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.

The US Dollar, Gold and Politics

In his latest "Gold report", Peter Schiff talks about the politics of Gold investments where he analyses the price of Gold and the US dollar based on which US presidential candidate is elected President in 2012. Each candidate has different views on monetary policies and debt reductions. Here are the results:

• Herman Cain: Bullish for Gold, Bearish for the dollar
  
• Mitt Romney: Very Bullish for Gold, very bearish for the dollar
  
• Ron Paul: Bullish for Gold, Bullish for the dollar
• Rick Perry: Bullish for Gold, Bearish for the dollar
• Newt Gingrich: Bullish for Gold, Very bearish for the dollar
• Obama: The Gold Rush is On !

He however mention that with Ron Paul the direction of the price of Gold is more difficult to access as after 2 years in his presidency he would probably put in place a very hawkish president of the federal reserve.

To conclude, if Ron Paul is not elected president of the US, you can rest assured that your Gold investments will most probably do well for years to come.

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.