Axel Merk: Gold at ECB: Accident or Strategy?

Axel Merk discusses the relatively constant Gold to Asset ratio at the ECB (15%) in his latest Merk Insight letter and tries to analyze if this is done on purpose.

Here's the full letter:

When the euro was launched, the European Central Bank (ECB) held approximately 15% of its assets in gold. That ratio has remained reasonably stable, giving rise to a variety of chatter, including suggestions that it may displace the U.S. dollar. We pursue the question on whether the ECB’s gold holdings are an accident or strategy.

Let’s look at the numbers. Below is a chart depicting the percentage of gold relative to the ECB’s total assets. As one can see, the percentage has remained reasonably stable despite a significant growth in total assets.

Total assets of a central bank may be considered a proxy for the amount of money that has been “printed”; it’s a crude measure as it does not reflect physical money printed; nor does it reflect money in circulation; neither does it reflect sterilization activities that also show a rise in assets. Still, a central bank balance sheet is often referred to as the printing press as money is literally created out of thin air (by the stroke of a keyboard) when assets are purchased. Federal Reserve (Fed) Chairman Bernanke has referred to this fiat money feature as the printing press. We like to think of it as super-money, as central bank purchases provide cash to the banking system, allowing them to lend a multiple of the money that has been “printed”. While banks have been reluctant to lend (the velocity of money has been low), the analogy we like to give is that if you give a baby a gun, just because no one gets hurt does not mean it is not dangerous. That said, let’s look at total assets at the ECB:

The interpretation shows that while money can be printed, wealth cannot be created out of thin air: as money is printed, gold has appreciated versus the euro. So while inflation has not shown up in indicators such as the Consumer Price Index, monetary easing is rightfully reflected in the price of gold.

Diving a little deeper to determine how much of this is strategy versus accident, let’s look at the gold holdings at the ECB once more:

The ECB marks its gold holdings to market, i.e. uses market prices for gold. The ECB was selling gold from the inception of the euro until the onset of the financial crisis; since then, the ECB’s gold holdings have remained stable. To understand the motivation, one needs to note that when one refers to ECB gold holdings, one is actually talking about Euro area gold holdings. While the ECB holds some gold, most gold is held by the respective central banks (this is not a discussion of where such gold is physically located):

Relevant is that each nation in the Eurozone pursues its own agenda with regard to its gold holdings. Germany has resisted political pressure within Germany to sell gold, as Bundesbank (Buba) profits would need to be transferred to the government; the hawkish Buba has indicated that it would be considered selling gold to help finance the government’s deficit. Italy, as one can see, has not sold any gold. Conversely, as a percentage of their holdings, the Netherlands had been rather eager to sell gold up until the financial crisis; Portugal, too, was an aggressive seller. As one can see, gold sales are not particularly related to the financial health of a Eurozone nation, but more to the cultural attitude in the respective nations towards gold.

Let’s cross the Atlantic to see whether the ECB’s gold strategy is undermining the U.S. dollar. The Fed’s gold stock is valued at $44.22 per fine troy ounce. For purposes of the chart below, we adjust the Fed’s gold holdings to market prices:

Note that the chart above starts in 2006, so as to focus on the period of the financial crisis. The Fed has been more aggressive than the ECB in printing money. As such, the percentage of gold in relation to total holdings has declined at the Fed in a more pronounced fashion. There is clearly no perfect relationship between the size of the balance sheet and the price of gold, as other factors also influence the supply and demand of gold; however, increasing the supply of fiat money (dollar, euros) may decrease its value when measured in real assets, such as gold. We have in the past referred to the Fed as the champ in printing money (as measured by the percentage balance sheet growth since August 2008), although the Bank of England has, as of late, taken on that title. But we digress.

From what we see, central banks have been scared into holding gold since the onset of the financial crisis. Beyond that, we don’t see an active strategy at the ECB to keep its gold reserves at 15% of total assets. Instead, the ECB’s comparatively measured approach has simply lead to a reasonably stable percentage of gold reserves. Of course that was before ECB President Draghi said on July 26, 2012, that he shall do “whatever it takes to preserve the euro.” (an interpretation of that may be that more money printing is on the way). For now, the cultural differences in responding to the financial crisis (Europe: think austerity; US: think growth) suggest that the euro should outperform the U.S. dollar over the long term, assuming the not-so-negligible scenario of a more severe fallout from the Eurozone debt crisis won’t materialize.

It may help to keep in mind that historically inflation is the response to a deflationary shock. If market forces were left to themselves, we believe the credit bust of 2008 would have caused a major deflationary shock. It’s the reaction of policy makers that fight market forces that may lead to inflation. Bernanke as of late brushed off such pessimism. As the charts above show, however, gold has been a sensitive – and sensible I might add - indicator to the trigger-friendliness of our central bankers.

Axel Merk: The US of E has Arrived!

Axel Merk published his latest Merk Insights entitled "United States of Europe has Arrived!". With lots of talk about a fiscal union, a banking union and a potilical, Merk wonder if we are assiting to the birth of the United States of Europe.

