DEZ
A Story of the Euro, the Dollar, Oil & the Yellow Metal
By Stephen Clayson
21 Feb 2006 at 02:26 PM EST
LONDON (ResourceInvestor.com) -- Since its inception, the euro has lacked the strength of global parity that intuitively one would associate with it as the currency of an enormous and significant economic area. But forces are building in the global economy that could change this, and with far reaching implications for the dollar, and for gold.
When the euro came into being into 1999, it was traded down heavily against other heavyweight currencies such as sterling, the dollar and the yen. The euro recovered somewhat from this, but has hardly been a pillar of solidity at any time during its life. However, several factors have now appeared on the horizon that could cause the euro to appreciate markedly.
One is that the realisation is growing that the euro is exceedingly unlikely to go away.
In the currency’s early days, sceptics abounded, and some went as far as to dismiss it as a mere flash in the pan. But every year that a crisis fails to materialise and threaten the euro’s integrity, is another year that the idea of an ephemeral euro become less and less tenable. Therefore, it stands to reason that a material appreciation of the euro attributable to this growing confidence will at some point be discernable.
There is also the possibility that trade in oil, and perhaps other commodities, will increasingly be denominated in euros.
On this theme, Iran is pushing ahead with plans to launch a new oil bourse on which trade will be conducted in euros.
Although previous, Russian plans for a euro denominated oil bourse were stymied beneath the weight of U.S. diplomatic pressure, Iran may prove much less liable to be dissuaded.
The dollar derives a significant boost to its valuation versus other currencies from its use as the main denominator of international trade in commodities, due to the extra demand for the dollar that this use creates.
So too would the euro should its use in this role increase substantially, while concomitantly the dollar’s valuation would be undermined. A switch away from the use of the dollar for trade in oil would have a particularly pronounced effect, given the sheer volume of transactions concerned.
Many will dismiss out of hand the idea that a euro denominated oil bourse sponsored by Iran could be taken up sufficiently to move the major currency markets, given that the country is increasingly considered a pariah by the West.
But what must be considered is that much demand for oil imports now comes from the East, most significantly from China, and that those responsible for sourcing the oil needed to sate this demand may have few or no qualms about buying the black stuff in euros, on an Iranian sponsored exchange.
The euro also stands to benefit from the coming diversification of many central banks’ currency reserves away from the dollar, the current valuation of which is poorly founded. The euro is one of the prime alternatives to the dollar as a reserve currency, and when this diversification begins to occur, that is if it has not already begun covertly, the euro will appreciate.
The immense foreign currency reserves of the People’s Bank of China will one day soon be switched substantially away from dollars;
the government of the P.R.C. has indicated as much, and such a move makes sense from the Chinese point of view, given the losses that the P.B.O.C. would otherwise incur once the dollar recommences its inevitable slide down to a realistic valuation.
The main determinant of the timing of this switch is when it is likely to cause the least disruption to the global economy, and it is a fair assumption that the Chinese are already ruminating on the matter. Once the P.B.O.C. makes a decisive move, central banks worldwide would follow suit, amplifying the effects on the currency markets.
Of course, such a switch will not just benefit the euro. The weakening of the dollar that it entails will also be of benefit to gold, which can be expected to appreciate as soon as the dollar resumes its movement downwards.
A proportion of those institutions and individuals holding sizable currency reserves will remain to some extent unsure of the euro and other major currencies excluding the dollar, and hence some will move into gold, with apprising effects on the metal’s price.
Nevertheless, other globally significant currencies such as the yen and the won can also be expected to appreciate as a result of reserve diversification away from the dollar.
Ultimately, this story has its roots far beyond the triggers here identified; the changing priorities of the People’s Bank of China, the coming of the Iranian oil bourse, and the ascension of confidence levels in the euro towards a critical mass. The fundamental forces that will drive the coming rebalancing of the global currency markets have been building for decades, but only now may the circumstances be right for their stark manifestation.
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