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The sovereign debt crisis in Europe has caused
leaders there to adopt a new collective policy that would link members under
a strict fiscal structure which may be called the European Fiscal Union. Like
the European Monetary Union, which established the Euro as the common
currency, the EFU would establish common liability for member state fiscal
conditions. Under the terms of a new EU treaty, each member state would be
required to meet debt/GDP ratio limits and other financial stress tests in
order to access bailout funds provided by a larger European Financial
Stability Fund. Using leverage, the EFSF could grow to 1 Trillion Euro. The
IMF and the ECB are additional sources of bailout capital, although the ECB
has been hesitant to lend to failing countries without other collateral or
backing.
As of Friday, 27 nations pledged to join the new
treaty arrangement. The United Kingdom has declined to participate in the
wider fiscal union.
Initially, the developments across the pond were
good news for the markets. The Dow rallied nearly 200 points Friday, and the
Euro gained against the Dollar. Gold and silver benefitted as well Friday,
but are giving up gains as the markets slump in early trading today.
But the devil is in the details. All 17 nations that
use the Euro agreed to sign a treaty that allows a central European authority
closer oversight of their budgets. Nine other EU nations are considering it.
A new treaty could take three months to negotiate and may require referendums
in countries such as Ireland. While the nine non-euro-zone countries
said they would join the new fiscal union, there were quickly notes of
caution from some corners, including the Czech Republic and Hungary.
Meanwhile the debt bombs in Italy and Spain are
ticking. Active ECB support will be vital in the coming days with markets
doubting the strength of Europe's financial firewalls to protect vulnerable
economies such as Italy and Spain, which have to roll over hundreds
of billions of Euros in debt next year. European leaders did agree to loan
the International Monetary Fund €200 billion ($267.7 billion) to help
struggling euro-zone countries and launch a €500 billion European
Stability Mechanism by July 2012. The ECB has yet to commit more than 20
billion Euros to failing clients at any one time, and is reluctant to risk
the much larger transactions required to stabilize debt-heavy
governments. One reason is that
ECB funding may be a disincentive for countries to follow through with
austerity measures. Free money is easy to spend, and given the chance,
governments usually do.
Without access to new funding under tight fiscal
controls, Europe may slip once again into a deep recession, which would hurt
US economic growth as well. The stakes are high for Europe to get it right
quickly.
So we can expect the markets to remain highly
volatile as events unfold in Europe. Today’s market action, for example
shows gold and the Euro are under pressure. The price of gold is telling us the
grand EU fiscal cannon is too small to succeed. Investors are choosing to sell their
risk holdings in favor of cash. Some investors are turning to gold as a
source of capital, in some cases to meet margin calls. Gold has been the only
asset class that has performed with double digit gains this year while stocks
and other commodities have barely kept above water.
And it’s not just investors that are
skeptical. Standard & Poor's reiterated its warning that downgrades of
Eurozone nations are a possibility while Moody's Investors Service said the
new fiscal agreement offered "few new measures" and it still
expects to reassess its credit ratings of the European sovereigns.
Europe is not the only economy facing a debt crisis
and possibly another recession. We need only to observe our own policymakers
to see what lies ahead.
Federal Reserve Policy
The Federal Reserve meets Tuesday for its regular
two-day Federal Open Market Committee (FOMC) meeting. That means Wednesday we
will hear from Chairman Ben on the latest status and outlook of the US
economy. There has been some talk that the Fed is considering reviving the
practice of publicizing its internal projections of interest rate and
inflation forecasts in an effort to better “communicate” to the
public. The Fed dropped this practice in 2007 because it was considered
largely ineffective. And besides, it proved once again that, as Yogi
observed, “Predictions are hard, especially about the future.”
Expectations are that the Fed will continue to keep
interest rates at 0.0 -.25%, and despite some calls for additional stimulus,
no new massive bond buying will be initiated—just yet. Chicago Fed
president Charlie Evans is calling for more stimulus now. “There is
simply too much at stake for us to be excessively complacent while the
economy is in such dire shape,” Evans said in his December 5th speech
in Muncie, Indiana. “It is imperative to undertake action
now.”
Chairman Ben has come to realize that the US remains
in a liquidity trap, that helpless condition wherein injecting additional
cash into the money supply has no positive effect on GDP growth. Even Paul Krugman knows that interest rates simply cannot get lower
than zero.
Notwithstanding, QE3 would go a long way to boost
Wall Street. And we have heard some preparatory statements from some Fed
governors on the merits of additional quantitative easing, as long as
inflation remains “in check”.
Would that the Chairman realize that economic
prosperity does not stem from monetary intervention.
We know now that Federal Reserve policy has failed.
Massive intervention has resulted in higher prices, growing inflation and
persistent unemployment near Great Depression levels. The Dollar buys less
and less. Real wages are declining. Government data show over the past
decade, real private-sector wage growth has bottomed at 4%, just below the 5%
increase from 1929 to 1939.
Economic recovery requires real wage growth. More
disposable income helps create demand for goods and services. Increased
demand causes businesses to expand, which means more production and usually
more employment.
But that simple calculus is lost on the central
planners. Instead, Washington believes that government spending creates
demand. But government spends the tax dollars it first takes out of the
economy in order to distribute funds to “better uses”. Robbing
Peter to pay Paul.
What we need is fundamental change. This will only
come when the majority of citizens realize that Keynesian economics is not
the path to prosperity and that the principles of free markets, private
property and sound money should and by right, ought to be embraced.
Until then, one must rely on individual choice to
guard against oppressive monetary policy. Sound money is the answer.
Investors
from around the world benefit from timely market analysis on gold and silver
and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the
principles of free markets, private property, sound money and Austrian School
economics.
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