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THE LAUNCH
On 1st January 1999, 11 of 15 member states relinquished their local
currencies and their central banks for a new single currency called the Euro,
under the control of the single European Central Bank. On the surface, no
problems so far, this will aid the movement of goods and services, and
trading conditions in general, amongst the member states and nations within the
region. But on closer inspection there is the potential for profound
ramifications particularly for those in the US.
Anyone involved
in the currency markets would agree that these markets have given the
participants a wildly volatile ride in the last 18 or so months. With the
introduction of the Euro and the resulting displacement of the US dollar
internationally, this volatility is likely to heat up dramatically in the
months ahead.
LAYING THE TRACKS
It is ironic that the tracks were laid for this wild ride back in the closing
days of the war in Europe in the summer of 1944. The smell of an allied
victory was in the air, and as if to divide the inevitable economic spoils of
the war, a relatively small group of the western world's notable economic,
social and political minds met in a small town in New Hampshire called
Bretton Woods.
John Maynard
Keynes and his plans to rebuild the world were to feature prominently in the
Bretton Woods Conference and its resulting agreements. He was about to become
the principal architect of what has become known as "post World War II
reconstruction".
At the time of
the Bretton Woods Conference, the United States, Canada, Switzerland,
Australia and New Zealand alone stood as the only industrialized nations to
have their treasuries, economies and banking system fully intact.
Keynes proposed
that a new international monetary system be established, headed by a strong
international banking system and a common world currency, not tied to the
strong discipline of a gold standard.
If the world was
to recover from its economic devastation, with so much of its means of
production being seriously crippled, its trade economies destroyed, and so
many nations so deeply in debt, it needed to expand. This expansion, he
argued, would be limited if paper currency was still anchored to gold. In
short Keynes reasoned that the industrial nations could re-equip and rebuild
through a process of interest bearing money supply, deficit spending, deeper
debt and increased consumption, even at the expense of future generations.
The outcome of
the conference was several agreements, which included the establishment of
the IMF, World Bank and the US Dollar as the world’s reserve currency
in place of the British Pound.
A GLOBAL RESERVE
CURRENCY
The stage was set for the United States and its now unrivalled currency, the
dollar, to feature prominently in all global trade, politics and economics.
From those post war boom years to today every international transaction, in
other words all the trade between all the countries, has been settled in US
dollars. The exception to that would of course be the free unregulated
marketplace where gold has continued to feature.
Today vast
quantities of US dollar reserves exist around the world, in the form of cash
and treasury debt certificates like bills and bonds, on the books of central
banks, financial and investment institutions and in the hands of private
investors.
PROGRESSIVE
DEBASEMENT
In the 50 years since Bretton Woods, the US dollar has undergone drastic change,
including the removal of all gold backing and massive inflation. The
crippling effects of this progressive debasement, to a large part have been
exported around the whole world, particularly to Europe, sheltering to a
degree those back at home in the United States.
THE FINANCIAL
EVENT OF THE 20TH CENTURY
In 1957, the European Economic Community was founded. Now, some four decades
later, the once illusive dream of a united Europe has finally arrived.
On December 11
1998, in the San Jose Mercury News, an article by Lori Montgomery in Berlin
said "After a thousand years of strife and war, the nations of Europe
will close the bloodiest century in their history by binding themselves more
tightly together into a United States of Europe".
"On New
Year's Day, Germany, France, Italy and eight other countries will merge their
economies, abandon their marks, francs and lire and introduce the Euro, a new
currency that will immediately become the world's second- largest, and may
one day challenge the supremacy of the dollar"(emphasis mine).
The creation of
EUROLAND and the launch of its currency has been called "the most
important aspect of the new environment in Europe". It has been said to
"present historic opportunities for European business and global
investors". It is without doubt, the financial event of the 20th
century.
The 11 countries,
which will be initially participating in the Euro, are Belgium, Germany,
Finland, France, Ireland, Italy, Luxembourg, The Netherlands, Austria,
Portugal and Spain. These 11 countries have met the strict criteria set for
participation in the Euro.
Euroland will be
one of the most powerful economic forces on Earth, with an economy second in
size only to that of the United States and with slightly more people.
NOT AN EASY ROAD
All analysts and commentators agree there are no end of challenges and
trouble facing the currency and the participating nations. On the surface
some simple but deep-rooted problems exist.
The participating
nations have tough domestic problems, for example an average 10% unemployment
rate.
In most member
states, chasms exist between leftist political leaders and the more
conservative bankers and financial heavy weights. For instance recently
German voters installed a left wing, social-democratic coalition led by
Gerhard Schroeder in place of Helmut Kohl, a euro champion. Schroeder's
finance minister, quickly initiated a bitter debate between the conservative
central bankers, who are dedicated to maintaining a stable currency, and
politicians who want bankers to lower interest rates in the hope of spurring
job growth.
