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ECB Breaks US Dollar's Neck on Euro-zone Interest Rates Statements

Interest-Rates / Euro-Zone Dec 09, 2007 - 02:59 PM GMT

By: Alex_Wallenwein


Best Financial Markets Analysis ArticleYesterday, December 6, 2007, the ECB's Trichet announced that, while currently holding steady at 4.00 percent, he is willing to raise the euro's equivalent of the US federal funds rate in a heartbeat if euro-zone price inflation continues to rise next year.

EU zone inflation is widely expected to reach 2.5 percent next year, well above the ECB's tolerance level of around 2.00 percent.

The past eight years since the introduction of the euro have shown that the ECB is usually good for its word. What its president says it will do mostly turns out to be what it eventually does.

While the ECB is still a central bank and therefore not very far removed from the institution's in-bred bias toward market manipulation, it plays an entirely different game than the US Fed does. It was set up that way. The entire euro scheme was set up in that fashion, and this latest announcement from Trichet proves the point.

At a time when the global financial world is reeling from the US generated credit crunch, when most currencies are competing with the greenback as to who can fall faster, and after the Fed already saw itself constrained to drop its interest rate-trousers by a half percent in September and another quarter in October, the ECB has the audacity to announce its bias toward raising its repo rate.

How can it do that?

For one, the euro has a much easier position to start out with than the dollar has.

The EU's common currency does not have to strain under the weight of gold-adversity as the dollar does. In the US, any remnants of public memory that gold was once a currency and is still the world's best safe haven bet had to be carefully stamped out.

The euro, on the other hand is rather buoyed by appreciations in the gold price because the ECB revalues its gold reserves quarterly at then-current market prices - while the USD hangs on to a useless and outdated $42 per ounce "official gold price".

The euro also started out with a clean slate. It had no trade deficit worth mentioning with any country, much less the world. The dollar does, and its deficit is burgeoning beyond any prudent measure.

CFR-driven "globalization" efforts have caused the US to grant China "most favored nation" status, which has led to the wholesale export of US jobs and manufacturing capacity to that country. That, in turn, made Americans dependent on cheap imports from China. This has helped US price inflation somewhat, but has also caused a huge trade deficit to build up. The enormous holding of US treasuries by Asian exporters and China are hanging over the dollar's head like the proverbial Damocles' sword.

US consumers quickly became the globalized world's economic engine. The world got rich on the backs of America's profligate consumption habits.

In order to keep Americans spending, the US business cycle has been, and continues to be, constantly stoked by below-market interest rates. That fulfilled two functions: It kept the US economic engine humming while keeping Americans far removed from any ideas of saving some of their income rather than spending it all, and then some. A prolonged period of low interest rates made saving unprofitable, even "uncool". Spending and investing in overblown stocks was way cooler.

Then came the real estate bubble. Rising home prices fueled the refi boom and gave Americans a way to hock their homes in order to fund future consumption.

After 9-11, the Fed dropped the federal funds rate in several consecutive emergency rate cuts all the way down to the one percent mark, where it stayed for a considerable period of time. The ECB had the luxury of following the US Fed's rate down only slowly and haltingly while the Fed cranked the monetary inflation machine for all it was worth.

When the Fed began raising rates again in 2003, the ECB simply followed behind, slowly, carefully – prudently - allowing the Fed to pull the brakes hard after previously flooring the gas pedal, giving the US housing market a bad case of whiplash.

With Trichet's announcement of yesterday, the ECB has now suddenly and unexpectedly yanked the Fed's chain – nearly ripping its head off. The dollar's free-fall had to end somewhere, and the tact that the dollar was standing on the hangman's platform with a noose around its neck made the extent of the fall somewhat predictable. It would fall until it reached the end of its rope.

That rope was temporarily let out just a bit longer back in early 2005 when the dollar began its two-year bounce. The euro wasn't ready, yet. Its economy could not yet digest a USD exchange rate of 1.40. Too many EU exporters were still dependent on the US consumer - but that has now changed.

Whereas previously the ECB simply stood pat on many occasions as the Fed went through its wild gyrations, proving itself to be a stalwart of caution and deliberation in the eyes of the world, it has now signaled that it will move in opposition to the Fed.

This latest ECB signal is about to become the dollar's death-knell.

If the ECB really does hike its repo rate next year while the US Fed is condemned to flood its own economy with liquidity in order to (temporarily) stave off a total credit collapse and deflationary recession, the dollar is simply doomed.

The Saudi's have already gone off their dollar-peg, and so have a number of other oil producing countries. They can't afford that peg any longer because following the Fed's inflationary policies will cause them to suffer the same kind of inflation – and they simply don't see a point in that futile exercise.

Without the dollar peg, there no longer is much of a reason to accept only dollars for oil. Their ruminations on the subject have recently been broadcast to the world when a microphone to the press room was conveniently left open during a "private" session of OPEC ministers. It's no secret anymore. It's been all over the news.

On top of that, Iran just announced that it has finally severed all ties to the dollar and will no longer accept any dollars for its oil, from anyone. Coincidence? I think not.

The 'Coup de Grace'

With its move, the ECB has demonstrated to the world that the euro is a far safer bet as a world reserve currency than the dollar has ever been since it decoupled from gold in 1971. That makes the euro the top choice of currencies likely to be taken in trade for oil by the world's oil exporters.

No dollar-demand by oil importers means that fully one half of the world's dollar supply - the half that is currently floating outside the US economy - will come "home."

Those dollars will not be welcome.

Oh well, at least Bernanke won't need to worry about there not being enough liquidity in the US economy to stave off the coming deflationary depression. He may not have to crank up his proverbial cash-helicopter, after all.

Remember, through all of this, that the euro is not gold-adverse.

It would be wise to take that into consideration when figuring our how high the fiat-price of gold will go in the future.

What can the United States government do to deflect the worst effects of this development?

It can repeal all capital gains an income taxes on the dollar-appreciation of gold circulated as money. Since the current US government would rather drive a stake through its own heart (if it had one) than do anything of the sort, there is only one thing left for Americans to do in order to avert this certain catastrophe:

Elect Ron Paul US President in 2008.

Got gold?

Alex Wallenwein
Editor, Publisher

Copyright © 2007 Alex Wallenwein - All Rights Reserved

Alex holds a B.A. degree in Economics and a juris doctorate in Law. His forte is research. In late 1996, he began to research how money is used by some to exert political and economic control over others' lives. In the process, he discovered that gold (along with silver) is the common man's antidote to this effort. In writing and publishing the Euro vs Dollar Monitor, he explains the dynamics of this process and how individuals can harness the power of gold in their efforts to regain their political and financial autonomy.

Just like driving your car, investing only makes sense if you can see where you are going. The Euro vs Dollar Monitor is the golden windshield wiper that removes the media's greasy film of financial misinformation from your investment outlook. Don't drive your investment vehicle without it!

Alex Wallenwein Archive

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