The European currency has depreciated dramatically against the
US dollar in the past few months, falling from over $1.50 on December 1st to
$1.35 today. The move has caused many investors to question the viability of
the European Union and its currency, while also serving to reinforce the
notion of the USD's position as the world's reserve currency.
To be clear, there has never been any question in my mind that
the euro is just another flawed fiat currency. It could never serve as a real
place holder for investor's wealth or become a viable alternative to owning
precious metals. However, it deserves to maintain its status as an excellent
diversification- currency for those who hold excess dollars. But we currently
find the question being asked more today than ever before if the USD can act
as a safe haven from the troubles over in Euro land? The answer to that
question can be found in the data and the data clearly shows that it cannot.
The 27 countries comprising the European Union's economy is the
largest in the world. It's GDP on a purchasing power parity basis was $16.5
trillion in 2009, which is greater than the $14.2 trillion US economy. The
economies of the 16 countries in the Euro zone that use the Euro currency
produced GDP of about $10.5 trillion on a PPP basis according to the CIA 2009
world fact book. That is equivalent to 74% of US total output. Therefore, the
economies of the EU (27) or Euro Zone (16) are similar in size and scope to
those of the US and should be viewed with the same gravitas. The size of the
European economy is not an issue.
U.S. GDP contracted 2.7% in 2009 compared with a contraction of
4.2% in the Euro (16). However, the annual change in prices in the Euro Zone
was just .9%, which is lower than the 2.7% Year over Year increase in the
U.S. Consumer Price Index. Therefore, while both nations suffered from a loss
of total output--with the Euro Zone contracting at a slightly greater pace
than that of the U.S.--the U.S. also suffered from a greater rate of
inflation. The data on growth and inflation is a wash and does not argue for
a much stronger dollar.
Yet according to the IMF, the US dollar accounted for 64% of
global central bank reserves. In comparison, the Euro currency represented
just 26%. Why is it that the U.S. economy deserves to represent such a
tremendous over-weighting of central bank reserves? Since their currency
holdings are so vastly concentrated, it places global central banks 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. But unlike the greenback no such over-owned
condition along with its concomitant pent-up selling pressure exists for the
Euro.
There has also been much distress over the current state of
Greek debt and justifiably so. The European Commission has projected the
Greek deficit will reach 12.2 percent of GDP and have gross debt of 124.9
percent as a percentage of GDP in 2010. However, taken in aggregate the
average deficit in the Euro zone will reach 6.9% of GDP in 2010. Yet the
deficit in the same year for the United States is projected to reach a far
greater 10.6% of GDP.
Not only is the annual shortfall of red ink greater for those of
us who use the greenback but from a gross national debt standpoint it looks
equally unfavorable as well. Currently the gross national debt of the US
stands at 87% of GDP. The European Commission projects that their gross
national debt will reach 84% of output this year and 88.2% in 2011. And In
contrast, 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.
While many investors are flocking to the USD for safety because
of debt downgrades in Greece, they are overlooking the risks associated with
our own fiscal imbalances. Steven Hess (senior credit officer in the
sovereign risk group of Moody's Investors Service) said this about the US
sovereign credit rating in a Reuters interview a few weeks ago, "...at
some point, we don't know when, there would be downward pressure on the US
credit rating."
Therefore, not only is our debt situation worse than Europe's
but our interest expense may increase significantly if or when our sovereign
credit rating is cut. Our debt service would then rise dramatically causing
GDP to contract. The Fed may be forced to step up their monetization of
government debt, which would send inflation rates rising dramatically. The
result would be an even higher debt to GDP ratio and may cause a massive
global rush out of dollars.
How then can the USD be seen as a safe haven from the Euro? The
two currencies have similar sized economies and there is no trenchant
difference in their health when viewing GDP and inflation data. Yet the debt
situation in the US is worse than in Europe and the USD is the most
over-owned currency on the planet.
Selling Euros to buy dollars is sort of like exchanging your
ticket on the Titanic for a ride on the Hindenburg. The answer is not to sell
one sinking currency and jump on another one that is drowning as well. The
only truly safe currencies are those that can act as a store of wealth, that
cannot be diluted by fiat and whose purchasing power cannot be corrupted by a
government. Investors the world over should seek the safer harbor that is
derived from owning commodities and precious metals rather than to believe
the USD can offer any real protection.
Be sure to listen in on my Mid-Week
Reality Check and to follow my blog Pentonomics
Follow me on Twitter: http://twitter.com/michaelpento
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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