Here's the full letter:

A vision "Towards a Genuine Economic and Monetary Union" has just been published by the European Union. Key components include integrated financial and budgetary frameworks. The goal is to achieve a “strong and stable architecture in the financial, fiscal, economic and political domains.” For a vision to work, it has to be realistic. The budgetary framework calls for “joint decision-making … and … steps towards common debt issuance.” Given that German Chancellor Merkel was quoted as saying Europe will not have shared liability for debt as long as she lives, such goals seem a tad ambitious. Understanding that Merkel is like a mother to the United States of Europe, she should consider nurturing it with vitamins, love and care.

Love

Love has a lot to do with communication. And while it should be so easy, we all know that we sometimes neglect to communicate with our loved ones. Translating that to the Eurozone, take charge, be a leader and communicate! Merkel may not be a Reagan, nor a Thatcher, but it ultimately falls upon her shoulders to frame the discussion. If she does not agree, there is little others can do to move forward. Tough love is okay, too…

Care

Intensive care is what peripheral Eurozone countries are in. Let’s focus on the good news in terms of European integration: those countries that require assistance have yielded sovereign control to the European Commission. Presto! That’s the key element of the union. Those that have proven prudent in managing their budgets don’t need to yield control to Brussels bureaucrats. But those that are not capable do. It may sound like an unbalanced union, where not everyone is ceding control, but given the political realities, policy makers ought to leverage the cards they are dealt.

Regarding the so-called banking union, the same principle applies: countries that have been incapable of cleaning up their own banking system, ought to cede control. Seizing control from national bank regulators, including a European resolution scheme are key; but unlike the proposed vision published by the European Union, such a scheme must start with the more modest goal of first intervening where calls for help have been issued.

Vitamins

The way you leverage on the framework is by providing hope and support to those that succumb to it. Some vitamins, when administered in too high a dose, may be toxic. The European Stability Mechanism, the ESM, has shown such toxic characteristics. Because the ESM subordinates all other debt, it has made such subordinate debt toxic. The ESM is a last resort bailout scheme, not a tool to promote a “strong and stable architecture.” The discussion about the solution must include Eurobonds.

Having said that, vitamins do little good if not accompanied by underlying lifestyle changes. Put another way, as long as policy makers look for evermore creative ways to finance rather than to reduce debt, the underlying disease won’t be cured. Ultimately, debt will need to be reduced. The way it looks, it may be more likely be through default than sustainable fiscal policies.

Squaring the circle

The price for living beyond one’s means and failing to regulate one’s banking system should be the loss of sovereign control over budgeting and regulation. This part is already reality, as evidenced by the various bailout schemes in place.

What is not in place is a mechanism to allow those chronically sick children to get back on the right path, for national governments to conduct policy with enough dignity, so that political backlash won’t tear those countries apart.

The solution must include a tough love support mechanism, one where sovereign debt of the country in need is not de facto labeled as toxic. At the same time it is fully understandable that a country such as Finland wants to receive collateral for loans provided to those that have a proven track record of living beyond their means. Once a check is written, it’s rather difficult to decide on where the money is going to be spent. As such, a basis of discussion for the Eurozone should be:

• Countries that want final control over where bailout money is spent, need to accept the seniority status of IMF and ESM money.
• Eurobonds (without seniority over outstanding bonds) should be issued to finance projects that are directly supervised by the European Commission.

If Spain wants a bank bailout that doesn’t jeopardize its sovereign bonds, it must yield control over its banking system. It must accept that fact that its banking system may be too big, that institutions may be liquidated and management teams fired.

It’s too early to write off Europe. In the short-term, expectations are so low that policy makers will have a hard time disappointing. In the meantime, central banks around the world appear to be hoping for the best, but planning for the worst. That may mean easy money, a weak U.S. dollar, with money flowing into currencies of countries whose central banks can afford to not join the fray. To us, it is no coincidence our analysis of recent market data suggests biases of major central banks towards easing, whereas central banks of smaller countries shift towards tightening monetary policy

Axel Merk: Growth vs Austerity Analysis

Axel Merk, of Merk Funds, analyses both current economic models: Austerity and Growth; he tries to find out which one is more sustainable? Since Merk Funds focus on currency investments, he has a look at the implications on the U.S. dollar.

