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Last week,
the G-20 meetings did not produce an expanded bailout fund for the eurozone. While this may bode well for the long-term
solvency of the member-states (moral hazard and all), it has also triggered a
market reaction that I expect to help destabilize the common currency.
Yesterday's market moves suggested that this development is good for the
dollar and bad for gold. Allow me to step back from the stampeding herd to
evaluate whether they are, in fact, moving in the right direction.
The argument
for the dollar and against gold is simplistic, and I will evaluate it against
the four-stage collapse I see ahead for the Western currencies.
Arguing that
gold is a hedge only against inflation, and taking current inflation figures
at face value, mainstream analysts have concluded that gold is grossly
overvalued - that it may, in fact, be the latest asset bubble to arise.
However, these analysts fail to account for why gold is a hedge against
inflation: it is ultimately an insurance policy against runaway currency
collapse. In other words, it's intended as a longer-term, wealth-preserving
purchase. Yes, some pit traders may be trying to make a quick buck shorting
gold and going long on dollars, but for individual investors, following suit
would leave them vulnerable to what may prove to be ahead. That is, a phased
destabilization of the euro, leading to a possible collapse of the US dollar.
In such circumstances, even today's volatile prices for gold and silver would
look attractive.
Phase One of
the threatened catastrophe is sovereign debt crisis, which is effectively
camouflaging a currency crisis. The Greek default is significant as the first
crack in the dam. But Greece is a relatively small problem. The bigger threat
is Italy, with its $2.4 trillion of debt and a 10-year bond yield having just
surpassed the critical 7 percent level. This is the ruinous milestone at
which the cost of new debt money surpasses the economic growth rate plus
inflation. Italy faces massive debt refunding, falling buyer interest, and no
hope of a bailout. If Italy were to default, it could threaten rapid
contagion to Portugal, Ireland, Spain, and other larger eurozone
countries, including perhaps France. In such an event, most international
banks and institutional investors, including those in the US, could suffer
severe, possibly total, losses on their holding of certain sovereign bonds. MFGlobal is but one speculative example of a looming
secular trend. Worse still, the writers of credit default swap (CDS)
derivatives, including many German Landesbanks
(state-level banks) and major US banks, could suffer crippling losses.
This would
lead to Phase Two of the collapse: a renewed and far larger banking crisis.
This, in turn, could bring stock markets tumbling and threaten major
institutional investors, including politically sensitive pension and
insurance companies. In addition, banks would become extremely wary of
lending to each other. Likely, the interbank market would freeze, but far
more severely than in 2008. It could result in curtailed lending and even the
recall of short-term corporate funding and call-loans. This could cause a
dramatic spike in US bank failures. Unwary depositors who have failed to
watch their banks closely could find their insured funds frozen, perhaps for
months, as the FDIC reorganizes the problem banks - and perhaps even waits
for its own bailout. This would add further downward pressure to economic growth.
Meanwhile,
the cascading banking crisis would likely push Europe into a severe
recession, even a depression. As the EU accounts for some 22 percent of world
trade, a European depression would no doubt drag down the US even further. In
response, the price of precious metals may face severe selling pressure as
liquidity becomes paramount.
This would
present an opportunity for long-term gold and silver investors.
Phase Three
would be a restructuring or dissolution of the euro and possibly a stampede
into the US dollar, sending its price and US Treasuries temporarily upwards.
With a far stronger dollar, the price of most commodities, including precious
metals, may fall temporarily in dollar terms. We are seeing a preview of this
dynamic with today's news on Italy.
However, to
reallocate one's portfolio in reaction to such a move could put an investor
in jeopardy. That is because Phase Four, the most alarming, would be
investors' realization that the US dollar lies at the root of the
international currency collapse and is itself vulnerable. Likely, this panic
flight from the dollar would develop suddenly, and
perhaps in undreamed of volumes. Doubtless, the speed and size of a stampede
out of paper currencies and into precious metals will take many investors by
surprise - just as the Credit Crunch in 2008 did. As the realization of
currency catastrophe spreads, the price of silver may start to rise faster
than even gold.
There's an
old saying that "the higher you fly, the harder you fall." The US
government is, by any measure, the luckiest government in centuries. It has
risen to unforeseen heights of monetary excess - and has been rewarded for
doing so. But it looks like lower flying planes are starting to stall out,
and one can only imagine - from this height - how fast and how far the US may
fall.
My humble
advice is not to try to time it, but rather to use your golden parachute
before it's too late.
John
Browne
Euro Pacific Capital, Inc.
John Browne is a former member of the UK Parliament
and a current senior market strategist for Euro Pacific Capital. Click here to learn more about Euro
Pacific's gold & silver investment options. For a great primer on
economics, be sure to pick up a copy of Peter Schiff's hit economic parable, How an Economy Grows and Why It Crashes
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