Paper Currency Giants and Gold Pigmies


Here’s a contrarian idea – buy euros.

No doubt investors were surprised at Port Phillip Publishing’s recent Strategy Session. That was when Wall Street banker and analyst Jim Rickards repeated his bullish call on the European currency.

It’s probably not possible to have worse press than Europe has had this year. It has dominated the financial news and almost all of it has been negative.

Greece is broke. Ireland is broke. Spain is on life support. Italy and France are about to have a cardiac arrest. And Finland wants out.

This is mainly due to the chronic budget deficits within the eurozone, especially the Mediterranean countries.

But for the moment, Europe is still running a trade surplus, mainly thanks to Germany, and the euro is a major currency in the swirling flow of global money.

And if Jim Rickards is right, the world is at the beginning of the third global currency war in the last hundred years or so. It could mean that not only is it time to buy the euro, but being aware of currencies is more important than ever.

The World of Currencies

One of Jim Rickards’ key points in Sydney was that capital flows dominate trade flows. What he means is money goes to where it feels safest, rather than moving in regard for the underlying economy.

The recent rise in the Swiss franc wasn’t because investors thought the world was going to pig out on more Nestle chocolate. Investors bought the franc because they were worried about other currencies, mainly the euro, losing value.

Smaller currencies like the Swiss franc and Australian dollar rose as money fled Europe in the wake of the banking crisis. The flip side is the euro has fallen against these currencies.

But there is a limit to how much money small economies like Switzerland and Australia can absorb.

The major currencies of the world are the US dollar, the euro, the Japanese yen and the British pound.

The joker in the pack is the Chinese renminbi. China has the second largest economy in the world but the renminbi is a closed currency. It doesn’t trade on the international exchange in the same way – yet. And it’s loosely pegged to the US dollar to hold down its value.

Other than Europe, only the US, British and Japanese economies are big enough to absorb large amounts of money without being destabilised.

But are any of these currencies any better than the euro?

Let’s start with the US dollar. The US has an enormous budget and trade deficit. Not only that, the Federal Reserve is deliberately trying to devalue the dollar to increase American exports.

But despite those efforts, the US dollar has been relatively strong lately, as it benefits from the same ‘safety’ trade as the Aussie dollar. Rickards points out that this is exactly what the Fed doesn’t want and so he reckons they’ll launch the next round of money-printing (QE3) sooner rather than later.

Because of that possibility, investors would do well to remember the old Wall Street saying, ‘don’t fight the Fed’. This could make investors wary of holding US dollars.

So the question facing investors is, if not the dollar, where else?

Japan has a debt to GDP ratio of over 200% and in 2011 ran an annual trade deficit for the first time in thirty years.

Considering the huge burden of government debt, many traders figure the Japanese Central Bank will print huge amounts of yen to hold down interest rates to keep the government from going broke.

What about the British pound then?

The Bank of England, known as the ‘Old Lady of Threadneedle Street’, has printed an enormous £375 billion since the financial crisis in 2008.In percentage terms, this is the most of any central bank in the world. That’s hardly better form than the US or Japan.

So where do large investors turn? The pound? The yen? The dollar?

Jim Rickards says none of those. He’s backing the euro…

Where You’ll Find the World’s Gold

Jim Rickards sees the world of money as mostly flowing to and from China, Europe and America.

If America cheapens the dollar further, his position is that China won’t allow the renminbi to appreciate. It will cheapen the renminbi to match the falling dollar.

And if those two currencies fall, the euro should rise. Relative to each other, for one currency to fall, another must rise. Of course, they can all fall when valued against gold.

And so Rickards thinks one way China will try to hedge its enormous exposure to the US dollar via its foreign exchange reserves is to invest in European assets.

But the Chinese don’t want Europe’s toxic government debt. They’ve got plenty of America’s already.

But if Europe can stabilise its bond markets, Chinese capital could be one factor that drives the euro (and European economy) higher over the next five years.

But there’s another reason Rickards believes China will invest in Europe.

When you put the 17 regional central banks of the eurozone together, they hold more gold than the United States, the largest individual gold holding country in the world. This makes Europe the strongest financial power in terms of gold.

This could provide a solid foundation for the eurozone to bounce back.

China’s gold reserves are about an eighth of Europe’s, which makes it, in Rickards nice way of putting it, ‘a paper giant and a gold pigmy’. That’s why China has accumulated gold and should continue to do so. This is another bullish sign for gold.

For Aussie investors looking for value on the cheap, a nice contrarian play is to back Europe while the Aussie is high and the euro is weak.

Callum Newman
Editor, MoneyWeekend

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Paper Currency Giants and Gold Pigmies