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The European experiment with a trans-sovereign currency is
facing its first acid test. The flashpoint today is Greece, which looks set
to default on its debt barring some outside intervention. While many
commentators have been squawking about the immediate crisis as if it were the
end of life on Earth, I would like to zoom out and discuss the history and
longer-term outlook for the euro and its parent, the European Union.
The launch of the euro was a major milestone in the sixty year
process of European federalization. Economic considerations have always led
the charge, from a normalization of tariffs to a free-trade area to a customs
union. Still, the launch of a pan-European fiat currency and central bank
without a unified political apparatus behind it was always considered a risky
move.
Since its launch, the euro has outperformed expectations,
establishing itself both as the world's secondary reserve currency and the
second most traded currency after the U.S. dollar. Because of this stellar
introduction, the euro has been proposed as the new primary reserve currency
in place of a devaluing U.S. dollar. However, its unusual foundation presents
risks to which most investors are unaccustomed.
In essence, the euro was created as a lever to encourage a
complete European political union rather than as a currency representing a
call on an already unified economy, as with the U.S. dollar. Jean Monnet, one
of the EU's founding fathers, is reported as saying, "Europe's nations
should be guided towards the super-state without their people understanding
what is happening. This can be accomplished by successive steps, each
disguised as having an economic purpose but which will inevitably, and
irreversibly, lead to federation."
The currency has largely succeeded in creating the will for a
federal Europe among the member states' political classes; however, the
citizens have voted again and again to maintain their countries' independence
since 2005. Thus, the Union was already losing momentum when the latest
financial crisis struck.
The combination of tight credit markets and high debt-to-GDP
ratios caused bond yields for the EU members collectively known as PIGS
(Portugal, Ireland, Greece, and Spain) to fly upward. As a result, Greece is
now in acute jeopardy of officially defaulting on its debts. Because a
political union was never implemented, Greece cannot be compelled to slash
its budget, nor can it assume the Union will prevent its fiscal failure.
This explains why investors are making short-term trades out of
the euro and into the dollar. While the Greek deficit-to-revenue ratio is
roughly equal to that of California in 2009, the latter functions with an
implicit (although untested) guarantee that the U.S. government will step in
before they are forced to default. The EU offers no such backing to its
member-states. In fact, recent questions have arisen out of Germany, the
primus-inter-pares of EU members, concerning the legality of the European
Central Bank (ECB) or the European Union ever giving direct aid to the Greek
government.
While many assume that either Germany, an ad-hoc group of
European states, or the IMF will bail out Greece, such a result would
represent a temporary fix rather than a policy precedent. The move would pose
more questions than it answers. If Greece were to be thrown a lifeline what
would happen if Portugal, and then Spain, were to ask for equal
consideration? Will Greece be spared expulsion from the eurozone if it fails
to take the austerity measures necessary to restore solvency? If not, what
message does that send to Ireland, which chose to slash its budget rather
than wait for a bailout?
These problems did not spring from the aether. The architects of
the euro, in pursuit of their political agenda, willfully disregarded the
historical divide between the Nordic economies, which have practiced low
inflation and fiscal discipline, and the Mediterranean, high-debt, easy-money
economies. While there were strict economic, monetary, and budgetary criteria
for entry into the currency, one can reasonably suspect that enforcement was
lax or the numbers were fudged. After all, the southern states' balance
sheets tilted deep into the red soon after acceptance in the Union. Now,
however, the ECB prevents them from monetizing the debt.
So, we are witnessing the results of this inherent
contradiction.
If the EU becomes the "bailout union," a free-ride
area where entitlement spending in Greece is underwritten by German
taxpayers, then the euro will stabilize in the short-term, as investors face
reduced uncertainty. However, this will lock the Union on a trajectory to
gradual monetary collapse - the path currently being followed by the U.S.
dollar.
If Greece is left to face the consequences of its profligacy,
then the integrity of the euro will be preserved. The key in this scenario is
whether Greece leaves the euro, or the Union, when it defaults. If it does,
we could see weaker economies cast out one-by-one until Europe returns to a
system of national currencies, with perhaps a rump euro uniting the Nordic
block. If Greece defaults but remains in the block, then short-term shock
will give way to a renewed confidence in the euro as a lasting reserve
currency.
The future of the EU is being tested severely, together with
much of the wealth of investors who have diversified into its currency.
Likely, this crisis will draw the EU member states into a covert political
struggle over the future of Europe. As this battle ebbs and flows, both the
euro and the U.S. dollar likely will suffer great volatility. Those of us
parked in the safe harbor of gold may benefit greatly from this transatlantic
turbulence.
John
Browne
Senior Market Strategist
Euro
Pacific Capital, Inc.
20271
Acacia Street, #200 Newport Beach, CA 92660
Toll-free:
888-377-3722 / Direct: 203-972-9300 Fax: 949-863-7100
www.europac.net
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John Browne is the
Senior Market Strategist for Euro Pacific Capital, Inc. Mr. Brown is a
distinguished former member of Britain's Parliament who served on the Treasury
Select Committee, as Chairman of the Conservative Small Business Committee,
and as a close associate of then-Prime Minister Margaret Thatcher. Among his
many notable assignments, John served as a principal advisor to Mrs.
Thatcher's government on issues related to the Soviet Union, and was the
first to convince Thatcher of the growing stature of then Agriculture
Minister Mikhail Gorbachev. As a partial result of Brown's advocacy, Thatcher
famously pronounced that Gorbachev was a man the West "could do business
with." A graduate of the Royal Military Academy Sandhurst, Britain's
version of West Point and retired British army major, John served as a pilot,
parachutist, and communications specialist in the elite Grenadiers of the
Royal Guard.
In addition to careers
in British politics and the military, John has a significant background,
spanning some 37 years, in finance and business. After graduating from the
Harvard Business School, John joined the New York firm of Morgan Stanley
& Co as an investment banker. He has also worked with such firms as
Barclays Bank and Citigroup. During his career he has served on the boards of
numerous banks and international corporations, with a special interest in
venture capital. He is a frequent guest on CNBC's Kudlow & Co. and the
former editor of NewsMax Media's Financial Intelligence Report and
Moneynews.com. He holds FINRA series 7 & 63 licenses.
Copyright © 2008
Euro Pacific
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