Montreal, Canada

Is the EUR a suitable alternative to a falling dollar? Are other currencies any better?

Over the last decade a record number of central banks worldwide have reduced their exposure to U.S. dollars while raising their allocations to the EUR and to a lesser extent, the Japanese yen. According to a recent report from the IMF, central banks today hold about 63% of their total reserves in dollars – a record low.

Since it was introduced in 1999, the EUR has gained a cumulative 28% versus the American dollar; the buck has also declined against every other major and peripheral currency in the world. Only once this decade has the dollar rallied – in 2005.

Current trends among central banks might be feeding a dollar bear market or likewise fueling a gold bull market.

Central banks are notoriously infamous for buying and selling currencies at the wrong time. This is also true regarding gold when dozens of banks continuously dumped the metal in the latter half of the 1990s – just as prices formed a bottom. In fact, central banks are among the worst market-timers – and not just the major central banks.

Banks in the oil-wealthy Gulf began aggressively buying dollars in 1999, 2000 and into 2001 just as the buck was completing a multi-year bull market that began in 1995.

Probably the shrewdest central bank is the People's Bank of China, who recently admitted in late April to holding twice as much physical gold in its coffers than officially reported to the World Gold Council. China, Russia and several other emerging market central banks are buying gold while advanced economy central banks have sold most of their stash – except Germany and the United States.

Are the emerging market central banks wrong to accumulate gold? I doubt it. But they might be wrong buying the EUR and yen – an admission they might be forced to make in the absence of a suitable dollar alternative with abundant liquidity.

Why is the EUR such an ideal alternative to the dollar? Despite being the second most liquid tradable unit in the world does it really deserve to be at current levels? The answer to that question is a resounding "No."

In August, the euro-zone's trade balance swung to a deficit from a surplus in July after exports plunged to their lowest levels in 4 ½ years. Budget deficits are already heading through the roof across the region – even in Germany.

The original guidelines of the Maastricht Treaty, which strictly defines budget deficit limits to 3% of GDP has been breached by most members in 2009. Though not a profligate as America, the Europeans are printing mounds of cash to desperately grow money-supply and inflation. Thus far these policy initiatives have failed.

If the EUR is such a great alternative then why is it plunging vis-à-vis the Brazilian real (-20%), the Australian dollar (-16%), Norwegian krone (-13%) and 8.5% against the Canadian dollar? Is this simply because commodities have surged since March? And against gold the EUR is dropping again, down 13.6% this year.

The EUR is not a great alternative to the dollar. The fundamentals for the single currency are poor and the prospects for devaluation are growing by the day; the lower the dollar falls, the higher the risk one or two single currency participants will leave the EUR or break from the currency grid. These include the Italians, the Greeks, and possibly the Portuguese.

The EUR is a mish-mash currency plagued by poor domestic consumption, rigid labor laws, high production costs across the region and a banking system that still starves capital. It's also wrestling with a massive leveraged buyout of Eastern Europe this decade, which is still unraveling. Yet it seems the foreign exchange market has not assigned a risk rating to this outlook; EUR investors are delusional.

Jim Rogers, one of my mentors over the years and probably the smartest global investor along with George Soros and Julian Robertson since the late 1960s, once told me the major currencies (USD, EUR, Yen) are like a "bunch of drunks at a bar, all intoxicated by rising debt and competitive devaluations; they're all no good." He was spot on. That phrase stuck with me since he first uttered those words in an interview back in mid-1995.

The EUR might be better than the dollar – almost anything is. But what does this really say about the EUR and other currencies? It says the global exchange rate mechanism is badly fractured, largely dysfunctional and prone to high inflation over time as paper money buys less and less as per our wages. It's truly a sad story.

All currencies are now in a downtrend versus gold since 2005.

Gold, and to a lesser extent, silver and oil, are ideal hedges against all currencies. The EUR is not a haven and is vulnerable to a crisis over the next several years. It's unlikely the single currency will survive without a severe devaluation – especially if the dollar remains weak, punching a hole into her exports at the very moment the region is desperate for economic growth.