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We agree with
Professor Rogoff that Greece should have defaulted
some time ago. Despite all the current efforts, Greece will default and that
contagion will result in a global, banking crisis. Even if we’re wrong,
the mountains of money that will be created and poured into the debt hole
will benefit the gold and silver prices. The Greek debt crisis is about
stemming the spread of bank runs, the breakdown of the other PIIGS countries
debt situation, and potentially the fragmentation of the Eurozone.
We’re on the brink.
In the last
week, we have seen global market confidence buckle in the face of slowing
growth and what may already be a recession. This is not the time that poorer
nations can use falling cash flow to repay mountains of debt. Talk of a 50%
haircut on Greek debt should be lifted to as high as 60% to 70% for the
Greeks to be able to manage its remaining debt in light of future, Greek cash
flows.
To get a
handle on the Eurozone debt crisis we have to imagine that each nation is an
individual. If an individual is bankrupt an offer of compromise is made that usually is 50% for the debt to
be written off. It’s not a ‘haircut’ of 50% of the debt
with the remaining balance to still be repaid. But such a haircut is a
‘managed default’. The banks that have to take a haircut see
their balance sheets drop by this amount, often making the ratios by which it
has to maintain too. This reduces the amount it can lend and often puts it in
a dubious financial position, bringing its own creditors down upon it. With
the global banking system so interwoven, the spread of such fears reaches far
and wide. We saw this last week in the downgrade of Societe
Generale and Credit Agricole,
two of France’s largest banks, because of their exposure to Greek debt.
If the Eurozone crisis finds other nations following Greece, then expect much
more of this type of downgrade.
What’s happening to Confidence in Currencies?
At this stage
it doesn’t matter which way the crises go. Confidence has fallen
worldwide in government debt situations and the banking industry, with fears
of more to come. The very fact that the developed world is in the financial
state it is, has caused the fall in confidence. If the Greek situation leads
to a convincing bailout, the weaknesses in the Eurozone will still remain.
Confidence in the euro has fallen and won’t return to the previous
year’s levels. With money fleeing the Eurozone, it only found the
dollar as an alternative. The Swiss Franc and the Yen have ceased to be
safe-havens because their central banks have intervened to weaken those
currencies. This left the ‘tree trunk’ of the currency system,
the U.S. dollar, as the only really liquid place to go. This was not because
of any value that could be retrieved, but because it’s the only
remaining currency that remains standing under pressure. Right now the euro
is gaining against it, as the world hopes that Greece will get a sufficient
bailout. But tomorrow it could weaken again. As to the dollar, its debt
crisis is more severe, but not as immediate.
Now stand
back a pace and ask…
“Can we
have confidence in the value of the Dollar, the Euro, the Yen, the Swiss
Franc or the British Pound?”
We all
appreciate that their values have fallen, but we have to use them as the only
available way of paying for things. Do we believe that the governments of
these countries are capable of restoring any inherent value in these
currencies? Are their structures and that of national balance sheets solid
enough to want us to hold our wealth in them? If your answer was not as
positive as it was four years ago, you have a measure of how their values
have suffered. Looking forward, do you believe that your confidence in these
stores of wealth will grow to the extent you want to hold them, or will you
do so with a careful eye on them, preferring an alternative, but not being so
certain where to go?
What has
floated to the top of national priorities for currencies is a global need to
have international prices –for the exports of goods from those
nations—retain their global competitiveness. This means a persistent
weakening with the rest of the world’s currencies following the weakest.
In itself this guarantees dropping values for all global currencies.
There’s nothing to be gained through a strong currency over time. This
structural shape of currencies is not likely to change. In fact, it’s
likely to produce more and more financial discord in foreign exchanges. Price
competition through exchange rates has to destroy value slowly, but surely.
Debt and Bank Crises
We may be
tempted to see the debt crises as a short-term problem, but as the
world’s leaders agree, they’re scaring the world and threatening
global financial stability. So this isn’t a case of the passing flu; it
describes a congenital weakness that needs a structural solution. Nowhere can
we see evidence of structural reforms likely to shore up confidence and
repair the global financial system. The system is flawed and most expect such
crises to persist for the foreseeable future.
So why not
just write off the entire world’s toxic debt, print the equivalent
amount of money to fill the holes and start all over again? After all if you
look back at the Fed’s QE exercise, doesn’t that amount to the
same thing? Well, almost. Now add to that a good dose of inflation, and debt
diminishes in value and asset values rise. Well, that would destroy all
confidence in the Capitalist system and money itself, wouldn’t it? No,
the world is locked into resolving these problems and ensuring the continued
working of the global economy in such a way as to retain confidence.
We’ve not seen such a dire financial scene since the Second World War,
(according to the outgoing head of the European Central Bank) and close to
the scene seen in the early 1930s. Then the answer was to massively expand
the global money supply, through the devaluation of the U.S. dollar against
gold by 75%.
We have no
doubt in our minds that the global, financial authorities want a similar
expansion of money for the purpose of diminishing the impact of the current
crises. But they have to do it in such a way as to convince people everywhere
that the system remains viable and healthy, despite such a debauching of
money. They cannot do it without convincing people that money has become
cheaper and less reliable. This favors precious metals.
Effect on Gold, Silver Prices
Investors
were shocked when gold dropped from $1,850 to below $1,600 in an almost
straight line. When they saw silver drop from $40 to $28 they were even more
shocked. After all, since 2005 gold has come from $300+ and silver from $6+,
so a $250 drop and a $12 drop seemed to be huge. Since then we have seen the
silver price recover $4 in one day and the gold price $60 in a day, with more
recovery to come. In percentage terms, when compared to other markets, we see
similar falls there and in similar percentages, but not the same vigor in
recovery. The big picture confirms that falls, in most markets, were
investors raising liquidity to lower leverage and protect against the falls,
just as we saw in 2008. This is something market observers cannot see ahead
of time. They accompany major shifts in investor perceptions about the
structure of global financial markets.
Just
as we saw in 2009 and onwards, the loss of confidence in global financial
markets doesn’t recover. In the gold market, since the pullback from
$1,200 to $1,000, we’ve seen gold rise to $1,910 and silver to mid-$40
area, a tremendous gain since then. What’s there to prevent a similar
shape to the precious metal markets going forward?
Take
a look at the function of gold and silver. Gold, in particular, is an
international asset and international cash. It can be used when all else
fails. We saw that in the recent falls. Investors could liquidate holdings
quickly and take good profits to cover losses, loans, and margin calls in
other markets. Once there’s a moderate stabilizing of markets, that
lesson is remembered. Investment house strategists factor that into their
policy decisions, realizing that in bad times, future profits lie in precious
metals.
In
the emerging world, the fall in precious metal prices is seen as speculators
getting out of the market and giving them an opportunity to buy at prices
they feel will allow for certain rises. Their faith in gold and silver
remains completely unshaken by the falls, which they see as part of the
ongoing suspicions about the developed world banking system and markets
speculation. To them the value of gold and silver remains untouched and
certain. Falls are seen as an opportunity to buy cheaply into the precious
metals.
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