I’ve spent a great deal of time in the last few months describing why the Greek crisis was much larger, more complex and a greater risk than anyone assumed. As stocks continued to chug higher (and I built short positions) an odd occurrence was brewing. Gold prices were rallying in tandem with the dollar. As the market began to crater and eventually crash 1,000 points in one day the gold market actually continued to rally along with the dollar! For anyone familiar with gold and forex markets this was more than odd. But there is a reasonable explanation for the move. And half of that move is entirely unjustified and incorrect in my opinion.

What if I told you that the Euro’s “inevitable demise” was not a condemnation of fiat money? You’d probably call me crazy. Well, that’s basically what several emailers have done in recent days. I received this friendly note from a reader recently:

“nice work predicting the risk in Greece and the Euro over the last few months, but you’re dead wrong about paper money and the gold standard. The Euro is proving that paper money does not work and gold’s recent price increases prove that the move towards a gold standard is on the horizon”

The irony behind the Euro crisis is that it is not at all a condemnation of fiat money. In fact, it is a condemnation on single currency systems such as the gold standard. I have long argued that the mess the EMU created in 1999 with the inception of the Euro was unlikely to survive a serious global recession in its original format. This was due to one primary argument. The gold standard and single currency systems have all ended in demise for similar reasons. There are several flaws in single currency systems, however, two are most notable:

  • They are inflexible
  • They are susceptible to corruption

The inherent inflexibility and inherent weaknesses imposed on particular trade partners within the currency system is always apparent in single currency systems. As I’ve previously noted in “Reflections on gold as an asset class“:

“the gold standard had a tendency to cause severe strains on countries due to trade imbalances and the inability to provide flexibility to countries with trade deficits.”

The move off the gold standard and convertible currency systems has generally been due to the inherent restraints imposed by such systems. For instance, trade deficit nations are at an inherent weakness when attempting to respond to recession because the trade imbalance results in rising unemployment and falling output and prices – an inherently deflationary environment. With your own currency this imbalance would naturally offset over time, but under a single currency system there is no opportunity for the floating exchange system to reach balance. This is just one very simple example of the types of inherent restrictions a single currency system imposes on a nation, but it’s particularly pertinent as we see this exact event unfolding in Greece – where the single currency system is destroying the country and handcuffing the government from properly defending their economy and thus providing for their citizens. Instead, they are risking default (a risk which does not exist within a sovereign issuing floating exchange system) and forcing their citizens into recession all so the surplus nation of Germany can enjoy price stability and continued high exports.  Such a system is wondrous during the boom, but it can be catastrophic during the bust.

The other critical flaw within the Euro system (and the gold standard) is a very human one and not necessarily unique to single currency systems.  In Europe, it is the unwillingness to accept political failure which ultimately results in a form of political corruption and manipulation in a misguided attempt to right a previous wrong.  In his “Money: Whence it came, where it went”, John K. Galbraith described this flaw in the gold standard:

“It had also a notable flaw. That was in asking, in an age of growing nationalism with a growing tendency to hold governments responsible for economic performance, that both nationalistic instinct and domestic economic management be subordinated to an impersonal, international mechanism, one capable of inflicting considerable hardship and distress. It was a flaw that supporters of gold did not accept. They saw any reluctance of governments as inhering in the lack of moral fibre of politicians – a lack that led them to try to ameliorate the strains that gold imposed. That the morality of politicians is difficult to alter in the short run was not recognized.”

The inefficient market irony within all of this is that the markets are viewing the Euro crisis as a condemnation and failure of fiat money. That couldn’t be farther from the truth. What we are seeing in Europe is in many ways what we would see if the world were living in a gold standard world or a convertible currency world. The same unnecessary restrictions would occur and trade deficit nations would be at risk of recession which would ultimately result in regional and perhaps global recession. The recent rise in gold prices is not based on the true fundamentals of mined gold, but rather on the hope that the Euro’s failure will increase demand for gold via its potential return as a true currency. As we’ve described above, that is entirely misguided thinking and perhaps the greatest real-time example of the inefficient market I have ever witnessed.

Of course, this doesn’t imply that gold prices are set to collapse. In fact, we are likely to see gold prices continue their record move so long as the weakness in the Euro continues. If the Euro collapses misguided governments will clamor for gold as they incorrectly worry over the stability of their own paper currencies. After all, the ignorance with regards to our monetary system extends up to the very highest levels of government and the total lack of understanding is on display in Europe every day as politicians make mistake after mistake and further destroy their economy. The politicians and central bankers have mishandled this crisis at almost every single step and this lack of understanding with regards to the monetary system is the single largest contributing factor. What does this all prove? The inefficient market is alive and well.


