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Why Euroland's streets aren't paved with gold
part 2 of 2

Mark Griffith
Jul 8, 2005

People rarely abandon habits overnight, or all at once, and followers of gold-euro coupling are no different. For a pair of years high dollar has meant low euro and low gold - while low dollar has meant high euro and high gold. A number of analysts saw this pattern break in the last few weeks. Now the pattern seems to be back for a while.

Old patterns like the gold-euro coupling have a repeating persistence that works a lot like price levels themselves.

Take a price level - such as 400 dollars an ounce for gold - or even other, less-studied price levels like 427 dollars an ounce.

When breaking through a price level, the old price level first acts like a ceiling, then like a floor - but in both cases it's like a ceiling or a floor made of sticky rubber.

The patterns of price behaviour are familiar. Rallies go up through the level, some distance beyond, then stall.... as if being pulled back by the sticky, stretching threads of a spider's web not letting a fly get away. The same thing happens the other way round - a price going down seems to penetrate, then slows, then stops, then starts to move back - not unlike a slow-motion trampoline.

Likewise, the linkage with the euro is going to be with gold awhile. Sometimes it will break away, sometimes it will seem to be sucked back into the coupling.

The long-term prospects for both dollar and euro are weak, but the market will take time to arrive, however slowly, at a consensus that both their prospects are weak against something else in particular (such as gold). Expect gold to mainly shine in weeks when there is no good news about either currency bloc.

Many readers responded to Part 1 of this article. Some, quite rightly, pulled me up about two points. One was the idea some readers got that I think the euro is not a weak currency. It is weak, just in a different way to the dollar. While overspending the US economic boom has allowed the dollar to float up and out of reach, the artificially stiff euro currency has pushed the Euroland economy down. Both are overvalued, just from different directions, as it were.

Furthermore, after a decade of unemployment-led currency "hardness" in what was to become Euroland, the currency is now being overborrowed surreptitiously by some members - witness the wangle clauses by some member states breaking their own rules about debt as a ratio of national income.

This gives us the interesting prospect of an artificially "hard" currency maintaining high interest rates at the same time as some members are borrowing under the table, so to speak. Since this makes it almost certain that one or more aggrieved countries will pull out of the euro sooner or later, the euro is a very unreliable bet long-term. The interest-deals that will be done to prevent an Italy or a France or a Greece from jumping ship will, of course, be a bigger problem for holders of the currency and of euro-denominated debt than the actual departure of one or two countries.

Emotional insecurity reigns, however, in Euroland. Once one country leaves the euro, as one will sooner or later, discussion will be intense as to "who is leaving next". Eurocrats are terrified of this, because deep down they suspect their project is little more than a conjuring trick between several bureaucracy-heavy countries who don't quite cut it in international-trade terms.

Yet it need not be such a big deal if a country leaves. Why should a country or two not leave, and another country or two join, Euroland each year? But when a club cannot bear to even talk about members thinking of leaving... that tells you how fragile the whole structure feels from the inside.

Which is why we can expect membership of the euro, and the terms countries have to satisfy to stay in it, to be very much made of sticky rubber, stretching whichever way they have to, to keep the whole crumbly deal together. If you want to bet on high interest rates for the PIGS (Portugal, Italy, Greece, Spain, for those readers who never worked in the flippantly rude world of London banking), then I'd like to bet against you. A credible threat to leave the euro will turn any interest-rate agreement to jelly. If you want to bet on low interest rates for more depressed Euroland economies like Germany or Holland, I'd like to bet against you too. With a currency designed to please everyone and destined to please no-one, sooner or later all things will come to pass.

Yet the stateist instincts of Eurolanders are unlikely to turn them into raging gold bulls any time soon, as I said in Part 1.

As one astute reader pointed out, French people have a very high rate of ownership of physical gold by international standards - many of them have a healthy suspicion of anyone calling themselves an official. This dates from the extraordinary episode in the early 18th century where a clever Scottish adventurer, John Law, persuaded the French King to issue paper promissory notes in whichever quantities (eventually) suited the crown.

This remarkable paper inflation disaster did three things of interest.

1. It created the French word "millionaire", used in English and lots of other languages even today, as some speculators became fantastically rich almost overnight in France's own version of Tulip Mania. 2. It so severely damaged the French crown and popular trust in the monarchy that the path was smoothed for the French Revolution a few decades later.