Here's the full newsletter:

To have budgets sustainable is as simple as matching revenue and expenses. Almost. Politicians have figured out that running a deficit may still yield a stable debt-to-GDP ratio, assuming there is economic growth. When U.S. politicians brag their budget forecasts bring down the absolute level of the deficit, it’s the debt-to-GDP ratio at best that may improve, assuming their rosy projections of economic growth prove correct. In the Eurozone, governments have – theoretically – committed themselves to running no more than 3% deficits, suggesting that such deficits lead to sustainable debt-to-GDP ratios. Not quite. Our research shows that, in order to achieve a long-term debt-to-GDP ratio in the low 50% range, deficits of no more than half of GDP growth may be run. If GDP growth is 3% a year, the deficit ought to be no higher than 1.5%. If 3% deficits are allowed, but GDP growth is only half of that – a more realistic assumption for many countries in today’s environment, the debt-to-GDP ratio will stabilize at above 200%. For a visualization of where the debt-to-GDP ratio will peter out given different growth and deficit scenarios, consider this table:

Average annual deficit	Average GDP growth	Long-term debt-to-GDP
1.5%	3.0%	51.5%
3.0%	3.0%	103.0%
3.0%	1.5%	202.9%

Why do we care about debt-to-GDP ratio? Allowing a high debt-to-GDP ratio is akin to playing with fire. Just look at the housing bust for an illustration as to what’s so dangerous about piling up too much debt: when interest rates are low, life feels great, the standard of living has gone up. But when interest rates move up, those with a higher debt load have to make disproportionate cuts to their standard of living to service their debt. According to the Congressional Budget Office (CBO), the U.S. paid an average of 2.2% of GDP in interest from 1972 until 2011. In its “Extended Alternative Fiscal Scenario” that assumes current policies, as opposed to current laws, remain in place, net interest payments will soar to 9.5% of GDP in 2037. In 2011, $454.4 billion in interest was paid in a $15 trillion economy; that is, 3% of GDP was spent in servicing interest payments. If the U.S. were to spend 9.5% of GDP to service its debt rather than 3%, it requires a cut of 6.5% of GDP in other services. It dwarfs the fiscal cliff (the reference to Bush era tax cuts running out coupled with spending cuts, absent of Congressional action) that might put a 3% to 5% dent on GDP. 

The pessimistic CBO outlook assumes what we judge to be an unrealistically low 2.7% average interest rate on debt payments. Should the market demand more compensation – generally referred to as bond vigilantes holding policy makers accountable – financing the deficits may no longer be feasible. Just ask Greece; or Spain.

With 10 year Treasuries yielding 1.6% in the United States, some argue that higher deficits are warranted. As the discussion above shows, the logic behind the view is fundamentally flawed, if not reckless. In the U.S., we differentiate between discretionary and mandatory spending. Mandatory refers to contractual obligations, the entitlements, most notably regarding Social Security and Medicare. Put simply, it may not be realistic in the long run to finance thirty years of retirement with forty years of work. As interest payments take a bigger chunk of GDP, discretionary spending is squeezed out. Be that an infrastructure project at the federal level; teachers at the state level; or firefighters or animal shelters at the local level.

In real life, there are some added complexities: we all fight for our benefits, take them for granted once granted and will fight vigorously to retain them. Also keep in mind that emergencies, such as natural disasters or wars, are typically not reflected in budget forecasts, as they might be considered “one off” items; even if that were correct, emergency spending adds to the deficit.

As debate rages whether austerity or growth is the solution to the plight of the developed world, keep in mind that there is a history spanning centuries, if not millennia, of governments spending too much money. In the old days, neighboring countries were “taxed” to fill domestic coffers: taxation, as in conquering other countries and taking treasures and slaves. Debt is a modern form of slavery, except that it is voluntary servitude. If history is any guide, don’t get your hopes up too high that these issues will be resolved. But investors may be able to navigate the waters, mitigate some of the risks or even profit from opportunities that arise in this environment.

The growth camp suggests that, with enough growth, a high debt load can be carried. That may be the case if such growth is not financed through debt. In recent years, trillions have been spent to achieve billions in growth – not exactly a recipe for sustainable budgeting.
The austerity camp suggests that, with enough austerity, books can be balanced. Except that, as services are cut, the economy is at risk of entering a downward spiral, increasing, rather than decreasing deficits. 

And while these two ideologies are being discussed, central banks struggle to either keep the banking system afloat (as in the Eurozone) or are helping to finance the government deficit (as in the U.S.). Indeed, the key difference between the U.S. and European model is that U.S. Treasuries appear to be backed by a) the taxing power of Congress and b) a lender of last resort, the Federal Reserve (Fed) with its printing press; whereas European sovereign debt is backed only by the taxing power of the national governments. The European Central Bank (ECB) has made it clear that its role is to support the banking system, not the sovereigns. In contrast, the Federal Reserve (Fed), while not admitting to outright financing of government deficits, has shown a willingness to do so in practice. As such, European sovereign debt is trading more like municipal bonds trade in the U.S., with weak “municipalities” (think Spain) paying a huge premium.

To be fair, the growth camp wants more than deficit spending; and the austerity camp wants more than cost cutting. Indeed, in a recent analysis Saving the Euro, we argued policy makers should instead focus on competitiveness, common sense and communication. Ultimately, both camps believe their philosophies should attract more investment as confidence is increased. In practice, the proverbial can is kicked down the road. By the time the can reaches the end of the road, it may be very beaten up. Indeed, an increasing number of investors are spreading their investments across multiple “cans” – we refer to these “cans” as diversified baskets of currencies, including gold.

