The Euro Crash

From as early as first quarter 2008 it was possible to predict the overvalued Euro, always able to gain from intrinsic US dollar weakness, was itself heading for a fall.

Unsurprisingly, speculators first transferred their bets to the traditional hedges, Gold and Oil, rather than directly attack the Euro but this strategy was soon troubled by the global economic recession.

Through 2009, for many months, the overvalued US dollar took the limelight and supplied to preferred target for speculators, but by third quarter 2009 they returned to chipping and hacking at the Euro.

The reasons for this loss of confidence are simple but numerous and start with the fact it has no status of "old and trusted" world money, like its big rival the Dollar. This was first officially produced and circulated as a national money backed by gold, in 1792.

Exactly like the Dollar since 1971, and like all other world moneys today the Euro has no physical backing. It is not convertible to a fixed weight of gold, other precious metals, or a basket of real resources. Technically, both the Euro and Dollar, the Yen, Yuan, GB Pound, Ruble, Swiss Franc and all other major moneys are "Fiat money".

Recent currency market sentiment underlines the Euro "Fiat money" is certainly not a Mercedes, Bentley or Porsche money. Its exchange value is defined by shifting economic criteria, can be changed by instant political decision, and ultimately depends on national political policy.

The longevity and sustainability of "Fiat money" is never guaranteed, which again is underlined at this time by press and media discussion asking: "Should the Eurozone be shrunk to only the stronger countries, or should the Euro be completely abandoned?"

Gresham’s Law The question today is how far does the Euro fall, against which moneys or real assets, and how fast. Taking its high and low values against the dollar since 2000 this gives large range, from around 84 US cents to 1.50 USD in Oct 2009.

As press comment already says, when or if the Euro becomes a "bad" money, it could in ultimate crisis conditions be simply abandoned, which takes us back to the original definition of "bad money", dating from the 16th century.

Gresham was a royal finance adviser to the very first Elizabeth of England, Elizabeth 1, at a time when her royal money was suffering badly from over 25 years of massive and mostly illicit gold bullion and metal silver imports. The first version of Gresham's law, and its forerunner the Copernicus law saying the same thing, date from the 1540-1560 period.

From around 1540 massive quantities of gold and silver arrived in Europe from the Caribbean, Latin America and pirate hideouts of the Atlantic. The long cycle theorist Kondratiev estimated Mediaeval Europe had an inflow of gold and silver, through 1550-1600, of perhaps 40 000 tons of gold and over 400 000 tonnes of silver.

Total gold stocks of all today's central banks reporting to the World Gold Council are placed at about 11 880 tons as of mid-year 2009, about 5 years of average global gold mine production, which for many years has been stagnant, showing no growth at all.

In Gresham's time, the total value of "official money" circulating was tiny relative to today but even then it was impossible to fully back Elizabeth's official money with gold.

This is even more impossible for today's central banks. Using only the most restricted definition of money in global circulation, called M1, this has a total dollar equivalent value of about 45 000 billion dollars, increasing at about 6 per cent to 11 per cent per year. This means that only a tiny fraction of 1 gramme of central bank gold could guarantee each dollar equivalent unit of paper money in circulation.

For the present therefore, we have to disagree with Gresham's one-liner that "Bad money drives out Good". Even in Elizabethan times it was impossible to defend the overvalued official money against illicit and rival moneys, by guaranteeing it with an automatic and formal, legal equivalent in gold.

Since the time of Keynes in the 1930s and 1940s, and the Oil Shocks of the 1970s we can add oil, food commodities and other "real resources" to the wish list of what should back an ideal world money.

More recently, since 2009, we can also add the notion of "CO2 money", a global carbon-related money based on very complex formulae ultimately depending on how much CO2 each holder of this new world money emits.

Is the Euro Good or Bad ?

If the Euro disappeared tomorrow, and apart from months or years of economic chaos in Europe, the ironic result would be a sharp rise in the US dollar price of real resources such as oil.

To be sure, the dollar would regain its lost status of sole reserve currency in global circulation - but very quickly would come under renewed speculative attack. Disappearance of the Euro would speed the long-term decline of the dollar, perhaps its own disappearance.

The Euro serves a critical shielding role for the dollar, which the also overvalued Yen cannot because of the smaller size of the Japanese economy relative to the EU27 or USA.

While the Euro exists, the US dollar can also exist, because the Euro shares the strain of playing world reserve money. When or if the Euro is abandoned, world monetary crisis will be inevitable and massive, with unforeseen consequences.

This reality is already discussed, sometimes in "coded language" in the negotiation of bailout funding to Europe's Dubai, that is Greece. Ireland, Portugal and Spain are not far behind. In this context, given global macroeconomic trends and underlying fundamentals it is likely the Euro can continue losing ground against the dollar, but this will unlikely attain parity.

Long before we reach 1 Euro = 1 Dollar, currency traders will start betting against the dollar again as political deciders rush to support both the Euro and the Dollar.

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