Who Owes You Nothing?
Seventeen countries have no way out.
The European Monetary Union began on January 1, 1999. Others joined a few years later. Estonia just joined in 2010.
Until 2008, the arrangement generally worked. For much of the decade, the euro's value held steady relative to the U.S. dollar. In 1999, one euro cost $1.18. In the fall of 2008, one euro traded for $1.60. The euro gained an average of 4% per year during the period. But when the credit crisis hit and the global economy entered recession, the situation turned nasty...
So from July to November 2008 the euro plummeted as the crisis struck. From its peak of $1.60, the euro lost nearly 25% of its value against the dollar in three months, bottoming at $1.23. Panicked investors fled the euro for the traditional safety of the U.S. dollar.
As our old friend and mentor Doug Casey is fond of saying, the U.S. dollar may be a worthless piece of paper – nothing more than the obligation of a bankrupt government. A "we owe you nothing" note. But the euro is worse. It's a worthless piece of paper from a toothless bureaucracy in Belgium. It's a "who owes you nothing?"
When a crisis hits, nobody wants to hold a "who owes you nothing?" asset. We recommend holding gold in these situations. Gold is a "nobody owes you anything" asset. It's the only widely accepted financial asset that is no one else's liability. But most global banks continue to trade dollars, not gold, because that's what other banks deal in...
In March 2009, Fed Chairman Ben Bernanke rewarded the world's investors for their dollar preference with the perfidy of a printing press. Bernanke began to print dollars, and the world began to flee the dollar. Within six months, the euro was trading at $1.50.
There was a widespread belief the ECB wouldn't engage in the Fed's kind of blatantly inflationary policies. France and Germany both suffered hyperinflationary periods in the 1900s. Their populations fear inflation more than a slowing economy.
But the ECB had no choice but to follow Bernanke's lead...
The first big problem was Greece.
On December 9, 2009, credit-rating agency Fitch Ratings downgraded Greek debt. After its review, the agency determined Greece could not hit its target budget deficit of 9.1% of GDP for 2010. (Down from 12.7% in 2009, this target was still three times what European Union rules allowed.)
This downgrade led to the discovery of even worse conditions. Over the next few months, the country's deficit numbers were exposed as bunk. In April, Greece's 2009 deficit was estimated to be closer to 14% of GDP. Revised 2010 estimates were closer to 14% as well, a far cry from the 9% the Greek government had forecast for 2010 just months earlier.
The Greek government had been playing financial games for years...
Investigators discovered in the beginning of 2010 that Greece had paid hundreds of millions of dollars in fees to experts at Goldman Sachs to help it hide much of its borrowing. The country also took advantage of the cheap interest rates received from being part of the euro since 2002. By the end of 2009, Greece had racked up an estimated 300 billion euros in debt, more than 125% of GDP. For perspective, the monstrous U.S. debt load is a bit more than 90% of GDP.
With this in the open, Greece's creditors – mostly governments, including the ECB and the large European commercial banks – began to find themselves in investors' and regulators' crosshairs. With such a debt load and deficits, wise investors wondered if Greece could ever repay its debts. If the loans soured, these banks' solvency would become suspect. The entire Eurozone structure would be questioned. What seemed like a sound path for the euro countries in the 1990s was proving to be a sinister trap.
Why is this a trap? Why is there no way out? None of the euro countries is the master of its own currency. Despite managing very different economies, all 17 countries are inextricably linked by the euro.
By the end of April 2010, the Greek government had to come clean. At the end of May, 11.4 billion euros in debt were coming due. For the entire year, Greece had 54 billion euros in debt to repay. It also had a budget deficit to cover. On April 23, the Greek government and the ECB agreed on a 110 billion-euro bailout. Was Greece saved? So it said...
The International Monetary Fund and European Union member countries agreed on another 750 billion-euro bailout fund. This would be available to control any problems that might arise in Ireland, Portugal, Spain, or Italy. Of course, as we pointed out at the time, about half of this bailout money was supposed to come from the same peripheral countries whose Treasurys can't pay their own domestic debts. The fund itself seemed implausible to us.