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • DanH

    Brilliant. These sorts of insights are why your site is an absolute must read for anyone who is serious about investing. Thanks for another great post TPC.

  • LVG

    would u short gold here?

  • Exertia

    Thanks for your brilliant insight as always TPC. You have mentioned in a couple of posts that you have turned short. Can you share any specific sectors / currencies / ETF’s that you are short on?

  • TPC

    No. In fact, I would look to be a buyer of gold and t-bonds on pullbacks. Don’t like gold up here, however….

  • TPC

    No longer short equities. Covered the day of the crash.

    Still heavy cash, short some derivatives, but cash equities. Letting the dust settle….My shorts were all built before the downside. Risk reward is no longer as favorable….

  • TPC

    Thats very nice of you. Thanks Dan.

  • Richard

    I agree with your argument that the Euro acts like a fixed currency regime or Gold standard. The reason convertible currencies fail is that when in deficit they eventually run out of reserves (gold drains). Usually this reflects a structural imbalance – the classic case was US printing money during the Vietnam war which broke the Bretton Woods system. But what then happened to Gold? it rebalanced to the new increased quantity of dollars and rose from $35 (fixed level under Bretton Woods until 1970) to within a whisker of $200 by 1974. Then a recession; followed by the rally to $850 by 1980. The key point in my mind is that when structural imbalances lead to massive deficits in some countries and massive surpluses in others the solution usually ends up with printing money to alleviate the deficit. In a democracy it seems the pain of contraction to offset the surplus side is politically untenable. So the system has a bias to debase the currency. Since the quantity of Gold is essentially fixed, its price rises relative to the currency being debased. (By the way the deficit/ surplus between US / China is out of balance too. Will the US raise rates to reel it in? no bloody chance. I doubt it will end well. Where Gold then?)

  • David

    Great insight TPC. I still feel a gold/commodity backed currency could work, not a standard where rates are set but where the market sets prices. I don’t think that there is a currency solution as all governments will handle their currency situation poorly, no matter what system is used. Despite my lack of faith in the fiat system I am now begininning to think it’s the only way to go so govenrments will have a backstop due to their inherent idiocy.

    On the issue of tresuries, would you be a buyer of the long bond and ten year (futures) on pullbacks? I’ve been a fan of this for a while and am currently all in cash, but I can see another run-up in bond prices similar to what happend back in ’08. It may not be as severe, but money will flow to where it feels it’s safe if things break down further. No one thought we would see rates below 3.50 again and here we are.

  • Bill

    Eur was doomed the day they decided that monetary policy would be linked among nations but fiscal policy would not.

    Fiat systems are ultimately a failure though as we will see inflation heightened in order to pay off massive global debt more cheaply.

    Double and triple dip anyone?

  • boatman

    95% agree on europe,cullen….”flailing attempt” is what i’ve heard the naked short sell ban described.

    i’m 62% up on gold in 18 mos. in a deflationary environment without trading it once….out fishing mostly….snook IS better than grouper n closer n more fun to catch with a rod…….. and up 42% in mutuals(out when u called it) thanks to you.

    my buy-n-hold-but-reposition stock guys(intrepid capital-pretty good at their craft) were EVEN in the last 10 yrs.i realize thats all tied to entrance and exit points.

    gold is the currency of fear…..thank god there is one…..and i see alot of fear coming…..sadly…..regretably i am not optimistic out 7 years.what would feed the engine?…..dotcom done that….tech n business efficiency…been there…housing?….i want to say child please but i already have…….only thing i can think of is alien intervention(?)…take your pick on which kind of aliens.

    on the offchance that we do start rolling again in the next 5 years (how do you do that with 8 years worth of houses lying vacant?…housing being the last big manufacturing business in this country-luckily they don’t fit in a shipping container), i do not believe helicopter ben can stick a 747 landing on a postage stamp with that electronic printing press (its never been done,afterall)…..inflation down the road…years down,granted.

    no, gold is never gonna be exchangable money again,i agree….or even back paper,probably not.

    for people to buy it, it doesn’t have to…… and everything that goes up, comes down.

  • Matt S.

    I agree that the fiat bashing is overdone. And gold may have made an important Cramer Top.

  • Octopus

    Rumours around that they’re going to sink the ship (Greece), Merkel is drafting law for orderly insolvencies and since they don’t want anyone to make money out of it they banned sht selling…

  • Jon

    Extending your own argument, you have to look at the US Dollar overseas. As China and many other Asian nations (and some latin American countries) have pegged their currency to the dollar they too are struggling now.

  • And

    Thank you for helping understand the depth of the problems in EU.

    From a private investor perspective I have closed all equity positions. But I sold some puts today, since I like a few shares and their price looked good in my view…

    Gold looks expensive now. The Euro will probably still go down in the next months, but a short is less attractive than it was before since the last downward accelleration.

