Much to the relief of jittery global markets, Greece's chronic debt problem has been papered over in a burst of European solidarity and apparent magnanimity. But this act of mercy may cost Germany its key position of financial dominance over the European Central Bank (ECB), which, in turn, could be detrimental to the long-term health of the euro.
And so even though the euro stiffened once the immediate default fears abated, the price of gold was pushed to a new all-time high in euro terms (and a five-month high in dollar terms). [i]
The euro is now second only to the U.S. dollar in importance to world commerce. It is held by most central banks and corporations as a legitimate diversification hedge against the U.S. dollar. Therefore, its stability is of key importance to international currency markets and global stability.
Increasingly, it is apparent that the Greek problem is a potential game changer for the euro. So far, the various rescue packages have failed to convince investors that Greek bonds are dependable over the long term. Despite Greece's successful short-term debt auction on Tuesday, the premium demanded by investors to hold longer-dated Greek bonds continues to increase. Today, the yield spread between 10-year Greek and German government bonds widened to just a shade below 400 basis points. [ii]
It remains to be seen whether the latest support package offered by the EU - a three year loan of some €30 billion at around five percent interest [iii] - will suffice to cover the major economic, structural, and even attitudinal changes that are necessary. Furthermore, the potentially larger budgetary problems of many Eastern European countries and the remaining PIIGS (Spain, Portugal, Ireland and Italy) still remain to stalk the euro.
Still, there remains an even more significant threat to the euro. The eurozone finance ministers' 'soft' Greek rescue package, when combined with ECB Chairman Jean-Claude Trichet's preparedness to continue accepting Greek bonds as collateral, spells the possible demise of the Germanic sound money policies underpinning the euro.
In the original formation of the euro, the Germans were prepared to give up their widely respected Deutsche Mark only if the euro would be run on a prudent and stable basis. In addition, to ensure compliance with their wishes, they demanded that the European Central Bank be based in Germany. As a sop for French support, they tolerated a plan that would eventually install a French ECB president (though the Germans made sure that ECB's first president, the Dutchman Wim Duisenberg, supported policies favored by Berlin.).
A Frenchman, Jean-Claude Trichet, did take over the ECB in 2003 and, much like our own Alan Greenspan, moved away from the hawkish tendencies that characterized his earlier reputation. Whereas Duisenberg was made famous for his "I hear you, but I don't listen" retort to angry politicians demanding rate cuts, Trichet has been much more willing to bow to pressure. This is causing great consternation in Germany. According to the German newspaper Handelsblatt, a former Bundesbank President remarked that, "Those who flirt with inflation, marry her. Trichet yesterday, kissed her."
In addition to raising eyebrows among German politicians, cracks in the sound money policy of the ECB should concern international investors as well. With the euro now threatened, where should international investors turn?
The budgetary and debt problems facing the U.S. government are so severe that, despite holding reserve currency status, America is now in danger of losing its triple-A credit rating. Last week, investors watched as U.S. Treasury Secretary Tim Geithner traveled to China, where he bowed, cap in hand, to beg the Chinese to revalue their currency. This raised the question as to whether the Chinese yuan is undervalued or the U.S. dollar is overvalued. Clearly, the U.S. dollar cannot be the safe haven for the world's savings.
The UK's pound sterling faces the same problems as the dollar. Stronger Western currencies, like the Swiss franc, are too small to absorb the bulk of funds fleeing the threatened euro without distorting their prices well beyond fair value. Gold seems to win by process of elimination.
Gold has hovered for some months in a tight range between $1,050 and $1,100 per ounce. It has held this level despite apparently low inflation and continued concerted efforts by central banks to de-monetize the metal. It seems many international investors, including the central banks of India, Russia and China, feel that, despite soothing words from politicians, all is not well with the paper world!
With a national debt now thirteen times larger than it was in 1980, [iv] investors in U.S. dollar assets are about to pay the inevitable price demanded by the profligate policies of Washington. Who can doubt that the spiking rates now on display in Greece will soon make an appearance on our shores?
As we have said before, we feel that the severe problems we face in America have yet to be fully realized. When they are, gold may be the surest footing in a world turned upside-down.
[i] 2010/04/09. "Gold priced in sterling hits all-time high". The Daily Telegraph.
[ii] 2010/04/14. "Euro, Greek Bonds Weaken Amid Fresh Greece Debt Nerves". Wall Street Journal.
[iii] 2010/04/14. "Bundestag Assent Needed Before Bailing Out Greece". The New York Times.
[iv] "Table: Historical Debt Outstanding - Annual". U.S. Treasury. Accessed: 2010/04/14.