What’s different between the U.S. and Europe is that the U.S. has a significant current account deficit. In our experience, countries with current account deficits tend to favor growth oriented strategies as they need to attract money from abroad to finance their deficit and, as such, to support the currency. While a bond market in shambles is a major drag on growth in the Eurozone, the Euro has been able to hold up reasonably well given the fact that the Eurozone’s current account is roughly in balance. A misbehaving bond market might have dire consequences for the U.S. dollar, even if one disregards the odds that the Federal Reserve may make U.S. Treasuries even less attractive by financing government spending (when a central bank buys a country’s own debt by printing money, such securities are intentionally over priced, potentially weakening the currency).

Merk G10 Currencies Monetary Score

Merk Funds has recently released a white paper entitled "G10 Currencies: A Monetary Policy Analysis" where they analyzed G10 currencies and gave a "Merk Monetary Score" to each of those.

The Merk Fiscal Score and a Merk Economic Score are aggregated together with the The Merk Monetary Score into an overall Merk Currency Score

In this 7-page white paper, they explains their methodology and the Merk Monetary Policy Score eventually ranks monetary zones as follows:

1. Australia
2. Canada
3. New Zealand
4. U.S.
5. Sweden
6. Euro Area
7. Norway
8. Japan
9. UK
10. Switzerland

The best currencies in terms of monetary policy would then be the Australian dollar and the Canadian dollar and the  worst currencies the British pound and the Swiss franc.

Axel Merk: Eurozone Election Hangover

Axel Merk, Merk Funds, published a new "Merk Insights" newsletter entitled "Eurozone Election Hangover" where he discuss the possible consequence of recent elections in France and Greece for the Euro and other currencies.

 With the hangover from elections in the Eurozone lingering, which answer is correct?

a) A socialist is in charge in France;
b) Nobody is in charge in Greece; or
c) None of the above

The good news about a socialist running France is that his honeymoon shall be rather short. It took the previous socialist President François Mitterrand two years before he shelved his activist agenda and became a moderate. The market won’t be that patient; that’s why we pick answer c) above: the language of the bond market will be the only language policy makers listen to. The bond market is in charge.

What about Greece? It might be possible to put together a minority government of Antonis Samaras “New Democracy” and the former ruling “PASOK” party that is tolerated by the “Independent Greeks.” Panos Kammenos founded Independent Greeks after disagreeing to the terms of his country’s bailout when he was a member of the New Democracy. In the eyes of the Greeks, Germany and the International Monetary Fund (IMF) appear to be in charge; with anger over yielding to demands of those with money, German flags are frequently put on fire during Greek elections. One way to manage Greece’s future would be to give Greece money with no strings attached, except to tell them that no more money will follow suit. That way, the Greek people will own their own problems and can no longer blame others for their plight. In practice, Greece is likely to fall into chaos at some point, as the country has been unable to achieve a primary surplus, i.e. be able to operate before making interest payments; the question in our view is where the resulting anger will be focused.

What does it mean for the euro? The euro is recovering after a dire Monday morning; keep in mind, though, that much of Asia had a holiday and missed digesting the disappointing U.S. unemployment report; liquidity is low, as London is closed for a holiday. Medium term, however, our bigger concern is that big money, such as the Norwegian sovereign wealth fund, is taking a step back from the Eurozone. As such, the odds of more liquidity provisions from the European Central Bank (ECB) have increased. We believe the euro will underperform other European currencies; note, though, that the world, including the U.S., will remain awash in money. The rocky road will continue as policy makers hope for the best, but plan for the worst. This should bode well for commodity currencies in the medium term; of these, the Canadian Dollar, Norwegian Krone and New Zealand Dollar are currently our favorites.

Axel Merk: Euro Crisis: Hope for the Best, Plan for the Worst

Yet another edition of Merk Insights entitled "Eurozone Crisis - Hope for the Best, Plan for the Worst", by Axel Merk of Merk Funds where he discusses the different scenario that may occur in the Eurozone amd the consequence for the Euo exchange rate (He expects the Euro to strengthen as short position are unwind).

Here's the article:
 

When Greece’s woes first rattled the markets two years ago, the pundits predicted a collapse of the euro.

The resilience of the euro has been due to a number of factors, not least of which is that the eurozone as a whole has a broadly balanced current account. As such, a misbehaving bond market doesn’t necessarily cause a plunge in the currency, as foreign buyers are not required to fund a deficit or protect against currency weakness.

The euro has also been on the other side of the Bernanke trade: the Fed’s printing of trillions of dollars is a deliberate effort to weaken the US dollar in an attempt to promote economic growth. Conversely, with the European Central Bank showing more restraint, the euro has been stronger, yet that strength has exposed a host of problems.

A similar pattern was evident during the Great Depression, where those countries holding on to the gold standard longer had stronger currencies, but suffered painful fiscal and political consequences of trying to do the right thing.

The focus should be on making the financial system strong enough to stomach potential sovereign defaults. And, as no one else has been able or willing to step up to the plate, the ECB has been forced to take on the task.