    Commodity prices might suffer also as the dollar strengthens and the European crisis becomes more serious?

    US debt then?

    It doesn’t look like any solution is on sight for the European crisis. Would you assume it is going down and Europe will revert to many currencies and position for such a scenario?

  • TPC

    In all seriousness, if I am Merkel and the Greeks I have the DM and Drachma presses firing on all cyclinders just in case. midnight sessions with parliament to implement an emergency currency reversion.

    Won’t happen though – they are being very stubborn about this. And that means the markets will be roiled for months….

  • TPC

    I generally like bonds. As you probably know, I see no inflation in our future. It’s a super contrarian bet, but it’s been the right one. Laddering up as opposed to cash is a fantastic allocation in my opinion. At least for some portion of ones account.

  • TPC


  • TPC

    Yes, the pegs are inherently weak, but an unfortunate ramification of an unstable economy…

  • dontrada

    guys check out this brand new site

    its loaded with free educational content and a “road map” going forward a few months. Definitely a great resource to consult before putting any positions on.

  • vasra

    Thank you again for insightful analysis.

    I have arrived at a similar conclusion, though through other means (esp. regarding strict gold standard).

    However, and this may be semantics, I think this is more a failure of an inflexible currency/monetary system across divergent economic areas, which results in inability to settle imbalances through natural (trade/price adjustment) means.

    We can have the same under any system: silver, gold, wooden sticks, fiat. whatever.

    It’s the inflexibility of the currency system (i.e. how it is employed) and compared to that, the differences of the economic areas under that currency system that cause the conflict.

    But yes, this does not change the overall argument you make:

    – EUR is (as currently employed) looking very doomed both as currency and as a monetary union
    – hard/strict gold standard would die due to similar (and also not-so-similar) issues. People who do not understand this, have not studied monetary history, but are reading goldbug garbage.

    Thank you again for the wonderful blog. In my meager understanding of affairs economic/financial, it is one of my favourite places for insight and level-headed analysis.

  • jenny

    TPC, how would you purchase your gold, via physical form or etfs? Please advice. Thanks.

  • TPC

    I see little value in gold over the long-term so it would just be a trade. I am enormously conflicted with regards to gold. I think the currency premium that is built in is nothing short of absurd, but I am in a very small minority when it comes to this sort of thinking so it’s foolish to disregard the majority.

    I personally own no gold for long-term investment, but love it for a EUR hedge trade on a pull-back (maybe legging in near 1,100). Especially if we get a rebound in risk assets in the near-term. I think this EUR crisis has many months and possibly years to unfold. Gold will be strong as long as the problem persists. I find a long US paper/long gold trade to be very attractive at a little lower levels.

    So, to answer your question – ETFs….

  • TPC

    Hey Boatman, where do you fish?

  • Leprechaun

    Sharp insightfull,well penned.

  • BK


  • BK

    As an avid reader in Australia (and a financial analyst), I have always been impressed by the quality of your work. You have outdone yourself here and would have to say that your logic makes sense and I think I had one of those ‘aha’ moments.

    Thanks once again for your insightful analysis


  • TPC

    You’re very welcome. I’ll take a beer next time I am in Australia :-)

  • Rom Badilla

    Excellent post, TPC.

  • digitalfour

    “The move off the gold standard and convertible currency systems has generally been due to the inherent restraints imposed by such systems. For instance, trade deficit nations are at an inherent weakness when attempting to respond to recession because the trade imbalance results in rising unemployment and falling output and prices – an inherently deflationary environment.”

    Please excuse my ignorance, I’m trying to understand this point of view.

    How can responding to recession in a monetary manner be good for an economy in the long run? Doesn’t inflating a currency necessarily lead to more malinvestment and thus a bigger recession eventually?

  • Lincoln

    I’m right there with you. Part of the reason so many people are in love with gold is precisely because they want the hands of their government tied. I am one such person although I’m happy to keep an open mind to alternatives to a gold standard. However, the thought that governments can and should try to “manage” their economies I think is a dangerous one. Most “management” is simply taking from some people to give to others, inflation included. I think the problem with the gold standard could be rephrased to say “governments irresponsibly borrow and spend money they don’t have to buy votes” – so of course when the chickens come home to roost you have a problem – same as any person on the street who either doesn’t know how or refuses to manage their finances properly.

  • Arsene Holmes

    Fiat Lux

    Just read this article and the little light went up.

    I’d never thought about the Euro this way and now it makes much more sense.

    Your website is one of the best.

    What makes it so,is obviously your insights.

    But what differentiates it,IMHO, is that your articles are concise and easy to read and understand. That really makes a difference.

    Thank you again for your wonderful work