As the U.S. economy struggles, an austere Europe rebounds

The stark reality of American leaders receiving warnings from their European counterparts about the need to curb spending and government deficits has been accompanied by the rising euro and falling U.S. dollar. On Monday, Aug. 2, the euro soared to a three-month high against the dollar and the U.K. pound reached its highest value in six months.

Policy decisions can and do affect the value of currencies. Look no further for a recent example than the United Kingdom and its new government’s unveiling of a fiscal austerity plan. Within a few months, the British pound has gained more than 11% in value, following a drop in May, after assuaging uncertainty among market observers about whether the U.K. government would address its troublesome deficit.

The International Monetary Fund on July 8 specifically called for the United States to intensify efforts to curb budget deficits. The 185-member international lending agency warned about a potential double-dip recession in housing, continued problems in commercial real estate and risk to the U.S. economy from the European debt woes.

While you're at Harrod's anyway, why don't you pick up a pound of gold?

A remarkable piece of news came out of London last week. Harrods, one of Europe’s best-known department stores, has begun selling gold bullion.

This unprecedented move by the famous retailer reflects the rapidly growing appetite for investment-grade gold, which has been enjoying a bull run even as the world is bogged down in a global recession. Used as a hedge against currency weakness, especially the dollar, gold has been trading at record highs. Many analysts think this is no temporary spike, but a long-term surge that will continue as the word monetary system is pulled down by the mismanaged and collapsing dollar. (To be sure, there are those who question whether gold is a sound investment, even in inflationary times.)

Swiss-based financial newsletter Daily Bell puts it bluntly:

“We are in a bull market cycle for money metals because fiat money is all but dead, including most importantly the American dollar.”

Simone Wapler, the editor of MoneyWeek agrees:

“Gold is being re-monetized. All the world’s paper monies are losing value – and credibility. There’s a race to the bottom as they try to devalue their currencies.”

Until quite recently, money was backed by gold. That changed after World War II, when Western powers set up a monetary system with the dollar at its center. The dollar was partially backed by the metal until 1971 when President Richard Nixon took it off the gold standard altogether. At that point, the dollar became pure paper money.

But there was a major problem with the change. Politicians will always print more money than they should. How else to pay for the promises that got them elected? This excessive printing is known as currency debasement and it ultimately leads to inflation.

Arab oil producers and Russia and China may adopt gold or nondollar currency for oil transactions

"In the most profound financial change in recent Middle East history, Gulf Arabs are planning – along with China, Russia, Japan and France – to end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar.
Secret meetings have already been held by finance ministers and central bank governors in Russia, China, Japan and Brazil to work on the scheme, which will mean that oil will no longer be priced in dollars.

The plans, confirmed to The Independent by both Gulf Arab and Chinese banking sources in Hong Kong, may help to explain the sudden rise in gold prices, but it also augurs an extraordinary transition from dollar markets within nine years."

(snip)

"The decline of American economic power linked to the current global recession was implicitly acknowledged by the World Bank president Robert Zoellick. "One of the legacies of this crisis may be a recognition of changed economic power relations," he said in Istanbul ahead of meetings this week of the IMF and World Bank. But it is China's extraordinary new financial power – along with past anger among oil-producing and oil-consuming nations at America's power to interfere in the international financial system – which has prompted the latest discussions involving the Gulf states."