 Global Imbalances are Getting Larger
- It's a Europe Thing
Benjy Godley
Godley IGH
The Bullion Merchants
18 March, 2005
Trade figures continue to show the depth of US deficits, which
stand at 6% of GDP. The dollar is falling in value. Warren Buffett,
regarded as the greatest investor in history sees this as inevitable:
"The dollar cannot
avoid further declines against other major currencies unless
the US trade and current account deficits improve. I think, over
time, unless we have a major change in trade policies, I don't
see how the dollar avoids going down. I don't know when it happens.
I don't have any idea whether it will be this month, this year,
or next year, but we are force-feeding dollars on to the rest
of the world at the rate of close to a couple billion dollars
a day, and that's going to weigh on the dollar."
The protectionist policies
of Asia (currency intervention, buying of US treasuries) have
meant that much of the dollar's decline has been borne by Europe
and a rising euro.
Furthermore, the Asian central
banks have been hinting at rebalancing their currency portfolios.
We have had hints from South Korea, China and now Japan. Each
"hint" has been "clarified", but still suggests
that the dollar is causing some concern. These hints suggest
increasing their euro holdings, which again will result in a
strengthening euro.
However, I am coming to the
conclusion that the euro is becoming overvalued. It has gained
more than 50% over the past three years. Is it because Europe
is the best place to invest? Or is it due to the global imbalances
that persist in the global economy? It is this that I am going
to look at.
A Strong Currency - A Symbol of Power
and Economic Prosperity
As the dollar has fallen against
the euro, the Asian currencies (tied to the dollar) have also
fallen. Europe, burdened by high taxes, regulation and legislation,
is currently suffering from weak domestic demand. Leaked drafts
from the IMF show concerns over European growth, with 2005 estimates
of a slowdown to 1.6%. This is mainly as a result of Germany's
appalling record of a meagre 0.8% growth. I would not be the
first person to suggest that Germany has inherited the crown
of "the sick man of Europe" from Britain.
Listening to industry, it can
be seen that the strong euro is damaging their competitiveness.
Below are a few quotes from the BBC business news website that
demonstrate the pain being felt by European manufacturers.
"European firms are
becoming more and more voluble about the damage the weak dollar,
and strong euro, is doing to their profits. VW said the feeble
dollar had forced it to ditch plans to bring to the US a successor
for its iconic minivan."
"Other companies, such
as Italian clothes firm Benetton, have responded by moving production
outside the 12-nation eurozone, since the dollar's decline has
been less steep against other currencies."
"And aerospace firm
EADS has said that it will now have to build 300 of its new Airbus
A380 super-jumbos to break even - a rise of 20% on its previous
forecast."
It seems that the strong euro
is not good for Europe, nor is it sustainable, in light of the
highly regulated labour markets, high taxation policies and weak
domestic demand we have been seeing in Europe.
However, with statements from
ECB president Jean-Claude Trichet of "We express our vigilance"
when discussing the fight against inflation, it is not surprising
that investors and central banks see the advantages of holding
assets in euros. For it holds a similar appeal to gold, in that
the euro can act as a store of value. With the ECB seemingly
vigilant against inflation and ready to raise interest rates
in order to fight inflation, the euro is a safe asset.
There is, as always, an oddball
in the mix. The European Stability and Growth Pact is currently
being flaunted with indications that France, Germany and Italy
are likely to breach the EU budget deficit ceiling of 3%. Why
should this happen? These countries need to increase government
spending to keep their economies growing. Despite low European
interest rates, European economies have fared so well. Consequently,
governments have had to step in. Examples of high unemployment
rates resulting in large welfare spending are not surprising.
More importantly, what are
the possible ramifications of this?
I find it amusing that politicians
and central bankers should once again be arguing about economic
policy. The staunchly independent ECB believes above all else
in fighting inflation. The European governments are accountable
to their people and do not have the luxury of independence. If
it comes down to breaking the 3% budget deficit ceiling in response
to the unemployed mass, we have seen that politicians will do
this. Of course, this again impacts upon the euro.
