20 Year of Eurozone and Gold / Commodities / Gold & Silver 2019

The oldcontinent is dying. The euro is on the brink of collapse. This is what you canoften hear in the press. But is that really the case? We invite you to read ourtoday’s article about the development of the Eurozone in the last twenty yearsand find out what are the real prospect of the euro – and what does it implyfor the gold market.

In December, wecelebrated 40 years of market reforms in China. In January, there was anotherimportant anniversary: 20 years of the euro area. So, let’s move from East Asiato Europe, analyzing the economic situation of the Eurozone and itsimplications for gold.

After years ofnegotiations and preparations, the euro was launched on January 1st, 1999. Initially, theshared currency was only virtual, and the national currencies were still legaltenders used in circulation. For ordinary citizens little changed. However, theexchange rates between national currencies were locked at fixed rates againsteach other, while the European Central Bank took control over their monetary policy.The euro notes and coins entered the circulation three years later.

The firstmembers included Austria, Belgium, Finland, France, Germany, Ireland, Italy,Luxembourg, the Netherlands, Portugal and Spain. Greece joined the club in2001, thought it should not have done, as it turned out later. Since then,seven more countries – Slovenia, Cyprus, Malta, Slovakia Estonia, Latvia,Lithuania – entered the Eurozone.

At thebeginning, everything was running smoothly. But then the financial crisis hit theEurozone heavily, revealing significantdefects in its architecture (the fatal flaw is that there is a currencyunion with the several independent fiscalpolicies). It was quiteperverse, as the GreatRecession erupted inAmerica.

However, the US– with its unified fiscal and political system – overcame the crisis relativelyquickly. On the contrary, the Eurozonesuffered a prolonged depression, as the financial crisis morphed into thesovereign debt crisis. Only when Mario Draghi famously pledged the ECB would do“whatever it takes” to preserve the euro, the market turmoil calmed. 

The truth isthat the Europe’s monetary union is still unfinished, as there is neither atrue banking union nor a capital market union. This is because the euro was the political project from thebeginning, not an economic one. It was never an optimal currency area. Butthe idea was that the euro would push European countries toward deeperintegration, making wars impossible. As economists, we are, thus, a bitskeptical of the prospects of the common currency and the whole bloc. Indeed,as the chart below shows, the Eurozone performed worse than the US. The formereconomy grew 31.4 percent by Q3 2018, compared to 50.5 percent for the latter.

Chart 1: RealGDP growth in the Eurozone (blue line) and in the US (red line) from Q1 1999 toQ3 2018 (as an index, where Q1 1999 = 100)

However, thepace of growth was also lower than in the US before the introduction of theeuro. And the common currency did not prevent the whole bloc from growing(although the performance differed among the countries). Actually, the euro’s performance has been demonized.Its performance has not been as poor as one could expect, given the moderategrowth in the GDP and all those gloomy headlines. Just look at thechart below, which presents the EUR/USD exchange rate since the creation of theeuro.

Chart 2:EUR/USD exchange rate from January 1999 to December 2018

As one can see,the euro’s value against the US dollar was initially $1.1812. From then to theend of 2018, it dropped to $1.1456, or 3 percent. Not so bad, given that fact that it is used in several economicallydistinct countries.

What are theimplications for the gold market? Quite important, as it turns out. Please lookat the chart above once again. Although the correlation is not perfect, it’s clear that the performance ofeuro, which is the second widely used reserve currency in the world, is significantly linked to the gold prices.

It’s true thatthe Eurozone faces many problems, including still weak banking system or the risein populism. But investors should acknowledge that the euro area is more robust today than it was at the start of theGreek sovereign-debt crisis (for example, the European policy makersestablished the rescue fund and launched the banking union). Moreover, despitethe populist revolution, almost 75 percent of the Eurozone’s population supportthe euro. Even in Italy, almost 70 percent supports the common currency. Andfunny enough: when the risk premium increased, Italy’s new government also started toexpress more sympathy towards the euro.

Allthis means that the euro is out of thedanger zone, at least in the short run. Actually, the slowdown of the U.S.(and China’s) expansion could push investors towards the euro-denominatedassets, especially when the ECB starts finally hiking its interestrates. If that happens and the euro strengthensagainst the US dollar in the second halfof 2019, the price of gold may go up.

Thank you.

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Arkadiusz Sieron

Sunshine Profits‘ MarketOverview Editor

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