Montreal, Canada

Is it the beginning of the end for the EUR?

Amazing how things can change in just a short period of time. Only a few months ago my phone was ringing off the hook as worried investors demanded more EUR exposure at the expense of a falling American dollar. Happily, I discouraged this trade at such low levels and instead, advised my investors to buy more gold because both drunken units had been falling like a rock vis-à-vis gold since 2005.

Though the EUR is now heavily oversold at these levels, the longer term picture for the single European currency might not be that bright.

What are the odds that the single European currency will collapse under the weight of Greek and other countries harbouring desperate finances? Though many investors and pundits would convincingly argue a break-up is almost impossible, the odds are increasing that a blow-up might occur over the next few years, if not sooner.

It would seem utterly unbelievable for the Germans to bail-out the entire Mediteranean belt – Spain, Portugal and Greece and possibly, Italy and even France. The Germans can’t bite a bullet that’s the size of an elephant and its electorate will refuse such a scenario anyway.

What we’re witnessing now as it pertains to the EUR is not without precedent.

The EUR is a real currency, unlike its predecessor, the ECU or European Currency Unit. The EUR is now the world’s de facto second reserve currency and trades freely in open markets worldwide.

The ECU, however, was a synthetic currency used widely across Europe for institutional purposes leading up the creation of the EUR in 1999; but the ECU’s history was violent as currency volatility compromised the unit in the fall of 1992 when the British pound and the Italian lira devalued and subsequently exited the European Exchange Rate Mechanism or ERM. Both countries were slammed, humiliated and saw their respective currencies tank about 17%.

The ERM served as the template for the EUR whereby a grid or band was implemented. Member currencies were not permitted to allow their currencies to fluctuate beyond the bands’ outter limits; if they did, the currency had to be dropped from the mechanism. That happened in September 1992 as the British and Italians dropped the ball. George Soros of the Quantum Fund famously made a fortune betting against the pound and won.

By the fall of 1992 the Bundesbank had only grudgingly cut interest rates, starving weaker nations that were suffocating from the ECU’s relative strength against other major currencies. Basically, the Germans weren’t cutting interest rates fast enough at a time when parts of Europe were struggling with a deep recession and weak export growth.

Does this story sound familiar? It should. This is playing out right now in the Euro-zone as Greece comes under attack and desperately tries to find a way to raise financing. Without European Central Bank liquidity or bridge-financing, Greece is bust.

From Greece, the funding crisis is spreading to Spain, Portugal and eventually across the Euro-zone possibly evading Germany and Holland – the only two countries with respectful finances. But I suspect if this spreads to the inner core of the Euro-zone then the Germans and the Dutch will become overwhelmed and suffocate.

Finally, the premise that the U.S. dollar is a “safe haven” amid a European sovereign debt crisis is a joke. Calling the dollar a safe-haven is like pegging Stalingrad a holiday for the Germany Army in 1942-1943.

The only currency that is outside of the credit system and that remains no one else’s liability is gold. That premise is worth something.

As this tumult spreads throughout the course of 2010 and beyond I suspect more investors will grow nervous and head into the yellow metal because government bonds are now a questionable long-term safe-haven in the age of violent capital markets and uncertain sovereign state funding.