than the $14.2 trillion US economy in that year. The
economies of the 16 countries in which the euro is legal tender produced a
GDP of about $10.5 trillion on a PPP basis. That is equivalent to 74% of US
total output in '09. Therefore, the economy of Europe, however measured, is
similar in size and scope to that of the US and should be viewed with the
same gravitas.
Rather than the comparative size of the
two massive markets, the primary issue is that the US dollar accounts for 62%
of global central bank reserves, even though it represents less than 25% of
global GDP. In comparison, the euro represents just 26% of FX reserves. Why
does the US economy deserve such a tremendous over-weighting of central bank
reserves, and is this a net benefit to dollar investors? I argue that since
their currency holdings are so vastly concentrated, global central banks are
in a tenuous and vulnerable position. Should they ever need to reduce their
dollar holdings - especially in concert - it would place tremendous downward
pressure on the US currency. Meanwhile, no such over-owned condition (along
with concomitant pent-up selling pressure) exists for any other currency.
Currently, the gross national debt of
the US stands at 93% of GDP. The European Commission projects that their
gross national debt will reach 84% of output this year and 88.2% in 2011. The
Congressional Budget Office projects our national debt to reach over 100% of
GDP in 2012, whereas the national debt of the EU will not reach 100% of
output until 2014, according to the European Commission. Finally, US interest
rates are much lower than those of the eurozone. From the looks of it, it's
not the euro analysts should distrust, but the dollar.
But What Happens the Next Time Down?
Investors the world over have
traditionally flocked to the US dollar for safety. Many well remember the
fall of non-dollar currencies in 2008, when the Dollar Index surged 27% and
crushed most commodity prices, including gold. How do we know that the next
international crisis won't cause the same global flight into the
"safety" of US dollars and out of secondary currencies like the
euro? The answer can be found in comparing the Fed's current approach with
the strategy it employed two years ago.
Ben Bernanke's initial response to the
credit crisis of 2008 was fairly muted. Given today's era of accommodation,
it may surprise investors to be reminded that the Fed left interest rates
unchanged throughout the entire panic period from April 30ththru October 8th,
2008, despite the fact that the S&P 500 dropped 37% during that time. And
Bernanke only slightly increased the monetary base by $160 billion during
that drubbing in equities. So, given the uncertainty and confusion that
reigned and the Fed's promises of stability, global investors flocked to the
dollar, as they have done in Pavlovian fashion ever since the Bretton Woods
Agreement was signed more than 65 years ago.
However, since the initial crash, the
Fed has abused the dollar so disastrously that the remaining well of
confidence has dried up. Ben sent out a fleet of helicopters to demonstrate
to the world that he would not tolerate the appreciation of the USD or allow
price levels to contract. While other central banks are beginning to tighten
policy, the Fed has only promised more "quantitative easing."
On the fiscal side, lawmakers in
Washington have diverged from their counterparts in Berlin and London by
refusing to consider any measures that would address growing debts. While
austerity takes hold around the world, profligacy still runs rampant in the
US.
In short, we are sending a loud and
clear message to global investors: "You will be severely punished for
seeking shelter in our currency and bond market!" The monetary base has
doubled since the crisis, to $2 trillion, and the announcement of another
dramatic increase is expected at the conclusion of the next FOMC meeting on
November 3rd. The Fed has engineered robust "growth" rates in all
the monetary aggregates, but yet has gone on record for the first time in its
history saying that the rate of inflation is too low. All this has resulted in
the US dollar losing nearly 13% of its value since June.
I went on record last summer saying
that selling euros (or most any other currency) to buy US dollars is sort of
like exchanging your ticket on the Titanic for a ride on the Hindenburg. The
only safe forms of money are those that act as a store of wealth, preferably
because their value will not be recklessly diluted by fiat. The Fed has put
the world on notice that the dollar can no longer be viewed as a safe-haven
currency. No such notice has been posted by the European Central Bank. And
although no fiat currency is really safe, it is clear some are abused much
less than others.
During the next phase of the crisis, it
is likely that investors will be more cognizant of these facts than they were
in 2008. As a result, I would expect them to seek shelter outside the dollar,
perhaps in other currencies but also in commodities and precious metals. The
days of panic dollar spikes may finally be over.
Michael Pento
Senior Market Strategist
Delta Global
Advisors, Inc.
Delta Global
Advisors : 19051 Goldenwest, #106-116 Huntington Beach, CA 92648 Phone:
800-485-1220 Fax: 800-485-1225
A 15-year
industry veteran whose career began as a trader on the floor of the New York
Stock Exchange, Michael Pento recently served as a Vice President of
Investments for GunnAllen Financial. Previously, he managed individual
portfolios as a Vice President for First Montauk Securities, where he
focused on options management and advanced yield-enhancing strategies to
increase portfolio returns. He is also a published economic theorist in
the Austrian school of economic theory.
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