Tipping Point for the Euro
Nowadays European politicians seem to be following two courses of action ‘kicking the can down the road’ and trying to make sure that there is no major calamity such as a bank run that ‘happens on their watch’.
As you will see from the pamphlet ‘EU Cannot be Serious’ I produced about 10 years ago, I am not a fan of the EU and think that the euro is, and always has been, an absurd financial experiment. Now the inevitable is happening, Germany, the largest exporting economy in the Eurozone is doing relavitely well with a weaker currency than would have been the case with the Deutsche Mark and the periphery weaker economies such as Greece, Spain and Ireland are suffering badly with a currency that is far too strong for them to be competitive.
George Soros summed up the problem in an excellent lecture on 2nd June 2012. These two paragraphs will give you the flavour of his comments:
“It took some time for the financial markets to discover that government bonds which had been considered riskless are subject to speculative attack and may actually default; but when they did, risk premiums rose dramatically. This rendered commercial banks whose balance sheets were loaded with those bonds potentially insolvent. And that constituted the two main components of the problem confronting us today: a sovereign debt crisis and a banking crisis which are closely interlinked.
The Eurozone is now repeating what had often happened in the global financial system. There is a close parallel between the euro crisis and the international banking crisis that erupted in 1982. Then the international financial authorities did whatever was necessary to protect the banking system: they inflicted hardship on the periphery in order to protect the centre. Now Germany and the other creditor countries are unknowingly playing the same role. The details differ but the idea is the same: the creditors are in effect shifting the burden of adjustment on to the debtor countries and avoiding their own responsibility for the imbalances. Interestingly, the terms ‘centre’ and ‘periphery’ have crept into usage almost unnoticed. Just as in the 1980’s all the blame and burden is falling on the ‘periphery’ and the responsibility of the ‘centre’ has never been properly acknowledged. Yet in the euro crisis the responsibility of the centre is even greater than it was in 1982. The ‘centre’ is responsible for designing a flawed system, enacting flawed treaties, pursuing flawed policies and always doing too little too late. In the 1980’s Latin America suffered a lost decade; a similar fate now awaits Europe. That is the responsibility that Germany and the other creditor countries need to acknowledge. But there is no sign of this happening.”
In my view too, the fear of a bank run in one or more Eurozone countries is a tipping point that would make massive printing inevitable. The prime aim of politicians is to stay in power and to be re-elected. To achieve this, they invariably take the soft option and ‘kick the can down the road’. This quote from Ludwig Von Mises the Austrian economist, explains how politicians keep in power carrying out policies that are against the wishes of the majority of the electorate.
“A government always finds itself obliged to resort to inflationary measures when it cannot negotiate loans and dare not levy taxes, because it has reason to fear that it will forfeit approval of the policy it is following if it reveals too soon the financial and general economic consequences of that policy. Thus inflation becomes the most important psychological resource of any economic policy whose consequences have to be concealed; and so in this sense it can be called an instrument of unpopular, that is, of antidemocratic policy, since by misleading public opinion it makes possible the continued existence of a system of government that would have no hope of the consent of the people if the circumstances were clearly laid before them.”
Erick Sprott and David Baker who are well-known bulls of gold and silver, explain their views in the May edition of the Sprott Asset Management newsletter Markets at a Glance. Their concluding paragraph highlights Europe’s problems very well and the probability of a bank run leading to further printing by the ECB.
“As we’ve stated before, no matter what happens in the Eurozone, the absolute worst case scenario for the authorities is a bank run. It terrifies all involved, because they can spiral out of control faster than governments can react to stop them, save for the most Draconian measures. They also prompt banks to liquidate whatever assets they can, revealing the truth about what their ‘assets’ are actually worth. In this environment, no one wants to find out what the market will really pay for them. We’re seeing this now in Spain, where according to Bloomberg, “Many Spanish banks are avoiding property sales so they don’t have to ‘mark to market’ valuations. Instead, they’re giving developers new loans to pay debt coming due to prevent defaults.” Sound familiar? We’re now at the point where a bank run in one Eurozone country could quickly seize up the entire system – not just in Greece or Spain, but throughout the entire Eurozone and beyond. Greek and Spanish banks are just like all the others; they operate with leverage ratios averaging 25 times their equity capital. They are all so overleveraged that it takes very little in deposit withdrawals to cause instantaneous liquidity issues. This is why we’ll likely see another ECB-induced printing program announced (with a new abbreviation, hopefully) before a broader bank run can take root. The Eurozone authorities simply cannot risk the consequences of bank runs in countries like Spain, Portugal or Italy, which are far too big to bailout for the over-stretched ECB. It’s not about Greece staying or leaving the European Union anymore, it’s about the ability of the European banking system to survive the impact of massive money transfers.”
More printing is likely in the US too. Denis Gartman the respected American guru, who is publisher of ‘The Gartman Letter’, said on 4th June 2012 that he believes there is now a 100% chance of further Fed easing. He concluded a CNBC interview with this advice:
“Sadly I think we are in a bear market. This environment sets up well for gold.”
Jim Slater