As the Euro goes the way of the dodo, where does that leave the Dollar?
by Gonzalo Lira
Posted Nov 30, 2010
The Eurozone is heading for a crash — anyone saying otherwise is either stoned, works in Brussels, or hasn’t checked the European bond market action lately: All hell is breaking loose there.
And if, as I have argued here, the Irish Parliament decides not to pass the austerity budget next December 7—that is, decides not to take the European Central Bank bailout—then hell is going to break out in Europe just in time for Christmas: Satan and Santa Claus just might be squaring off on the Rue Belliard before year’s end.
Therefore, the smart money starts thinking about what’s going to happen after the euro-crisis-climax happens.
In other words, what’s going to happen to the dollar, once the euro goes the way of the dodo. First, we have to understand how we got here, in order to figure out what’s going to happen next.
The Banana Republics of Europe
In the 1970’s and ‘80’s, various Latin American republics foolishly pegged their currency to the U.S. dollar. It worked like a charm—at first. At first, all these small-fry countries took advantage of the fixed currency exchange rate to get indebted in dollars, and go off on a big-time shopping spree.
It all ended in tears, of course, when the bill came due. Chile, Argentina, Perú, Uruguay, at various times they all had their currency pegged to the dollar. And in each of those situations, once the currency peg became unsustainable, their economies crashed.
This is exactly what the smaller economies of Europe did. As I argued back in April, if you look at the euro as simply a very complex currency peg, then the solvency crisis we are witnessing in Europe was inevitable. Just like the banana republics in Latin America, the PIIGS of Europe got over-indebted to the point of insolvency.
What are the Europeans doing? Trying to save the gangrenous limbs, instead of the Patient
When the Latin American economies and their bondholders realized—the hard way—that their dollar-peg was unsustainable, the countries devalued their local currency, and started rebuilding their economies.
The bondholders? That is, the people fool enough to lend to these countries which had pegged their currency to the dollar? If they were lucky, they took a haircut. If they weren’t so lucky, they went home with a big fat bagel—a big fat zero. What has the ECB been doing, with regards to the failing eurozone economies of Greece and Ireland? They’ve been trying to prop them up with bailouts—but keeping those economies pegged to the Euro.
What are the bailouts? Why, they’re loans. In other words, the Euro-morons are lending money to these shaky economies so that they can pay off their other loans. The Euro-drones in Brussels are not allowing Greece and Ireland to default and restructure: They are instead insisting in bailing them out and imposing austerity measures, without forcing haircuts on the bondholders. So as the Greek and Irish economies continue to deteriorate, they have an overly strong currency for the weakness of their economy, and they are being forced to pay 100c on the euro, on loans they cannot possibly repay. The effects are obvious:
Already, the Greek bailout of this past spring—which was supposed to be repaid in 2014 and 2015—is being extended to 2017. And casual observers of the Irish situation realize that, with the bailout costing €85 billion at 5.8% interest, there is no way that Ireland will ever be able to grow its way out of this debt. Greece and Ireland will be debt slaves forever, even as the crushing weight of the euro grinds their economies down.
Meanwhile, the bond markets realize that the bailouts of Greece and Ireland are only kicking the can down the road—the bureaucrats in Brussels are simply giving Greece and Ireland more loans to pay off older loans. So the bond markets are simply leapfrogging ahead to the next crisis-point:
As I have argued here, Spain is the battleground where the Eurozone will either survive as a much smaller partnership of core member, or where the Euro will be utterly wrecked—and possibly the European Union along with it.
So What Would Happen To The Euro?
There are two possibilities:
One, the Euro-shitheads of Brussels try to do in Spain what they’ve done with such remarkable incompetence in Greece and Ireland—prop up the sovereign debt with more loans. The bond markets—just like in the Greek and Irish cases—realize this is futile, or at best palliative, and therefore go to the next weak economy on the list: Italy.
Just as Greece and Ireland went down the tubes, Spain goes down, Italy goes down, until the bond markets settle on France—the ultime eurozone member. French sovereign bonds are attacked, Germany pulls out altogether—
—in short, a big old mess, with the euro left for dead on the side of the road, and all the countries going back to their original currencies, but with interest rates in the double digits, as the European bond market is wiped out.
