January 15, 2012

Euro vs Dollar

When people say: " The Euro and the Dollar are all the same, and the causes of the problems we face today", it's sometimes hard not to giggle. The idea comes to my mind that there are in fact a lot of similarities between these two currencies. As there are similarities, there are differences. This subject isn't  easy to explain, but I'm going to give it a try! Not with throwing difficult terms at your face or hard to grasp mind games, but with some graphs. With the idea that one picture says more than a thousand words.

As we know, money has three functions:
1. Medium of exchange
2. Unit of account
3. Store of value.

I rather wouldn't go deeper in this money definition, as I hope everybody can agree on this. The first two functions are both to the Euro and the Dollar equal. So when people say they are the same, in fact it's partially right. But, what about the third function? Store of value?
I could hear you saying again it's the same for both. And again, partially right.
When we use both currencies as a store of value (our savings), it is the same.

But what does the architecture of those two currencies actually tell us? And by architecture I mean, how does the issuer of these currencies show us how their currencies perform as store of value?  For the Euro the issuer is the ECB, and for the Dollar the Fed.
We all know central banks hold gold, but is there a difference in the way they value their currency to gold?
Or maybe better, are the issuers of our currencies really showing the state of it?

Let's look how the ECB values it's gold holdings.

As we can see  the ECB marks it's gold holdings quarterly at market prices. As these prices are rising since the creation of the Euro, the value is rising also. But, hey? If the value of gold measured in that currency is rising, than that currency itself is actually falling in value. So the ECB is showing us something. We, as the people, can use the Euro as a store of value but as time passes the purchasing power will be affected negatively.

When we move back to the dollar and try to get a closer look on the valuation by the Fed of it's gold holdings we see a first difference.

The Fed still values its gold at $42.22 per ounce. This price was set during the fixed gold standard. So actually the Fed is telling us here there is no need for a separate store of value, as their currency (the Dollar) is still as good as gold. Even though we can't exchange roughly $42 for one ounce of gold any more, the Fed is still hanging on this cliff. Why? Again, no need for gold here, our Dollar is equally good as a store of value.

When we see the valuation of the federal gold holdings we see the stunning number of $11.1 billion. As we would draw this line into the graph of the ECB's valuation we would see a flat line just above zero. This flat line means that the creation of new currency wouldn't have impact on your savings. As we all know this is far from true. It will affect your purchasing power in the future and not in the way we want as saver.

Here we can draw a conclusion. While the ECB is open about the function and value of it's currency, the Fed isn't. And as the ECB is offering an alternative for the longer term (tax free gold everywhere in Europe), the Fed chairman Bernanke is calling holding gold  'some kind of tradition'. As the gold exchange standard for the Dollar stopped in 1971, the main offender of the Dollar (gold) was put to silence for several decades. But with the creation of the Euro, the Dollar has a new opponent. An opponent who knows monetary history and the inevitable course for every currency. In the end it always returns to it's intrinsic value, zero.

With this difference I would like to show that the Euro and the Dollar are far from the same. The Euro project is a threat, no let me state it different, a HUGE threat to the Dollar world as we know it. And in this light we should look at the news articles reaching us through all the media. Has Europe budgetary problems? They do.
Is it threatening to the Euro as a currency? As threatening as it is to the Euro, so is it to the Dollar as these problems are not only budgetary. They're monetary and worldwide. When we look at the Dollar as old fashioned and almost history, we can look at the Euro-structure as the inevitable future. A future with "free floating physical gold", and not as it is now a price set by derivatives and numerous claims on the same piece of gold.


DP said...

We, as the people, can use the Euro as a store of value but as time passes the purchasing power will be affected negatively.

Hi Boefke,

This statement, while to some extent being true, is perhaps overstating your point a little, I think. You need to have a common definition of "purchasing power" that you can share with the reader, I believe.

If you share in common a definition like "how much weight of gold you can buy with X units of currency", then yes your statement is correct as presented.

If you share in common a definition like "how much bread, milk, eggs, broccoli, etc, you can buy with X units of currency", then this is where the overstatement arises, IMO.

FOFOA mentions this real revaluation of gold concept (not for the first time) in The Studebaker Effect:

So why buy gold? Why buy only discrete coins and unambiguous bars of physical gold? And why right now? A historical perspective is necessary for understanding the answers to these questions. Crisis resolutions always involve the sacrifice of someone. And that someone is usually the savers. But there are always winners and losers. Devaluations play out like a seesaw. There is a force (the crisis devaluation), a fulcrum (what is being devalued against), and a load (the beneficiary or the winner). (See also the linked image, earlier in this comment, from the same source.)

Force : currency hyperinflation

Fulcrum : The real world of things (including bread, milk, eggs, broccoli, etc)

---> Load : Physical gold. <---

DP said...

And that, dear reader, is why you need to BUY. PHYSICAL. GOLD. NOW.

DP said...

FYP? :-)

Boefke said...

Hi DP,

Thank for your comment.

I think we are talking here about 2 different things. Or better said, my guess is you mean after the revaluation, and I mean the present situation.

Now it's obvious that the purchasing power of our Euro's are affected negatively in either way. As the price of food is rising, so is the gold price. That's what I meant above.

After the revaluation you are probably right. There won't be such a need as it is today to hold physical gold in the amounts we do. Gold as a reference point will do the job than.

Although I came across the picture you posted in your comment, the real understanding wasn't there until now. So thank you for that, really appreciate it!

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