On November 28, 2010, Ireland received an 85 billion-euro bailout after months of denying it needed one. The problems stemmed from a real estate bust, much like the one in the U.S. The Irish banks' assets evaporated, and without additional capital, they were going broke. Depositors, fearing the worst, had been withdrawing money by the billions.
Of course, the Irish government was guilty of profligate spending, too. Its national debt exceeded 90% of GDP, and its budget deficit in 2009 totaled more than 14% of GDP. To receive the bailout, the Irish government agreed to a four-year plan to raise taxes and slash $20 billion from its spending, including a cut in welfare payments. Now, the Irish budget deficit is forecast to be 10% in 2011 and 8.6% in 2012. It doesn't appear $5 billion per year is nearly enough.
Up next... the Portuguese. They too had been denying their debt and deficit troubles. Like Greece and Ireland, the government overborrowed and overspent as its economy grew in the years leading up to the 2008 recession. In 2008, the country's external debt (money borrowed in foreign currency) ballooned from $272 billion to $460 billion, nearly a 70% increase. Its overall debt was more than 70% of GDP by the end of 2009. The budget deficit was 9.3% of GDP in 2009 and 9.1% in 2010. The situation was unsustainable.
Finally, on May 4, Portugal was bailed out. In exchange for a cash infusion of 78 billion euros over the next three years, Portugal has to decrease its budget deficit to 5.9% of GDP in 2011, 4.5% in 2012, and 3% in 2013.
Two days later, Greece suddenly re-entered the fray. News leaked that Greece was discussing leaving the euro. It roiled the markets, and the euro plummeted from $1.48 to less than $1.44 over the weekend.
Greek bonds now trade with yields greater than 20%, implying an imminent threat of default.
Europe has two possible courses of action... either will destroy the euro... while making us a nice profit.
Either Way, the Euro Will Crater
The first course of action is for the ECB to buckle and give Greece another bailout. (Greece is looking for 30 billion euros.)
If that happens, we will see the euro slide again. The reason is simple. A bailout means money-printing. That devalues a currency. It also reminds investors the strength of the currency they are holding is only as good as the strength of the economy behind it.
The ECB isn't doing so well. Greece is back for round two. Ireland and Portugal are suffering. This time, the euro may slide even further than $1.20. If Spain goes, look out below. As we've explained before, the euro bailout fund is nothing by empty promises from bankrupt countries. The only way to bail out Europe is to pull a "Bernanke" – print, baby, print.
Regardless of how the situation is handled, it won't solve Greece's problems. Greece has a solvency problem... not a liquidity problem it can fix with a few extra euros. The country is essentially bankrupt. You know about its debt and deficit quandary, but...
What's really hitting it in the mouth is its "business" keeps losing sales. The economy, heavily dependent on tourism and overseas shipping, is shrinking. Tourists are no longer going to Greece. The reports of how depressed most of the people are don't play well. The people who aren't depressed are angry and given to striking and rioting. Greece is not a place anyone wants to visit. The Greece-based shippers are losing business to competitors elsewhere, many of them based in Asia where growth is heating up.
Greece's economy shrank 2% in 2009 and 4% in 2010. In 2011, it is forecast to shrivel another 3%. Greece is on its way out of business. Who wants to lend money to a country going bankrupt? The Germans are tired of it. The Finns are raising hell, too. Without their votes, Greece isn't getting any ECB money... All 17 euro countries have to agree to a bailout.
This brings us to the second course of action: Greece leaves the euro. This is really the only ultimate course of action. It gives Greece one huge new advantage: It allows it to have its own currency that can be valued by the markets according to its specific economic conditions and managed by its own central bank.
Otherwise, Greece is left in a trap – along with the other 16 euro members – where currency adjustments are painful and made by political consensus among those whose interests and situations are completely alien. Greece is an economic disaster, Germany a juggernaut.