Goldman Sachs reckons the Australian dollar is in deep trouble. 'One of the best long term trades out there at the moment is long euro versus short Aussie,' said Thomas Stolper, chief currency strategist at the investment bank. In other words, he expects the Australian dollar to fall in Euro terms.

Ignore for the moment that Thomas' last name means 'stumble' in German (ours means 'bump'). What would a drop in the Australian dollar mean for Australians and our economy?

To be honest, it's an invalid question from the start. It presumes the value of a currency affects the economy. It's really the other way around. The currency reacts to the economy. It tries to balance imports and exports by falling and rising when one of them gets out of hand. At least, that's what's supposed to happen.

But currencies are the last bastion of central planning. Governments control how much money is in the economy, and how much it costs you to borrow it. That stops things from working the way they should. The result is instability.

And because money is half of every transaction, the government's involvement causes instability right across the economy. It's ironic that governments have rolled back many of their interventions in the economy, but left the one that really matters. And then they blame free markets for anything that goes wrong.

Anyway, the Europeans and the Americans are printing lots of money. The Australian central bank isn't anywhere near as much. Surely that means the Aussie dollar will rise, not fall as Goldman Sachs expects?

But what if the Aussie dollar has already risen to reflect the newly printed money? As traders would say, it has 'priced it in'. If it has, where to from here? What will make our currency fall?

Well, Europe and America have had their housing bubbles pop. Ours is yet to burst. And we've got a resources curse too. Our economy is dependent on exporting dirt, which can change in price and demand very quickly. Worst of all, our banks are reliant on foreign financial markets. All that bodes ill for our currency.

Economic Forces vs Manipulators

What you've got here is a clash over who controls exchange rates, between currency manipulators and economies. Do central banks, which print money and sometimes intervene in foreign exchange rates, have control? Or do currencies move to try and reflect economic reality?

The answer might not matter if you're an Australian. That's because our currency manipulators (the RBA) probably want a lower Australian dollar at the same time that the weakening economy will cause one. If the Australian economy suddenly worsens as the housing bubble pops, the resource boom ends and the banks face a funding drought, the Aussie will plunge. That's what Goldman Sachs expects, to some extent.

When things go wrong, they tend to do it at the same time. On Wednesday, our steak leaked blood all over our shopping. Then, while cooking the steak, a shelf which holds vast amounts of glassware and beverages fell, shattering everything over the floor. After we vacuumed it all up, we knocked over the glass we were drinking from in exactly the same spot (and before you make any assumptions, it was only cordial).

The economic equivalent is about to happen to Australia. And poor economic times usually mean a weaker currency. You can take advantage of Goldman Sachs 'trade of the century' using the Euro ETF listed on the ASX. As the Aussie falls against the Euro, the ETF should rise in price.

But what bugs us about that idea isn't the Australian dollar. It's the Euro side of the trade. Why on earth bet on something that is the focus of economic pessimism at the moment? Usually, being a contrarian is a good idea. To paraphrase a famous investment maxim, 'buy when tear gas is in the streets'.

From a Bad Currency to a Worse One

But what if the Euro's rot runs deeper than anyone realises? And what if the solution to the Euro mess is actually going to be a complete disaster?

Most historians will tell you about the rise of Hitler in terms of inflation and the treaty of Versailles. But the story really starts with a badly thought out political union.

By combining several different cultures into one Austro-Hungarian Empire, the ruling family fostered all sorts of internal strife. That's where Hitler got his obsessive nationalistic fervour from. He hated having the Austrian Germans grouped in with the Slavs instead of their own 'race' to the north.

For the record, we're not too sure how 'German' Austria's neighbours, the Bavarians, are. They wear pants with flaps and slap each other in time to strange music to impress girls. But we plan on doing some research this weekend at Melbourne's Hofbrauhaus. They're celebrating Oktoberfest.

Meanwhile, in response to the Euro crisis, European politicians are trying to create another political union to rule over people that don't fit together. Rather than being free to trade with each other, they're forced to accept each other's rules and courts. Pretty soon the infighting will begin. Infighting is solved by strongmen like Stalin and Mao. That's what Hayek's book 'The Road to Serfdom' is about.

Back to the currency question. There are three ways the Euro could break up. One favours the Euro over the Aussie Dollar, and the second suggests it could plunge alongside the Dollar. If the weaker countries leave the Eurozone, that will send the Euro upwards, because of the remaining strong countries.

If the strong countries get sick of the Euro mess and leave, the Euro would be left with weak countries, and would fall. Under the third option, a complete abandonment of the Euro, who knows what would happen to people holding the currency? Do you get Deutschmarks or Drachma?

Until next week,

Nickolai Hubble.
The Daily Reckoning Weekend Edition