By charging only 1 per cent on unlimited 3-year loans, the ECB is allowing banks to reap substantial profits by buying higher yielding securities. This can be extremely profitable. In the US, the Fed brags about handing over $80bn in profit to the Treasury, neglecting to state the fact that the more money a central bank prints, the more securities it can buy and, thus, the greater the interest it earns. The ECB, though, “splits the coupon” with the banking sector, boosting their profitability.

For now, policymakers hope the ECB’s elixir will continue to soothe the markets, but the fear of contagion is still a big concern. With Greece temporarily patched up, the focus may shift again to Portugal, Spain, and Italy. Policymakers in emerging markets have cause for concern, too, as European banks have been a key source of funding for these markets. Emerging market funding is often provided in US dollars, stoking contagion concerns for US markets. Prime US money market funds were all too willing to buy US dollar-denominated commercial paper issued by European banks.

Indeed, central bankers have ramped up their efforts, seemingly planning for the worst. The Fed introduced a currency swap line to alleviate US dollar funding concerns in Europe. The ECB conducted its 3-year long-term refinancing operations (LTROs). The Bank of England provided another dose of quantitative easing. The Bank of Japan pursues its newly anointed inflation target. These are all variations of printing money.

With all major countries printing money, the problems in the eurozone may ease for now. Add to that the large degree of short positions previously built up in the euro that still need to be wound down, and the single currency should do just fine for the time being.

There’s a price to be paid, though: we don’t see how the ECB, in three years’ time, will be able to mop up the trillion-euro liquidity it has provided. The ECB has now introduced a structural rigidity into its monetary policy, akin to what the Fed is faced with. In many respects, central banks have disrupted the natural transition of market-ascribed economic health by imposing their colossal might (balance sheets) onto the markets. This should be alarming. Central bankers are increasingly manipulating rates all along the yield curve.
Such policies take away crucial economic gauges (market-based interest rates across the yield curve) from investors and policymakers. As result, policymakers can no longer rely on these metrics in setting appropriate monetary policy.

Politicians, too, no longer get market feedback to encourage reform. Spain has already indicated it will further soften its budget goals. Yet, without the ECB’s liquidity provisions, the bond market might have responded with its own “encouragement” to run less of a deficit, by selling Spanish debt.

This is not just a European problem. Look at the proposed 2013 US Budget and it becomes clear that, without the encouragement of the bond market, policymakers may have little incentive to pursue fiscally sustainable policies. With its significant current account deficit, the US dollar may be much more vulnerable than the euro should US bond markets act up.
In the meantime, Greece is experimenting with a carrot and stick assortment of incentives. That approach may be doomed to failure as each time a target is missed the ire will be directed at creditors, most notably Germany. To move beyond planning for the worst, Greece and others must learn to own their own problems rather than rely on central banks and other people’s money

Axel Merk: Currencies: Crisis & Opportunity

Axel Merk, Merk Funds, published a new "Merk Insights" newsletter entitled "Currencies: Crisis & Opportunity".

In this newsletter, he discusses the choices to be made by Germany and tries to understand why Germany is so generous:

• The exposure of financial institutions towards Greek debt. A lot of progress has been made in making the European banking system more robust; the envisioned 53% write-down of Greek debt is priced into markets already. Concerns regarding outright exposure to Greece have abated. Rather, concerns linger about the inter-dependency across financial institutions, the potential “contagion” as other countries – and thus financial institutions across Europe and beyond - may be considered at increased risk of default.
• In 2010, Germany exported €5.9 billion worth of goods to Greece, a 10.2% drop versus the previous year. While significant, Germany’s $3 trillion economy could stomach losing exports to Greece.
• Germany’s desire for peace in Europe.

Merk also explains that "Relative calm has come back to the market, but at a price: for Germany, it is that it now owns the Greek problem."

 He goes on to explain that "Another price has been paid on the monetary front. Since November 1, 2011, when Mario Draghi became President of the European Central Bank (ECB), we’ve witnessed a seismic shift in how monetary policy is being conducted. While we applaud Draghi for his clarity and determination, his decision to provide almost €500 billion in three-year financing to banks (LTRO) at a mere 1% may come at a tremendous cost."

For now, the market appears ecstatic but it may lead to serious problems down the road.

After talking about the currency crisis, he discusses about the opportunities:

Massive short positions previously built-up need to be unwound. As central bankers around the world hope for the best, but plan for the worst, lots of money is being printed: by the Fed, the ECB, the Bank of England (BoE) and Bank of Japan (BoJ), to name the prime instigators. Commodity currencies, i.e. the Australian Dollar (AUD), New Zealand Dollar (NZD) and Canadian Dollar (CAD) should be the main beneficiaries. While these currencies have performed well, Australia is undergoing some domestic political turmoil and Canada’s fate is closely linked to that of the U.S.; as a result, the NZD would be our favorite in that group. Having said that, geopolitical tensions and monetary easing have boosted oil prices in particular, causing headwinds to global economic growth and, with it, also to commodity currencies. If those headwinds play out further, we would make the Norwegian Krone (NOK) our preferred choice, as Norway benefits from rising oil prices, as well as providing investors with relative safety in Europe. It’s not surprising that gold, the one currency with intrinsic value, continues to appreciate in this environment. 

