Issue No. 17. February 1999 28.II.1999
But we do not have a healthy, stable global economy. And the fact that the
price of gold did temporarily rise during last year's stock market
upheavals suggests that there are enough investors around who still see it
as a potential safe haven to make a difference. Accordingly, my view is
that a small percentage of gold or related investments remains an
attractive hedge for protecting a portfolio from the effects of a Wall
Street crash - which is still a looming threat.
With the price of bullion as stable as it has been recently though, I am
revising my short-term call from "cautiously bullish" to
neutral. I have not added to my own holdings, which remain at a modest 3%
of my portfolio; held, as explained above for no other purpose than as a
hedge.
As an aside, a well-known gold bear, Andy Smith, recently gave a
conference presentation criticising the growing belief among goldbugs that
the yellow metal is a good investment during episodes of deflation
("Gold and Commodities in deflation: attempted facelift."
Bank Credit Analyst conference, Miami, USA February 1999.). I have a
great deal of sympathy with much of what he had to say, but it did not
negate the points I made above. Historically before the modern era of fiat
currencies periods of deflation were normal cyclical events which acted as
healthy corrections of prior inflation. But such events are irrelevant to
what we are looking at these days, which is the possibility of the
bursting of the largest stock market bubble ever experienced and the
financial and economic upheaval that will follow - of which deflation will
be a prominent but secondary effect. I will be surprised if the purchasing
power of gold does not rise substantially in such circumstances.
Still, such considerations are only theoretical yet and it remains early
days. There is no evidence on the ground that anything like this will
actually happen. I offer no opinion either way. I do expect that we will
begin hearing about frictions in the system before the end of 1999, and it
may be possible then to begin to attempt to predict if they could
undermine the stability of the euro. In the meantime, holding euros in the
form of German marks or Austrian schillings might be wise.
Whilst it is still too early to predict the final success or failure of
the single European currency, it is not too early to start assessing the
strength of the euro. It is only eight weeks after launch, but significant
trends can already be seen.
The euro was touted as a "hard" currency like the German mark,
with the European Central Bank being intended as a strong, independent
body (in the tradition of the post-war German Bundesbank) charged with
establishing the credibility, strength and stability of the new money. In
order to enable it to do so, it was to be free from political
interference.
But, months before the ECB even took charge, there were already disturbing
signs that national governments and politicians were attempting to find
ways around both the spirit and letter of the agreed rules. (See Issue No. 10 May 1998)
Well, this is indeed what is happening, and it is noticeable when reading
the British and European financial press that one no longer sees much
evidence at all that anyone still seriously claims the the euro is going
to be a true hard currency: this isn't made explicit, rather it is simply
not raised or discussed. This does not mean that it is not widely hoped
and expected that it will be a success and an increasingly important and
widely-used global and reserve currency. But a store of value with the
stability and credibility traditionally associated with the mark of the
Swiss franc, no. Do not treat it as such.
It is ironic that it is the German national government that has been
putting the most pressure on the ECB (they want to see lower interest
rates). The election last year of a left wing federal government in
Germany may turn out to have been a most unfortunate event for the future
of the euro.
So, how well may we expect the euro to perform in the short- to
medium-term?
In its first month (January), the euro was the currency of choice for more
than half of all new international bond issues, with a total value of
US$69.3 billion. US dollar denominated bonds accounted for $55.7 billion
(40%). This compares with 30-35% in recent years in the eleven legacy
currencies. The biggest attraction of euro bonds particularly to
institutional investors is their liquidity: of the euro-zone currencies
only the DM provided sufficient liquidity for the large US and Asian
funds. Euro-denominated bonds have proven especially attractive to
Japanese funds.
This is quite promising, and the trend appears to have continued during
February, but, on the other hand, it is only to be expected that there
would be an initial high demand if for no other reason than the imperative
for funds and investors to quickly balance their portfolios into the new
currency. We will have to await the longest term track record in the
issuance and demand for euro-denominated bonds in order to assess its
significance.
Euro exchange rates are more telling at this stage. They show a clear
trend which unfortunately points towards a rather weak currency. The value
of the euro has fallen almost continuously since the beginning of the
year, and by mid-February it was down 5% against the US dollar, and 4.5%
against sterling. (Sterling weakened last week on news that the government
is now leaning towards joining monetary union - which implies lower
interest rate down the road). Certainly, it is still possible to argue
that this is the new unit finding its own level as investors struggle to
value a huge new currency which has no track record and no precedent, and
the optimists will be looking for signs of levelling off and then an
extended period of exchange rate stability that will make it increasingly
attractive. My outlook is as follows:-
As average interest rates fall around the world, those factors that the
euro optimists see as important - size and liquidity - will tend to become
relatively less important to investors than interest rates and the
perceived determination and ability of the ECB to maintain the exchange
rate stability of the euro. However these latter factors are precisely
those that are threatened by interfering politicians, so they will have a
much
more damaging effect than they would have had in an environment of high
interest rates and a relatively stable global currency regime.
Pointer: The most important single factor for the euro at present
is how vigorously the new ECB (a) asserts its independence and (b) defends
the euro, as opposed to the emphasis it places on on some fuzzy economic
objective. The British financial press e.g. The Financial Times are
covering this rather well and are a good source of information, though you
may have to read between the lines sometimes because they tend to be
biased towards United Kingdom entry into monetary union.
There is an important test going on right now, and the outcome will be
worth
watching carefully. The German economy is sliding into recession in
response to global economic problems and to domestic factors. This has led
Oskar Lafontain, the new finance minister, to put great pressure on
the ECB to reduce interest rates further, believing that this will
stimulate the euro-zone economy. He has even threatened "fiscal
easing" i.e. increased government spending, if interest rates do not
fall soon. Either - a surge in government spending in Europe or an
inappropriate reduction in interest rates - are exactly the things that
the terms of monetary union specified were not to happen. Either could
lead to a crisis of confidence in the euro. Watch this space.
copyright© 1999 Max Moseley and The Skeptical Investor, All Rights
Reserved.
Gold:an update
Were it not for the threat of financial upheaval still facing us, I would
be very pessimistic about the future of gold as a financial asset. Given a
healthy, stable global economy, there is little doubt that governments and
central banks around the world would continue, step by step, to sell off
more and more bullion reserves. In due course is process would culminate
in the demonetisation of gold accompanied by a collapse in its price.
The euro: eight weeks on.
The new European currency unit, the euro, came into existence on the
first of January. For the time being however, it exists only in a sort
of
half-formed way: the eleven legacy currencies of the euro-area are still
there (there are no euro coins or banknotes yet) and what really happened
on January 1st was that all the exchange cross rates between these
participating currencies plus the new "reference unit" - the
euro - were fixed. I do not want to overstate this way of looking at it
because there are important differences that distinguish the new monetary
union from a mere system of fixed
exchange
rates, especially the facts that interest rates are uniform and there is a
single central bank. But, until the old monies are totally abolished in
2003 we do
not exactly have a true single currency system either, and seeing it in
this
way may help the investor by bringing into sharp focus dangers that are
inherent in this first phase of the experiment in European monetary union.
Past attempts to fix the exchange rates between the currencies of two or
more disparate economies have had a poor record. The strains take time to
build up, and are often invisible at first, but tend to be cumulative over
time and the usual outcome is a catastrophic collapse of the arrangement.
We have been witness to several spectacular examples recently.