The European Union established the growth and stability pact which imposed the following two conditions on all members
1) Deficit spending cannot exceed 3% of the GDP
2) Total Government debt should not exceed 60% of GDP
The table below clearly illustrates that many of the members are blatantly ignoring these rules.
Budget Deficit as % of GDP
Debt as % of GDP
Spain’s budget deficit could reach 90% of GDP by 2011, currently it is roughly at 60% and rising, so we have yet another contender to join the list of troubled nations. S&P has already downgraded Spain’s sovereign AAA credit rating. In fact, at this point Germany is the only country in the EU that deserves the AAA rating, the rest all face varying degrees of trouble.
Germany the head honcho is in no mood to lend money or help its fellow members as they have their own problems. Now a strong currency makes it hard for struggling countries to make their exports attractive by devaluing their currency. Under the one currency umbrella, they no longer have this option. For example, Italy had a history of systematically devaluing the lira when faced with tough economic conditions; this option is no longer available. Thus the next step is to simply openly flaunt the rules. If no punishment is forthcoming for breaking these rules, then there is nothing to stop other members from joining the party.
Thus there is a very good chance that something could crack here and that the Euro might not end up being as safe as so many make it to be. While the US has problems, the problems facing the EU are starting to look even more daunting. Look at the table above all 4 nations are openly flaunting the rules laid by the growth and stability pact, actually when we add Spain to the list, the count rises to 5.
This situation is going to create rifts in the EU as weaker nations now have to adhere to a fixed standard without having any flexibility to adjust monetary policy based on their own needs; the only option then is to openly flaunt these rules. This in turn is going to aggravate the larger stronger players such as Germany and France, which could possibly lead to one of the following outcomes.
Some members could be kicked out (very dramatic move and not likely right now)
Members could start to openly revolt against these rules and make demands to ease them or ask for lengthy time extensions before coming into compliance.
Finally, the richer members might be forced into bailing out their weaker neighbours.
Either of the developments could have a very strong negative impact on the Euro. So when we look out the window it appears what we stated many times in the past might become a reality. “Every currency is rotten” and the rats are jumping from one sinking ship to another. We are also very close to entering competitive devaluation stage or what we have coined as “the devalue or die era”, where every nation in order to gain an exporting edge starts to devalue its currency.
Thus individuals should not smugly gloat over the dollar’s demise, for they might be missing the real trouble that is taking place in their own backyard. This problem facing the EU is another reason why the dollar could potentially mount a stronger rally than most expect and why it might even potentially surpass all our posted targets. When the ship is sinking panic takes over and people jump before they look. Thus if anything out there makes investors feel skittish about the Euro, it could potentially trigger a mad rush for the exits. Are we saying this is definitely going to occur? No we are not but given the large deficits 5 members in the EU are running; it’s safe to say that all is not well and that the situation could take a turn for the worse very rapidly. Greece could turn out to be another Iceland, if they do not get their act together very very fast.
Very important final factor
The US dollar for all its current woes is at least backed by the full faith of the US government; the Euro in contrast is backed by nothing. No one nation backs it, it's backed by a group of nations whose economic conditions could/might force them to eventually abandon the Euro (strong examples right now are Greece and Italy, Spain and Portugal are not far behind). Going forward the currency markets are going to become increasingly complex and entangled. This is the reason why we have pushed our subscribers over the years to make sure they have a core position in bullion (Palladium, Silver and Gold).
Traders looking for short term ways to benefit from a dollar rally can consider the following strategy
Go long UUP, Short FXE and GLD. If you are more aggressive you can short individual Gold stocks.
Long term traders can implement the following strategy
Wait for a strong pull back in Gold and Silver, and then consider opening up positions in GLD and SLV. One place traders can start to look to open up positions would be if Gold bullion manages to test and hold above the 900 ranges. Take small bites instead of one large one. This way if Gold and silver should trade lower, you will be in a position to take advantage of this move.
Disclosure: We have a position in UUP, Gold bullion, and are planning on opening positions in GLD and SLV down the line
Disclosure: We have a position in UUP, Gold and Silver bullion, and are planning on opening positions in GLD and SLV down the line