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Fractures in Euro Currency, Bank Turmoil, lifting GoldGary Dorsch For almost a decade, yields on bonds issued by different Euro-zone governments moved close together. By joining the Euro-bloc currency regime, every member state could suddenly reap the benefits of "free-riding" in the Euro-zone bond market, or borrowing at almost the same interest rates as Germany, irrespective of whether the country's economic fundamentals justified the lower rate. But as the global financial crisis gathered in intensity last September, yields in the 16-member Euro-zone bond market started to diverge. Global investors became more selective, and started demanding higher interest rates from member states with large budget and external trade deficits. Euro-zone yield spreads diverged more widely than at any time since the introduction of the Euro, with Germany enjoying the lowest interest rates and Greece and Ireland offering the highest. But the vision of Euro-zone economies and interest rates converging behind the shield of a shared currency, pulling Europe together economically and politically to rival the United States, has begun to unravel, raising skepticism about the long-term viability of the Euro itself, and sparking a flight into gold as a safe-haven. Already, three Euro zone economies, - Spain, Greece, and Ireland, are under heavy attack from the global banking crisis and credit rating downgrades, and there are concerns that Portugal and Belgium, may be under fire next. Currency union may have narrowed the wide-gap between the richer and poorer nations of Western Europe, but the good times also masked the underlying structural differences between the various economies, which are now becoming more visible as the global recession deepens. On January 29th, the Die Zeit newspaper wrote, "The global banking crisis is widening the interest rate gap between the Euro countries. Serious economists are wondering when the first state will go bankrupt. After that it's only a short step to catastrophe - the collapse of the currency union." Membership in the Euro-currency was originally tied to strict budgetary discipline. The annual deficit of a member country was to be limited to a maximum of 3% and its total debt to 60% of the country's gross domestic product (GDP). But for many years, Greece, Spain, and Italy took advantage of the easy money that came their way, borrowing beyond their treaty-set limits, while their trade deficits remained wide. But S&P downgraded Greek debt to A- in January, citing a current account deficit of 14% of its gross domestic product - the highest in Europe.  A year ago, Greece could issue 10-year bonds priced to yield +50-basis points higher than Germany's Bund. But trade surpluses from countries like Germany are no longer being recycled back to Greece and other less prosperous Euro-zone countries.Instead, Greece has become a favorite target for the European bond vigilantes. Greece expects to borrow 43.7-billion euros this year, pushing its debt-to-GDP ratio to almost equal to the country's 250-billion euro annual output. Without the crutch of Euro membership, Greece could not have attracted foreign investors at interest rates that were nearly equal to those of German bunds, while its economy ran a trade deficit of -36.5-billion euro, compared to Germany, the world's biggest exporter for the past six-years, which earned a surplus of +178-billion euros in foreign trade last year. Standing alone, the Greek drachma would have plunged, and sending Greek bond yields even higher. The European Central Bank has slashed its key repo-rate by 225-basis points since October to 2.00%, unwinding a tightening cycle that spanned over the previous 2-½-years. Yet despite the drive towards sharply lower ECB rates, yields on Greece's 10-year bond have begun to move in the opposite direction, climbing 125-basis points higher, while at the same time, yields on Germany's 10-year Bund have tumbled by 75-basis points. In lockstep, the price of gold has risen from 540-euros /ounce in September to above 720-euros/oz today, tracking the widening interest differential between the German Bund and the weakest link in the Euro- bloc. One of the drawbacks to membership in the Euro-bloc is the lack of sovereignty over one's own money supply. The electronic printing press, often utilized by central banks to monetize the government's debt, is largely controlled in the Euro-zone by the Bundesbank hawks, united with ECB chief Jean Claude Trichet. The ECB hawks reject the increasingly popular embrace of "Quantitative Easing," which is being adopted by central banks in England, Israel, Japan, the United States, and even Switzerland, in order to combat the destructive force of deflation. The Euro-bloc also precludes member states from unilaterally devaluing their currencies, in a beggar thy neighbor strategy, to boost overseas exports.  Interest rates for Spain's 10-year note have jumped a half-percent since the beginning of this year, which might not seem unusually large on the surface, but is actually quite destructive, considering that an underlying trend of deflation is seeping deeper into the Euro-zone economy. Measured in Euros, the Dow Jones Commodity Index is 38% lower than a year ago, and it's only a matter of a few months, before EuroStat begins to report consumer inflation turning sharply negative. While government and media commentators are still attempting to assure the public that there could be no repeat of the 1930's, - a deflationary spiral leading to global depression, the commodity markets are telling a different story. Deflation is seen as a precursor to depression, because falling prices generate less cash flow to companies, reducing their ability to pay-off debts, which in turn, can lead to a vicious cycle of mass layoffs, production cutbacks, and weaker consumer spending. For Spain, higher bond yields and mortgage rates are especially worrisome, since the number of Spanish jobless has risen by 1-million workers in the past 12-months, as thousands of small businesses, which employ around 80% of the workforce, lose access to easy credit and can't roll-over debts. The Spanish jobless rate rose to 14.4% in December, twice the average of the European Union, while industrial production has plunged by 20% from a year ago. To read the rest of this article, click on the hyperlink below: http://www.sirchartsalot.com/article.php?id=104 Feb 17, 2009 321gold Ltd |