Related articles

• You: Eurozone crisis live: ECB to launch massive cash injection (guardian.co.uk)
• Draghi: Greek compliance must be 'flawless' (sfgate.com)

Peter Schiff: There is no safe haven in currencies!

Peter interview on CNBC Fast Money on 30th of December 2011. He explains the Euro short trade is crowded and Gold is still under-owned. 

Every central bank is printing and people are looking for currency alternatives such as Gold.

Jim Rogers: Buy the Euro and the Swiss Franc in 2012

Apparently, despite all the talks about a currency crisis in Europe, I'm not the only one to think the Euro may be a buy in 2012, as Jim Rogers was interviewed on CNBC on the 3rd of January 2012 saying he would consider investing in the European currency along with the Swiss Franc. The main reasons he wants to invest in the Euro are the large short position in the Euro and the fact that it is an election year in France, so they will probably do something (spend money or monetize the debt) to make the market feel better for a while. However, he believes this would be a terrible mistake and we'll have to pay the price in 2013-2014.
I'm also worried about the Japanese Yen, as in the last few month they had a trade deficit. If this persists, it would be negative for the Yen. I suppose Jim Rogers plans to convert some of his Japanese Yen holdings into Euro and CHF.

How to Save the Euro

Axel Merk, Portfolio Manager at Merk Funds has published an update to Merk Insights newsletter entitled "Guide to Save the Euro".

The articles is composed of 3 main parts:

• Fiscal sustainability
  Fiscal sustainability is about revenue and expenses, but also about perception.
• Method 1: Surrendering sovereign control over budgeting process
  When a government asks the IMF to help, tough austerity measures are imposed, a de facto handover of sovereign control to an outside agency
  
• Method 2: Embracing bond market pressures
  It requires dealing with the reality that low interest rates must be earned. It also means that governments have to embrace the reality that they may have to renegotiate some of their debt.

The conclusion is that we should "expect a muddled combination of increased IMF support, increased fiscal convergence, increased focus on strengthening bank balance sheets, increased involvement to keep banks afloat (the ECB is already debating providing multi-year unlimited credit lines), and increased cost of borrowing for Germany. However, this is likely to remain a drawn out process and the tail risks that European policy makers mess this up cannot be ignored, either. We come back to our initial argument: a lot depends on perception. Perception is a function of leadership and a credible path that is likely to lead to results. The prime minister-elect of Spain wasted his first opportunity to make a good impression. The German psyche has been badly wounded by the botched auction. In typical European fashion, another summit has been announced to discuss closer fiscal integration. In case anyone wonders why this process is so painful, it is because the right decisions are politically so incredibly difficult to make."

The full "guide" can be read at http://www.merkfunds.com/merk-perspective/insights/2011-11-30.html

Peter Schiff: The Real Currency Crisis is Coming to the US

Interview with Peter Schiff on Fox Business News (1st of December 2011) where he explains the Eurozone has severe problems but it's nothing in comparison to the United States and that the real currency crisis is coming to the US to the dismay of Fox Business host.

Jim Grant: Europe Debt Crisis Will Lead to More Money Printing

Jim Grant is interviewed on the 10th of November on Bloomberg discussing the current European debt crisis.

He explains that the ECB is likely to print money and purchase Italian government bonds. It called that the ECB's MF Global trade.

He then talks about the federal reserve and also says to avoid farmland (in the US) as it is now overpriced some places and gives an example where farmland rental yields around 2 to 2.5%, the lowest in 40 years.

This debt crisis may turn to a currency crisis very soon. However, all major currencies (USD, EUR, JPY and GBP) are racing to the bottom and it's difficult to see which one will get there first. Even though the Euro is currently in the spotlight, it's amazingly still very strong against the dollar and the British pound although it may change with the new ECB president who has already lowered the interest rate to 1.25% at his first meeting.

Axel Merk: Overweight the Japanese Yen

As Greece will hold a referendum whether to approve the austerity measures and the "no" will probably win hands down, Merk Funds recommend over-weighting the Japanese Yen and under-weighting the Euro in the short term.

Here's the the full Merk Insights letter below:

Greek Prime Minister Papandreou is throwing in the towel: by calling for a popular vote on austerity measures now, we believe he is almost assured a no vote. This allows Papandreou to say that he tried everything he could to avoid a default, but the people have spoken. Having said that, as we write this analysis, Papandreou appears to be changing his mind and may cancel the idea of a referendum as quickly as it came about. Still, the message is clear: a default is coming.