3. It left a portion of the French nation with a deep affection for gold, and a lasting distrust of any kind of money printed on paper - hence the surprise of one alert reader at my claim that Euroland is not ripe for a massive move into gold.

The difficulties with the idea that Eurolanders are gold bugs just waiting to happen are several though. The wise minority of Frenchmen who still hoard gold under their beds (and a few really do just that) is smaller than it used to be, and to some extent this is already in the market. This section of (largely provincial) France is already holding about as much physical gold as they can afford to. They're not all about to buy tons more.

Worse, Euroland's governments are able and willing to tax or regulate these and other people from acquiring assets in other kinds of gold (certificates of deposit, futures and options contracts, shares in gold mines). This "paper gold" sector is bigger than physical gold, and is a lot more practical as a route for thousands of small investors to quickly increase their exposure to precious metals - a lot simpler than getting some ingots to put in the attic, though there is nothing wrong with that of course.

It may sound paradoxical to say on a website that criticises over-reliance on paper money that paper versions of gold allow more people to move more money into gold more quickly than physical ownership, but that's how it is. Unfortunately, there is a matching cost. Paper gold can be tied up out of citizens' reach with government red tape a lot more easily.

Oddly, the distrust of paper money among Eurolanders with good memories directly led to the belief that the euro should be made credible with over-high interest rates. That currency still looks crisp on the outside, but is increasingly soft on the inside: an unattractive monetary version of the marshmallow. What started out as a currency too soft for the Germans and too hard for the Mediterranean PIGS, is turning inside out. If Mediterranean state and local-authority borrowers keep on borrowing at attractively low rates while growth continues to stall in the Nordic and Germanic members of Euroland, they will find themselves, bizarrely, with something too hard to let the Germans invest to restart economic growth and too soft to restrain the PIGS borrowing until they're in over their heads.

However, I sound too pessimistic. As yet another reader prompted me - is there not room for re-education in Euroland? The general attitude on large swathes of the European continent (that all prosperity really comes from government and belongs to government in turn) means that the general attitude will continue to be: our governments have messed up the currency - they must now make a better currency for us in its place.

This is after all a continent of people who find compulsory state-issued identity cards as natural as breathing. These are mainly people who simply refuse to believe that sophisticated countries (like Britain and the US) can actually have lower crime rates and more of the world's money entrusted to their banks without everyone being safely tagged by state officials.

Perhaps I overstated. Even Europeans can learn, and one per cent of one per cent is a lot of people - should that many even ring up their bank to find out about shifting into gold. Still, there are larger games in town. Major progress is more likely to come from US institutions losing interest in the gold-euro coupling, and being ready to sell euros and buy gold.

Think of the now-partly-repaired gold-euro link as an opportunity in disguise, a breathing space giving us time to prepare. Gold may follow the euro down during opportunistic selling based on the dollar suddenly looking less bad than it did. But wait until genuinely bad news hits Euroland's currency, enough to unwind some of the world's already-large reserve-currency positions in euros. When the slow unravel of Euroland becomes finally, undeniably visible - that will be the time to have those gold call options already in place.

The euro going suddenly through a significant floor will break the link, shift reserve-currency money into the precious metal, and ramp up gold like nothing since the 1980s. Not because Euroland is economically sick (it is not bursting with health, but it makes some good stuff and is not about to turn into Ethiopia), but because the instrument itself, the euro, is at times deeply uncomfortable for some of the countries in Euroland, and it is only a matter of time before one of them refuses to bear the discomfort and shrugs it off.

It will be mainly non-European money shifting into gold (hence the title of this article), but a true who-is-going-to-leave-this-week crisis for the euro will be an opportunity for gold like no other on the horizon. Cloudy old Europe will by and large persist in trusting official fiat currency. But that same trust will sooner or later cause a Euroland political crisis. Study carefully and wait patiently. That political crisis - however short-lived - is going to be more than a silver lining for speculators.

Mark Griffith

Mark Griffith has a BA in Economics and Philosophy from Cambridge University, England; has traded in the open-outcry futures and options pits of LIFFE, London; has been published by Forbes Magazine, Financial Times newsletters, Playboy Russia, and American Spectator.

He writes about commodity markets and finance, and is researching a book about how firms can profit from virtual currencies. He can be contacted at

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