In early
December, member nations took the unprecedented step of jointly slashing
interest rates, uniformly setting rates at 3% in every member nation except
Italy. This was seen as a positive step to spurring economic growth. But it
further fueled fears that the major players, France and Germany, are already
pushing the new currency toward instability.
January 1999
began the start of a 3-year implementation strategy. During this transition
period, existing national currencies will coexist with the Euro.
This means
participants within the economies of member states will need to carry 2
prices for their goods and services. For instance groceries will be priced in
Euro’s and also in the price of the local currency. Employees will be
able to be paid in the currency of their choice.
Banks will have
to run two sets of transactions, reports and accounts, in Euros and the local
currency.
The drain and
expense on infrastructure is immeasurable. The burden of preparing for the
Euro has been placed squarely at the feet of corporate and private
enterprise.
THE UPSIDE
Despite all the obvious problems associated with the introduction of the new
currency, earlier scenarios of a failure in the new currency seem to have
dissipated.
Virtually no-one
now predicts the euro will fail. Quite the opposite, commentators are
becoming increasingly optimistic about the potential of the new monetary
union, and are instead talking about the opportunities it offers the
investor.
The strict
criteria the participating member nations had to meet to join the union are
expected to improve the performance of their internal economies.
Healthy trade
figures have emerged from the 11 countries taking part in monetary union. The
countries are expected to record a trade surplus of $100 billion for last
year. By comparison the U.S. is expected to post a trade deficit of about
$140 billion.
US DOLLAR DILEMMA
Norbert Walter, chief economist of Germany's Deutsche Bank recently said
"The euro will be to the dollar what Airbus is to Boeing,''
This is a fitting
statement ; you see it is the displacement of the US dollar and the effects
of that displacement on the international markets that will effect us in the
future, and particularly those living within the US.
The day the
single currency was launched, its combined economies represented nearly 300
million people. This united trade zone contains the equivalent of US$27
trillion in combined financial assets. This compares to the US total
estimated at US$24 trillion.
The remaining 4
EU countries are welcome to join at any time that they meet the criteria and
choose to participate. At the moment the combined Gross Domestic Product of
the 11 member EU is second only to the US. If and when the remaining nations
join the 11, Euroland's GDP will exceed that of the U.S.
While still not
official the Euro is to have gold backing of at least 15%. This will be the
first time since 1971 that a major currency has had any gold backing.
US DOLLAR
RESERVES
Vast quantities of US dollars are held as reserves, trade and investment
currency, circulating cash and so on around the world. The mighty US dollar
accounts for nearly half of the world's foreign-held bank deposits and two
thirds of official foreign reserves. Over half of world trade is invoiced in
dollars.
Of all the US
Treasury bonds ever issued, the vast majority are held by overseas investors,
institutions or central banks.
As of January
this year, the second largest trading block in the world will no longer use
US dollars to settle their accounts. In simple terms that is about 1/3 of the
total US dollars held overseas to facilitate International trade. These US
dollar reserves will start to enter the market.
Likewise, other
nations, corporations, banks and financial institutions within the region are
free to buy, sell, hold and exchange Euros, just as they currently do with US
dollars. A portion of the US dollars they currently hold will also start to
enter the market
But it
doesn’t stop there. Globally nations are looking to the Euro dollar
with interest. As I said earlier much of the damaging effects, the inflation
and boom bust cycles caused by the debasement of the US dollar have been
exported around the world. The people who understand this process have long
memories and don’t forget.
China currently
holds around US$140 billion in foreign exchange reserves. In October last
year China’s Central Bank governor announced that over time China would
switch a substantial portion of it foreign exchange reserves from US bonds to
Euro’s.
When China starts
to switch its foreign exchange reserves from US dollars to Euro dollars, it
is only fair to presume that other Asian economies would follow suit.
THE BEACHFRONT
CONDO
When every-one wants a beachfront condo, demand drives their prices up. Then
a hurricane comes through and changes every-ones mind – no-one wants
them any more, and so invariably their prices plummet.
Just like any
sought after or highly regarded asset that suddenly goes out of vogue, its
value falls to the point where the sellers meet the buyers. The more sellers
and less buyers you have in a given market, the lower the prices will fall.
THE BRITISH
EXPERIENCE
This deposition of an international currency has happened before this
century. One need only look at the plight of the British pound on the
international scene and within the British Empire after WW2, to see the
inescapable effects on an economy where this has happened.
Its worth
remembering that before Bretton Woods officially dethroned the Pound, the
British Treasury did not have the same degree of debt the US carries today.