The sad part is that Greece has not been able to eliminate its primary deficit (the deficit before interest payments), so that it could have the potential to bounce back upon a default. On the contrary, Greece may fall into chaos or anarchy. The threat of such a scenario, in turn, may prompt European policy makers to instigate a Marshall Plan to rebuild Greece. While we can ponder about the Greek drama, it’s paramount to contemplate the consequences for the rest of Europe and the euro.

First, the good news: market pressures should accelerate reform. Specifically, we expect bank recapitalizations will both be accelerated and increased in scope; if you can’t save the sovereigns, at least make the banking system robust enough to absorb defaults. That’s better than any insurance scheme policy makers can come up with.

Expect dramatic actions by policy makers, akin to those seen in October 2008. Just as policy makers did not initially heed the markets then, the pressure is now on to follow through with substance after last week’s sketchy plan to save Europe, and ostensibly, the world. Specifically, pressure on Italian Prime Minister Berlusconi is mounting rather dramatically to engage in real pension reform. In comparison to both Spain and Ireland, which have seen relative market improvements, the markets have scolded Italy. While it is possible to turn the tide, the longer the wait, the more the market will demand.

What would alleviate the pressure is a commitment by the European Central Bank (ECB) to be the lender of last resort for Italy and Spain. However, that’s unlikely to happen, at least not in the short term. As of today, the ECB has a new leader, Mario Draghi. As an Italian, he will be under pressure to be rather hawkish. His first press conference is this Thursday. He could announce a program to buy unlimited Eurozone debt, and sterilize such activities. However, such a move would take the pressure for reform away. And a central bank’s role is not to make the life of policy makers easy. If Draghi were to pursue the route of least resistance, he could easily be labeled as, well, Italian, in his approach to central banking.

Any revised bailout fund for Italy is likely to cost France its AAA rating. France itself also has lots of homework to do. The lesson here is that policy makers always wait until the last minute to engage in reform; some day down the road, the market will focus on the U.S.; at that stage, the U.S. dollar may be under severe pressure: the U.S. dollar is more vulnerable given the significant current account deficit.

So for now, the drama continues. To summarize, expect more on bank recapitalization and reform. A wild card is whether the European Financial Stability Facility (EFSF) is going to be bolstered in earnest. For those politicians that still believe Greece can be held afloat: stop believing in fairy tails and move on. The market will.

As far as our positioning is concerned, we had increased our euro holdings ahead of the summit last week. We have since reduced it. We had also substantially reduced the yen ahead of that summit. Our outlook calls for substantial volatility in all currencies, except for possibly the yen; as such, our risk assessment is currently favoring the yen disproportionally. As October 2008 has taught us, though, rational investors may be forgiven for changing their view of the world on a daily basis… Stay tuned and subscribe to Merk Insights.

U.S. Dollar and Euro - Review and Outlook

Axel Merk & Kieran Osborne, CFA, Merk Funds have just published their outlook for the US dollar, the Euro, the Chinese RMB and several other currencies.

They have a bearish view on the US dollar:

Policy makers in Washington didn’t help appease market concerns: leaving the decision to raise the Government’s debt ceiling to the last minute only exacerbated market fears of a U.S. default and further degraded investor’s view of policy makers; ...Standard & Poors subsequently downgraded the credit rating of the U.S. government, citing the inability of the political leadership to come together and agree on a plan to sustainably rein in the deficit over the long term as a key reason for downgrade. We consider these developments have further eroded the safe haven and reserve currency status the U.S. dollar has held for so long, and continue to view the outlook for the U.S. dollar negatively over the medium to long term.
...
minutes from the FOMC meeting show there was support for further expansionary monetary policy, or quantitative easing, which would constitute “QE3”. It is our assessment that the likelihood of the Fed instigating QE3 has risen significantly, in part due to the weakening economic outlook, but also because of the composition of voting members next year. All three dissenting voices will be replaced in 2012 and the average monetary policy stance of voting members will become much more dovish (only one voting member is considered a hawk – Jeffrey Lacker, the Richmond President)¹. With inflation expectations declining, we consider Fed Chairman Bernanke may again present the need for further easing, arguing deflationary risks have become elevated, or at the very least, that further easing will not generate significant inflationary pressures. We believe the impending FOMC composition may consider this argument compelling, and is likely to err on the side of overstimulation. All of which leads us to believe that the outlook for the U.S. dollar remains to the downside.

even if in the short term there are risk, they are bullish on the Euro in the medium to long term:

Europe certainly has problems, but in an odd way, it is the inflexibility of its political make-up that may lead to a stronger euro over the foreseeable future. ...
Many individual countries find themselves with very weak political leadership, but interestingly, have instigated, in many cases, very strict austerity measures with opposition support. The issues facing the Eurozone are significant, and there is no simple, easy solution; it’s likely to be a drawn out process rectifying years of malinvestment brought about by unconscionably low funding rates for periphery nations (Greece could borrow at rates similar to Germany for years leading up to the crisis). In turn, economic growth may be restrained over the foreseeable future. Note, however, that economic growth is not necessarily a precondition for a strong currency; it is not incompatible to have poor economic growth on the back of a strong currency – just look at Japan.
...
We believe two key reasons have contributed to Japanese yen strength – weak leadership and a current account surplus.
...
On the above two factors, the Eurozone is not so dissimilar to Japan: the Eurozone has a broadly balanced current account, fiscal union is disjointed at best, and many individual nations have very weak political leadership. Furthermore, the ECB has a sole mandate of price stability, and is reticent to provide any direct bailout funding or directed asset purchases to the financial industry, or specific sovereigns, for fear of overstepping its bounds (or being taken to court by the Germans).
...
As a result, we consider the euro can appreciate on the backdrop of weaker economic growth and continued divergence in monetary policies

