The Euro’s Pain May Be the Dollar’s Gain

11/17/2011 11:20 am EST


Howard Gold

Founder & President, GoldenEgg Investing

Escalating yields and economic distress in Europe is good news for the US currency, because it's still the safe haven, but we need to learn from the Old World's mistakes before our own debt problems grow out of hand, writes editor-at large Howard R. Gold.

The crisis in the Eurozone has entered a new phase.

Unelected "technocratic" governments are taking power in Greece and Italy. Their remit: pass tough reforms politicians wouldn't propose and voters wouldn't accept in normal times. Shock doctrine, here we come.

Bond investors usually love this stuff, but now they're barely smiling. Yields on Italian ten-year notes fell briefly below the dangerous 7% threshold that created a panic last week, but then crept back up there Tuesday.

Meanwhile, the bond vigilantes have driven yields on Spanish bonds above 6%. Wasn't Spain supposed to be out of the woods? And yields on bonds issued by France, Austria, even the rock-solid Netherlands have moved higher.

Yet, through it all, the euro has held steady at around $1.35-midway between its 52-week high near $1.50 and its 2010 low below $1.20. You'd think that with all the talk of the single currency unraveling, our own greenback would have gained more.

And it will, when the crisis worsens. The US has some big problems, but watching Europe makes me grateful for ours.

If we can stay out of recession and make at least some dent in our own fiscal morass-watch Congress's supercommittee for any hints-the dollar's decline will slow and we may enjoy reserve currency status a bit longer. Further in the future, though, I think we'll have to share the stage with others.

So does Barry Eichengreen, an economics and political science professor at UC Berkeley and author of Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System, which was a finalist for the FT/Goldman Sachs Business Book of the Year Award for 2011.

In an interview, Eichengreen told me there are no real alternatives to the US dollar for now. And we need to get through the euro crisis before we can even think about a global role for the single currency again.

He said the current crisis has moved far beyond the worries about Greece we've had all summer and fall. "The fate on the euro doesn't rest on what happens in Greece," he told me. Greece comprises 2.5% of the Eurozone's GDP; Italy represents almost 17%, and that is where it will sink or swim.

He said European officials are "in a game of chicken with the Italian government." He compared it to mutually assured destruction, the Cold War doctrine that both the US and the Soviet Union could destroy each other several times over, and that was an incentive not to start a war in the first place.

German chancellor Angela Merkel and French President Nicolas Sarkozy, as well as eurocrats in Brussels, are pushing Italy's new government to ram through draconian reforms to cut debt, increase labor "flexibility," and raise the retirement age.

Italian households actually are pretty wealthy, but government debt is a shocking 120% of GDP, and growth in both productivity and GDP has been minuscule for years.

The new prime minister, Mario Monti, is a former economics professor and university president who also served on the European Commission, which makes folks in Brussels comfortable. He replaces the despised Silvio Berlusconi, a notorious lecher and an embarrassing buffoon.

Monti's hope: By suspending elections until 2013, his government can go boldly where no man or woman or politician has gone before and make Italy a more efficient economy. Buona fortuna, Signor Monti.

NEXT: Crunch Time Is Here


He doesn't have much time. The Italian government has financing needs of ?600 billion (more than $800 billion) in debt over the next three years, half of it next year.

So, it's crunch time, and the stakes couldn't be higher. Eichengreen thinks that if Italy defaults or leaves the Eurozone, the consequences would be "catastrophic-Lehman Brothers squared."

"A big run in Italy now will drag everyone else down. So many banks would be impaired throughout Europe," he said, as banks would be forced to mark down the value of bonds and other instruments tied to Italy. How do these bankers manage to get into one mess after another?

The only real solution, in Eichengreen's view, is for the European Central Bank to step up and assume the traditional central bank's role of being a "lender of last resort" during a crisis.

The ECB "will have to behave like a normal central bank and restore normal market conditions," he said. "As the crisis continues to worsen,.the only way the panic can be for the ECB to step in and buy Spanish and Italian bonds." Billions and billions of euros worth of Spanish and Italian bonds.

Just this week, ECB officials explicitly ruled that out, and the Germans who dominate the institution see hyperinflation under every bedpost. But ultimately they may have no choice.

"I'm optimistic that European leaders will do what it takes when push comes to shove," said Eichengreen. "Unfortunately things may have to get worse."

That's where the dollar might gain from Europe's misfortune. Right now, the ECB has fixed short-term rates at 1.25%-low, for sure, but much higher than the 0% rate the Federal Reserve has pretty much guaranteed until 2013. So, myopic bond investors and currency traders are playing arbitrage games and ignoring the elephant in the room.

But if the crisis gets worse-and who doesn't expect that?-stocks will sell off, Treasury bond prices will rise as yields plunge, and the dollar will rally. In times like that, the US dollar and US Treasuries become the world's safe haven, along with gold.

Since late April's speculative peak in stocks and silver (which coincided with the dollar's 52-week lows), the US dollar index has rallied about 7%, and it traded near 78 on Wednesday.

The absence of good alternatives may prolong the dollar's status as a reserve currency, too. Sterling is a shadow of its former self. The Swiss National Bank has put a ceiling on the Swiss franc, which had a huge run earlier this year, and pegged it to the euro. Japanese authorities keep a close watch on the yen. The Canadian and Australian dollars and Scandinavian currencies are too small to assume reserve status.

The Chinese yuan, however, may well become an option, as China increasingly uses the yuan to settle bilateral trade agreements, and uses Hong Kong to make the yuan a more global currency.

"They're not going to overtake the dollar tomorrow, but they are moving faster than anybody could anticipate," Eichengreen told me. A new report from an independent commission backs him up.

The European crisis has probably prolonged the dollar's time as a global reserve currency, largely because of the terrible alternatives. But eventually, probably in a decade or so, we will have to share the world's stage with other rising currencies, especially the Chinese yuan.

The euro can make a comeback, but it will need drastic political and economic reform on the Old Continent.

Let that be a lesson for us, too: The longer we don't get our own house in order, the sooner the dollar's dominance will pass.

 Howard R. Gold is editor at large for and a columnist for MarketWatch. Follow him on Twitter @howardrgold, read more commentary at, and check out his political blog at

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