Tuesday, 10 February 2004

EU Finance Ministers Vote to Turn Euro into Eurotrash

That’s a headline you won’t read in any newspaper, either in Europe or in the United States. But “eurotrash” is an apt description of what the Finance Ministers of the 12-nation European Monetary Union seem to have in mind for the euro.

In late November, after months of finger pointing, EMU finance ministers voted to permit France and Germany to continue violating the “Stability and Growth Pact,” an agreement between the 12 countries using the euro as their official currency. The pact, which is the core of the euro’s credibility, stipulates that when euro-club members run government budget deficits larger than 3% of GDP, the offending nations must either hike taxes or slash spending. If they fail to do so, huge penalties are supposed to be imposed, which in Germany’s case alone would have resulted in annual fines of undefined10 billion (US$12.5 billion).

However, France and Germany, the largest and most powerful members of the euro-club, have announced they’re no longer willing to play by the rules. And the club’s less powerful members don’t have the political muscle to force them to do so.

If France and Germany can get away with this policy, other EU members might try doing so as well. If enough countries flout the Stability Pact, investors will begin suspecting that the politicians can’t be trusted to keep a disciplined fiscal policy underpinning the euro’s value. This could cause the value of the euro to fall quickly, since, unlike national currencies, it is backed neither by gold nor the power of a sovereign government to tax its citizens.

We’re not the only ones worried. The president of the German Bundesbank, Ernst Welteke, says the decision “risks damaging the credibility of the institutional framework of European monetary union and also confidence in the euro.”

No one knows how quickly the EU’s fiscal irresponsibility will result in a euro-crisis. All we know is that the events of the last few months significantly increase the risks involved in owning euros on a long-term basis. Unless you’re an active currency trader, it is perhaps time to use the current bull market in euros to begin taking profits.

It may seem like an odd time to warn about the euro when it’s appreciated nearly 50% against the U.S. dollar in the past two years. But I believe that it’s time to convert your euro holdings into another currency. It’s always better to sell into strength than into weakness.

You may miss the last 10% of the euro’s gains against the U.S. dollar – now approaching 1.3. I wouldn’t be surprised if it reaches 1.35 or even 1.40 – but I think we’ve already realized the vast majority of profits. What should you purchase with your euros? I recommend gold, a currency that has actually outpaced the euro against the dollar, but that has not appreciated against the euro. From January 2003, gold has gained 25% against the dollar but only 3% against the euro.

Gold is rallying against the dollar in a more sustained way than it has done for 20 years. And it will rally against the euro if the EU’s largest and most powerful countries continue to undermine the euro’s foundation.

Mark Nestmann