Finally, they mention they still have a positive view of the Chinese Yuan:

We continue to see upside potential in the Chinese renminbi and believe policy makers will continue to be incentivized to allow the currency to appreciate to tackle domestic inflationary pressures.

The full outlook is available at http://www.merkfunds.com/merk-perspective/insights/2011-10-19.html

The Death of the Euro

Here's an interesting debate about the Euro on CrossTak, RussiaToday on the 14th of October 2011.

How much liquidity is needed to save the Eurozone? Why go in more debt to overcome deadly indebtedness? And is Germany going to remain the prime sponsor of the euro experiment? Will we see the Eurozone change its boundaries? CrossTalking with Andrew Lilico (Clue: He's the man!), Jeff Madrick (Keynesian clown) and Jon Gaun (Eurosceptic) on October 14.

There is also an interesting part in the interview where they discuss whether TARP solved the US problem or not and Andrew Lilico compares the US debt situation with the one's of Italy.

Five Favorites Currencies by Peter Schiff and Axel Merck

Peter Schiff of Euro Pacific and Axel Merk of Merk Investments have just release a new report about entitled: "Peter Schiff’s & Axel Merk’s Five Favorite Currencies for the Next Five Years"

The first 4 currencies they select is based on different geographical zones:

• The Anglosphere: Australian Dollar (Peter Schiff) & New Zealand Dollar (Axel Merk)
  
• The Nordic Bloc: Norwegian Krona (Peter Schfiff) & Swedish Krona (Axel Merk)
  
• Continental Europe: Euro (Axel Merk) & Swiss Franc (Peter Schiff)
  
• East Asia: Singapore Dollar (Pete Schiff) & Chinese RMB (Axel Merk)
  

The last choice is their wild card:

• Canadian Dollar for Axel Merk
• Chinese Renminbi for Peter Schiff

If you want to know the reasons behind their choices you can download the full 23-page report at http://www.newcurrencyreport.com/

Jim Rogers: Buy the Euro After Greece Defaults

Jim Rogers is interviewed on CNBC on the 9th of September 2011 where he discusses the possible Greek default and subsequent contagion risks to other PIIGS. He recommend to buy as much as Euro as you can after the crisis, as the Euro would be lower but be a stronger currency in the long term. Jump to 6:55 on the video below to listen to Jim Rogers.

David Morgan - The Currency Crisis Continues

David Morgan of http://www.silver-investor.com is interviewed by Stellaconcepts on the 8th of September 2011.

David Morgan explains the currency crisis continues (citing the Euro crisis) and that Gold is not in a bubble.

He also gives a possible target of 5000 USD for one ounce of Gold, but as he believes it's actually the fiat currencies that go down instead of Gold going up, he prefers to see the price of Gold in terms of ratio to the stock market or silver. He except the Gold to Silver ratio to return to its historical ratio of 16.

He is very bullish on Silver because of 3 reasons:

1. There 66% less silver than during the 1980 bull market
2. Back then, it was mainly a US market and now it's a global market
3. Internet is there and allow people to quickly buy or sell

Finally, he gives his views on the Comex which he thinks will never (officially) default as there are mainly loopholes and he states that mainstream media is biased against Gold (the barbaric relic).

Consequences of a Euro break Up by UBS

UBS has written a 21-page report discussing the potential impacts of a Euro break-up.

It explains why the Euro should not exist as it is structured today and "simulate" break-up scenario (weak country leaves, strong country leaves...) and try to anticipate the possible consequences.

To conclude they answer the question "How should investors invest in case of a Euro break-up?" The answer:

The only way to hedge against a Euro break-up scenario is to own no Euro assets at all.

You can read the report below.

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CHF is now effectively pegged to Euro at 1.20

In a dramatic move, the SNB has decided to put a floor on the price of the CHF vs Euro, a floor at 1.20 CHF per Euro. This is a defacto peg to the Euro as the Swiss franc is unlikely to decline and this resulted in a massive 8% move in the Swiss Franc / Euro exchange rate a massive move (probably unheard of) in the currency markets. (See chart below. Source: Yahoo Finance)


Another battle has been fought in the currency war and the Swiss Franc is no longer a safe heaven. There remains the Yen (but I wonder why) and possibly the Singapore dollar (SGD) which appreciated around 6% against the USD since the beginning of the year. Of course, there is still gold and silver which should remain the real safe heavens.