Nor did they have the balance of trade deficit with the rest of the world
that the US has today.
And by comparison
there was nowhere near the level of foreign held reserves in pounds as there
is in US dollars today. Prior to Bretton Woods, the pound had been used along
with gold and the US dollar in international trade. There had been no clear
international monopoly on currency.
But despite all
of this, for over three decades the British economy struggled with the harsh
effects of this international displacement of their once great pound. The British
economy missed much of the post war boom, experienced by most of the west.
Devaluation in the Pound reeked havoc domestically in Briton, culminating
eventually in an IMF bailout in 1975.
WHAT THE FUND
MANAGERS THINK
In November 1998 CNNfn reported a survey by the Deutsche Bank. It took the
views of about 200 global fund managers responsible for US$7.5 trillion. Many
central banks were represented in the survey. Three-quarters of fund
managers, including a majority of U.S. fund managers, said the euro would
rival the dollar as the preferred currency for debt issuance within five
years. With central banks among the main investors in bonds, this suggests
the euro could rival the U.S. dollar as a reserve currency by 2003.
The analysts and
fund managers that predict the new currency will present a serious challenge
to the dollar, are right.
This displacement
of the US $ globally may take some time but it will happen – it is
inevitable.
‘AAA’
RATED WISDOM
The future plight of the US dollar becomes even more important when one
considers for many years now, investors the world over have been fed the same
prevailing wisdom – "if the investor really wants a safe haven for
his wealth, free from the storms of the stock market and real estate booms
and busts, there is only one place to go – dubbed "the flight to
quality" has not been gold and silver in the physical possession of the
holder, but - AAA rated US treasury bonds".
Could it be that
prevailing wisdom of the day is again about to be found wanting?
THE IMPORTANCE OF
RATES
Throughout August and September last year, it would have appeared to the
observer that the US economy was in a deathly tailspin. Triggered by the
Russian debt default, losses in the US stock market were approaching 20% from
mid July highs. With crashing confidence and plunging markets in the US, the
Asian and Russian crisis threatened to become a global economic and financial
crisis.
Every 1000 points
lost on the Dow Jones is equivalent to around $1 trillion in lost equity.
$100’s of billions had been stripped from mutual funds, share
portfolios and the hip-pockets, of average American’s.
To ward-off
plummeting markets and deflation in the US and a worsening global crisis, on
3 separate occasions between late September and mid November 1998, the Fed
lowered official US interest rates, from 5.5% to 4.75%.
In January 1999
the effects of this monetary intervention by the Federal Reserve is evident.
Markets have temporarily settled. For now, talk of global crisis has ended.
Investors with notoriously short memories have again driven stock markets
back to record highs (buoyed by small cap, high tech stocks).
WALKING THE
RAZORS EDGE
Back in Europe 10 of the 11 participating nations have set interest rates at
3%. At the moment US rates are at 4.75%. In other words holding US dollar
reserves attracts a 1.75% premium over the Euro – the US dollar is a
higher yielding investment.
The higher
premium the US now pays should slow the displacement of the dollar internationally,
but in the long run, can’t stop it. As US dollar reserves are dumped on
the open market at an ever-increasing rate, pressure will mount on US
monetary authorities to increase the premium – or lift US interest
rates.
Deflation in the
US (and Australia) is waiting just around the corner. Stock markets are the
highest they have ever been in history. Any increase in the official rate
will re-ignite deflation and slam markets through the floor.
Domestically
within the US throughout 1999, pressures will again swell toward lowering US
rates, to combat a slowing economy and intensifying deflation.
The problem with
an unsustainable system ; its only a matter of time before you are in a
no-win situation. In the months ahead these opposing pressures on US rates
are going to escalate dramatically. US monetary authorities will continue
walking the razors edge.
A UNITED EUROPE
Europe is a vast patchwork of differing political ideologies, economic
theories, painful memories and cultural habits. It may be that mixing all
these elements behind a central currency and bank would be like mixing iron
with clay – but time will tell.
‘AAA’
RATED SECURITY
The launch of the Euro and the inevitable displacement of the US dollar is
not the end of the world. On the other hand, it is sure to add to the turmoil
in the months ahead.
I am reminded of
Larry Burkett’s closing words captured on the documentary
‘Millennium Money’ when he said "ultimately God is our
security, not gold, not silver, not any assets at all".
Philip Judge
Anglo
Far-East Company
Also
by Philip Judge
Philip Judge is the 3rd generation of a family that has had
substantial involvement in the Precious Metals markets. He has researched,
written and spoken on the gold, silver and commodities markets for over a
decade. Philip works in the marketing and operations department of The
Anglo Far-East Bullion Company, an internationally based Bullion Banking,
Investment Management and Financial Services Company
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