Slack fiscal controls pose
a threat to the strength of the euro. Fiscal deficit has to be
financed somehow. The fear is that the markets will shun the
bonds of weaker eurozone states such as Italy once global credit
conditions tighten. A sharp rise in yield spreads between the
Franco-German core and the eurozone periphery could put a severe
strain on monetary union. However, this strain is all part of
the learning curve for the ECB. The worry is that the euro could
become devalued.
I personally do not believe
a strong euro is sustainable whilst European labour markets are
tightly regulated and whilst Europe remains over-taxed. In light
of this, it seems to me that the euro's strength is due in no
small part to Asian currency manipulation and dollar weakness.
More imbalances are building up, leading Europe into stagnation.
Currency Debasement
There comes a point when a
strong currency becomes a burden. Europe is beginning to experience
this. With the depreciation of the dollar, increasing pressure
is put onto the euro turning it into a de fact currency of strength.
A strong currency is now a burden in today's increasingly protectionist
world. It would seem to me that currency debasement is a situation
that is quickly becoming plausible.
The farce of the European Stability
and Growth Pact is allowing European governments to run deficits
in an effort to boost their slowing economies, whilst simultaneously
helping to debase and devalue the purchasing power of the euro.
In the face of a falling dollar,
it is strange to hear of weakness in the euro. I believe that
we will witness a fall in both the dollar and euro simultaneously.
With the current currency manipulations of the Asian economies
focused on the dollar, this appears unlikely.
However, the euro cannot take
the burden of the falling dollar alone. I believe that currency
debasement is likely ahead, with competitive devaluations (albeit
governed by the markets - i.e. central banks will allow their
currencies to fall - similar to the Fed and the dollar at the
moment).
When this occurs, I believe
we will see the repercussions in a decoupling of the dollar gold
link, with gold moving independently. At this point gold's store
of value properties will prove most valuable.
Conclusion
We are all reading about the
falling dollar, with particular interest for its repercussions
on gold prices. However, the focus is always only on the dollar.
It is necessary to view the wider picture of the dollar against
the euro and the Asian currencies. In my mind, the euro is becoming
overvalued against the dollar, judging by Europe's economic performance.
With that in mind, I do not see gold propelling to over $500
on dollar weakness alone.
The strength of the euro is
chiefly due to the foreign currency policies of the Asian economies.
This euro strength is not sustainable. Providing the Asian economies
maintain their dollar link, I cannot see the euro rising dramatically
against the dollar, possibly falling again due to euro weakness.
Only, when the market begins
to take account of an overvalued dollar and euro, will gold begin
to move due to its own strength, rather than due to the "dollar-gold"
link. I believe this is occurring faster than some analysts predict.
It will be important to watch European fiscal spending policy
and ECB responses, for these could shape the next movements for
gold prices. Any indications of currency debasement, and falling
euro and dollar values will be long-term gold positive.
Wishing you all well,
Benjy Godley
Godley IGH
b.godley@godleyigh.com
www.godleyigh.com
Benjamin Godley is managing director
of Godley
IGH,
a UK bullion house providing investors with safe, secure channels
to invest in gold bullion. His background is one of the precious
metal industry, with his family's involvement in the industry
stretching back to his father and grandfather. Their refinery,
G.
C. Metals Ltd.
is still refining today as one of the few independent British
refineries. It is through this background and his interest in
Economics, in which he obtained his degree, that he has progressed
into gold trading and gold investment. He continues to write commentaries,
papers and economic studies, and it is in this personal capacity
that he writes market commentaries.
This document is not and should not be construed as an offer to
sell or the solicitation of an offer to purchase or subscribe
for an investment. Information and commentary contained herein
comes from sources believed to be reliable, but this cannot be
guaranteed. Expressions of opinion are the author's alone and
are subject to change without notice. From time to time, the author
may hold positions in issues referred to in this document, and
he/she may alter them at any time. Investments recommended herein
should be made only after consulting with your investment advisor,
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©Copyright
2005 Godley IGH. All Rights Reserved.
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