Gold News

Germany Over-Extending Its Euro Role

Buoying weaker economies bodes ill for the Eurozone's biggest economy...

GERMANY IS the richest and most powerful nation in the Eurozone and the most important lender on the bailout scene, writes Julian Phillips at GoldForecaster.

But how far can they go before they have lent too much and how far can the Eurozone go before it too, is overextended in helping the distressed members of the European Union? What then?

Germany's economy is on the rise with manufacturing and exports leading the way. The last quarter of 2010 was a good one for Germany and 2011 promises even more for that country. Germany is way ahead of its Eurozone partners because of its work ethic and extremely high standards. No other Eurozone nation can match its performance.

The advantages for Germany of so many European nations being members of the Eurozone are huge through the common currency – the same as fixed exchange rates between those nations – and therefore the ability to exports to those nations without the interference of a rising exchange rate. Hence capital flows unfettered from the other Eurozone nations to Germany, not only from trade but capital. In other words Germany has earned the wealth of its other members much in the same way as China is sucking away the wealth of the developed world through its export competitiveness, its 'peg' to the US Dollar, plus its work ethic and low wages.

But as we have seen in the last year and more, this advantage has its limits. Once the wealth 'runs out', the ability of its fellow EU members to buy more German goods runs out too and debt limits stand in the way. One way to extend the process is for these importing nations to be 'rescued' so that they can buy another day. Witness Greece, Ireland and potentially Portugal, Spain and Italy. Germany seems to be the ultimate guarantor of the whole region. We don't think that this can last for much longer because Germany has only so much money to lend too.

As it is, Germany has pledged more cash than any nation to bail out debt-ridden states such as Ireland. Can they lend more to the much larger Latin nations? Most observers think not. In fact that prospect is starting to be factored into Germany's fixed- income market. The yield of the benchmark 10-year German bund will climb to 3.28% by the end of 2011 from an average 2.78% last year. By contrast, yields for Irish bonds of similar maturities were at 9.25% on Dec. 30 and the yield on 10-year Greek bonds was 12.59%.

The more Germany supports bailouts, the less German bonds can be claimed as a risk-free asset. While Germany has one of the lowest deficits in the 17- member euro region, it has earmarked 119.4 billion Euros to the European Financial Stability Facility for countries in need of bailouts. The contribution, the biggest by any nation, amounts to 27% of the fund. If the Latin nations need help from Germany and they do give it, then too many Euros will be issued and its credibility as a global currency will slide. In 2010 Eurozone problems shook the world coming out of the blue at a time when the Euro was held up as a good example against a poor Dollar performance.

With German Bunds now set to see a rise in yields, despite the support for "peripheral" Eurozone debt promised by the Chinese government, the entire creditworthiness of the Eurozone has now come into view. 2011 we believe will prove to be a far more traumatic year for the Eurozone than 2010.

How will this affect the Euro/US Dollar exchange rate? How much simpler this answer would be if only the Dollar would stop weakening itself. But the Dollar, while being the currency of a united bloc in a fiscal union, has considerably more balance sheet problems than the Eurozone. The two currencies are sliding down together, which is why we have seen the exchange rate hold around $1.30 for the last few months.

If the Dollar were to stand still, the Euro could slide to parity (€1 = $1). If the Euro were to stand still, the Dollar could easily fall to $1.70 against the single currency. But we don't expect much of a change in the global exchange rates except the fall of both against the Yen and the Swiss Franc.

Many may have been hoping that the Yuan would be 'un-pegged' from the US Dollar but that now seems an unlikely eventuality now. We are of the opinion that when China is ready they will send a flood of Yuan to the outside world that will ensure it will be more likely to fall than to rise, for this would be in China's best interest. We have no doubt that China is actually quite pleased to se a growing reliance on China's investments into Treasuries and into Euro bunds and bonds of all kinds.

After all this is where the power they want lies. A steady exchange rate of the Euro to the Dollar is in their best interests as their power over European and US capital markets grows. Forget any military conflict between east and west, the power lies in financial conquest. The only weapons against such a conquest is protectionism through exchange and capital controls with the ultimate victory going to the one who can produce quality goods the cheapest.

The result for all is a growing instability and uncertainty in the developed world as China burgeons.

How could Germany's policy benefit gold? The moment Germany's Bunds yields stated to rise, the market was telling us that Germany was moving towards a point where it would over-extend itself. The moment this happened, it was telling us that the EU itself was seeing risks rise. The possibility of some members being ejected from the Eurozone is being discussed in the markets. We believe that Germany will halt its support of the bailouts at some point in time. This will lead to a Eurozone fragmentation to some extent. This will contribute to rising tensions and monetary controls (as well as protectionism) in the global economy.

With London and Europe dominating the Gold Price (look at the path of the Gold Price in the Euro) we fully expect the Eurozone problems to continue to encourage Europeans to want to hold more and more gold.

Yes, once the US start to fail to resolve their own major deficits and the markets react accordingly, they too will see gold as a protection against the ills of the dollar too. But the trail blazed by the Eurozone will be the path the US will follow. The resultant fragmentation of the global monetary system will leave paper currencies inadequate measures of value.

Get the safest gold at the lowest prices using BullionVault...

JULIAN PHILLIPS – one half of the highly respected team at – began his career in the financial markets back in 1970, when he left the British Army after serving as an Officer in the Light Infantry in Malaya, Mauritius, and Belfast.

First he worked in Timber Management and then joined the London Stock Exchange, qualifying as a member and specializing from the beginning in currencies, gold and the "Dollar Premium". On moving to South Africa, Julian was appointed a macro-economist for the Electricity Supply Commission – guiding currency decisions on the multi-billion foreign Loan Portfolio – before joining Chase Manhattan and the UK Merchant Bank, Hill Samuel, in Johannesburg.

There he specialized in gold, before moving to Capetown, where he established the Fund Management department of the Board of Executors. Julian returned to the "Gold World" over two years ago, contributing his exceptional experience and insights to Global Watch: The Gold Forecaster.

Legal Notice/Disclaimer: This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. Gold Forecaster/Julian D.W. Phillips have based this document on information obtained from sources they believe to be reliable but which it has not independently verified; they make no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Gold Forecaster/Julian D.W. Phillips only and are subject to change without notice. They assume no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, they assume no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information, provided within this report.

See full archive of Julian Phillips.

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

Follow Us

Facebook Youtube Twitter LinkedIn



Market Fundamentals