That’s the worst case scenario.
The second possibility—the possibility that should have been implemented with Greece, and which I think the Euro-crats will implement come the Spain-Italy debacle—is to kick countries out of the eurozone. This is the sensible thing. I also think that it is the likely thing: The weak and insolvent economies—Greece, Ireland, Portugal, Spain, Italy, Belgium—get tossed out of the euro, and go back to their local currencies, with their debts restructured. As I see it, kicking out the weaker economies is the only way to cure this currency gangrene that is killing the entire eurozone. To stop gangrene, you gotta suck it up and cut off the limb. To stop what’s happening in the eurozone? Same thing.
If this currency gangrene is allowed to spread—if the EU and the ECB insist on bailouts for all the eurozone economies, while insisting they all stay in the euro and pay off 100c on the euro—then the European monetary union is doomed, as is the European Union itself.
Therefore, the weak and insolvent nations will have to be expelled from the eurozone, in order to save the stronger, healthier economies. There are several countries in the European Union that have their own, non-euro currency—cutting loose economies that obviously are hurt by the euro is the rational thing to do. Then again, with the Euro-twerps of Brussels, you never know.
So where does that leave the Dollar?
You have to understand one thing about the eurozone, if you are to understand anything about the eurozone: It is big. Sure, the eurozone is smaller than the dollarzone—but not by much: Its GDP in 2009 was €8.5 trillion ($11 trillion), roughly 78% of the U.S.’s GDP.
The combined GDP of the PIIGS+Belgium in 2009 was about €2.5 trillion—therefore, if they are shown the door, the reduced eurozone would remain a very respectable €6 trillion.
Any big move on the euro would have a massive impact on the rest of the world’s economy, including the U.S., including the dollar—and don’t let anyone tell you otherwise.
Therefore – regardless if it’s a (worst case) full-on euro-collapse, or a (best case) orderly expulsion of the weak and insolvent economies from the eurozone—the big winners will be precious metals, commodities (industrial, agro and oil), the Swiss franc, the pound sterling, British gilts, the dollar, and U.S. Treasury bonds. In that order.
Europeans have history to guide them: They know that in times of trouble, precious metals are the safest haven. Furthermore, a lot of them—rightfully—don’t trust the crazies running the Federal Reserve: They think that QE and it various iterations are insane.
So they’ll flee from the euro to precious metals. Commodities, too, would rise as well, for roughly the same reasons. The Swiss franc and especially the British pound will rise—hard—with a euro-quake. The Swiss are a traditional safe haven—but the British under Cameron are winning kudos for their austerity measures. Regardless of whether one thinks they are half-measures or not, there is the perception in Europe that the UK is firmly on the H.M.S. Austerity: This makes the pound very attractive, to Europeans.
Much more so than the U.S. dollar: The dollar will also rise in a euro-crash, but not because it’s so attractive—it’s not. Like I said, the Europeans do not trust the crazies at the Eccles Building. But with everyone exiting the euro, inevitably a portion of them will go to the dollar, if only as a hedge against sudden moves in the franc and the pound. Same with U.S. Treasury bonds. Their absurd yields will go even more absurd—but Treasuries will be an asset class of last resort, for European capital fleeing the euro.
So regardless of how the euro ends—either by a total currency collapse, or an exodus of weaker and insolvent member states—the dollar will strengthen somewhat, but that will be as nothing compared to the British pound and the Swiss franc.
And the dollar will weaken—substantially—against precious metals or commodities of all classes, when the euro crashes. As many of you know, I’m Hyperinflation Boy. So as regards that subject, a collapse in the euro—total or partial—will in fact hasten the arrival of dollar hyperinflation.
The reason I think so is because, even as the dollar strengthens against other major currencies, it will fall against precious metals and commodities, both industrial and agro, including oil. As commodities are all bid up by Europeans exiting their ruined currency, it will put price pressures on the dollar, which will skew the American economy even further in the direction it is already tipping towards.
So a collapse in the euro is not good news for the dollar—on the contrary: It’ll hasten the dollar’s fall.