Client & Advisor Update - May 24, 2010

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Euro vs. Dollar is a Race to the Bottom

The following is an opinion piece written by Peter Schiff, president of Euro Pacific Capital and author of Crash Proof 2.0: How to Profit from the Economic Collapse. Mr. Schiff, a Republican, is also running for the U.S. Senate seat currently held by Banking Committee chair Christopher Dodd.

Last week, the European Central Bank abandoned all pretense that the euro would be the worthy heir of the Deutsche mark; based on the enormity of the nearly $1 trillion bailout of Greece and the moral hazard it creates for other spendthrift member-states, the euro is instead on its way to becoming the worthy heir of the drachma. While the bailout was intended to restore calm to the continent, thereby strengthening the euro, the result is a currency that has lost its shot at glory. Like Terry Malloy... it coulda been a contender.

Prior to this bailout, many investors - myself included - held to the belief that the German-led eurozone would be more fiscally responsible than countries whose governments have unilateral control over their own currencies. Given the decentralized political structure of the eurozone and the independence of the ECB, it was assumed that Western Europe would be unlikely, and perhaps unable, to inflate its way out of debt. As a result of this assumption, Europeans have enjoyed low interest rates and favorable exchange rates since the euro's introduction.

However, many member-states, Greece first among them, abused the borrowing privileges conferred by a strong currency and, to put it bluntly, bit off more than they could chew. Rather than allowing Greece to default, which would have put real teeth into Europe's previously untested commitment to fiscal responsibility, Europe proved it was all bark and no bite. The net effect has been to demonstrate that the ECB will monetize the debts of any member-state that has borrowed too much. As this understanding sinks in around the globe, the euro just sinks.

Unfortunately, many are mistaking this euro weakness for dollar strength. A quick glance at the price of gold - which has made new highs in both currencies - quickly disproves this myth. The fact is that both the dollar and the euro are losing value. At the moment, the euro is losing value faster; however, in the race to the bottom, my money is still on the dollar to win.

It is generally believed that the US government will never default on its debt, no matter how much red ink it generates nor how onerous servicing that debt might become. For now, the rest of the world seems content to buy our debt - despite the fact that they are paid next to nothing for the favor. To those who have raised concerns that foreign buying may someday cease, the Fed has clearly telegraphed its intention to print as much money as needed to buy up any debt that remains unsold. Under these conditions, those who now question the future validity of the euro without casting similar warnings on the dollar are employing a shameless double standard.