The gold price stabilized while concerns over sovereign debt have intensified, fueling a U.S. dollar rally and pressuring the price of gold, the shares of gold mining producers, and stock markets across the globe. The uncertainty over Greece’s ability to fund its growing deficit led to speculation that a bailout by the European Union was forthcoming. The Euro slid yesterday versus the U.S. dollar, dropping below the 1.40 level for the first time since July 2009 and trading 7.6% lower than its print of 1.514 against the dollar on November 25, 2009. The U.S. Dollar Index (DXY) rose above 79.0 - its highest level since August of 2009. The high correlation between the euro and the price of gold has held firm over the past eight weeks, with the euro’s decline and gold’s plunge moving together in virtual lockstep.

A mountain of debt, a $1.4 trillion budget deficit, and somewhere in the range of $60 trillion in unfunded liabilities creates an ominous fundamental backdrop for America’s currency. However, the other leading global currencies face their own set of headwinds and the euro has declined recently as questions over the ability of the European Central Bank (ECB) to dictate monetary policy to independent nations facing disparate economic challenges has come to the forefront.

Greece has drawn the most attention as of late as it has been revealed that the country must raise 53 billion euros in 2010 in order to fund a budget deficit that comprises 12.7% of GDP - the largest among any member nation of the European Union. While Greece was able to sell 8 billion euros earlier this week, it was forced to do so at a 30 basis points (0.3%) premium to market expectations, adding to concerns that interest rates would be forced continuously higher.

Greek bonds fell for the third consecutive day with the 10-year note yield rising 41 basis points to 7.16%, a 92 basis point rise over the past two days alone. The difference in yield on Greek government securities versus its counterpart German bunds rose to 3.96 percentage points - the widest spread since the creation of the euro and the highest level since the collapse of Long-Term Capital Management in October 1998.

Credit default swaps on Greece’s sovereign debt rose to their highest level on record as rising interest rates serve to compound the problem of raising the additional capital necessary to fund the government’s deficits. Widening credit spreads and questions over whether the ECB would be forced to create a rescue package for Greece weighed on the euro, heightened investor risk aversion, and led to liquidation across numerous asset classes - including equities, commodities, and the gold price.

The French newspaper Le Monde reported that a bailout package was being formulated, but both the German and French governments refuted the report. Greek Prime Minister George Papandreou stated at the World Economic Forum in Davos, Switzerland that “We need no bilateral loan…We never asked for it.” Bill Gross of PIMCO, manager of the world’s largest bond fund, exacerbated sovereign debt fears by classifying Greece as the “canary in the coal mine.”

With the popularity ratings of government officials in decline and trust of politicians plunging, several market commentators likened Mr. Papandreou’s comments to that of Alan Schwartz - CEO of Bear Stearns - prior to the investment bank’s implosion and subsequent bailout. Given the complicated intertwining of financial derivatives across the globe, the past 18 months have demonstrated that a financial entity can appear safe one day, but the next day a mass exit could ensue if confidence is lost.

Financial markets remain on edge and the global economy, while no longer teetering on the brink of collapse, remains heavily dependent on fiscal and monetary support from governments across the globe. Recent events have revealed the fact that central banks, whether the U.S. Federal Reserve or the ECB, will do anything and everything in their power to prevent a bout of deflation. Without arguing the merits of the policy response, these actions have consequences. Stimulus, higher deficits, greater debt loads, zero interest rates, and aggressive money supply growth all denigrate the value of a nation’s currency. There is no free lunch and while exchange rates amongst nations will fluctuate versus each other, the trend of all currencies depreciating versus the gold price looks set to continue indefinitely.