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Eurobomb Ticking Down, II

-- Posted Tuesday, 5 June 2012 | | Disqus

By Scott Silva

Editor, The Gold Speculator


Last January, we warned readers of these pages of the “Eurobomb Ticking Down”, which forecast financial chaos across the Eurozone would come as the result of continued deficit spending, massive accumulated sovereign debt and growth of entitlement program spending to unsustainable levels.


Today, the G7 is holding emergency meetings to deal with the imminent collapse of Spanish sovereign debt in the bond markets, even as Germany considers funding a bailout package for Spain, or possibly changing its position in favor of the Eurobond solution to the regional banking crisis. As Papa Hemingway emmingwayHewonce observed, bankruptcy happens two ways, “Gradually, then suddenly.”  Today, Treasury minister Cristobal Montoro said that at current borrowing costs financial markets were shut to Spain. If the bond market were suddenly no longer available to Spain as it struggles to refinance its debt, without restructuring, Spain’s financial system would collapse, pushing its battered economy further into recession, then likely, depression. Already, one in four is out of work in Spain. Yet the government is unwilling to accept terms of any EU rescue plan.


Greece is fairing no better.  Standard & Poor's announced today there is 1/3 chance that Greece will exit the Eurozone in the coming months, following the elections on June 17th. The credit agency further stated a Greek exit would “seriously damage Greece's economy and fiscal position in the medium term and most likely lead to another Greek sovereign default.” Another Greek default would impact other Eurozone economies which would also face credit rating write- downs-- a vicious downward spiral.


The emergency conference call of G7 members today is not likely to result in immediate action. The G20 is scheduled to meet June 18-19, immediately following elections in Greece. A major topic will be the path to financial stability for the Eurozone. All G20 members, including the US and China have a stake in the summit outcome.


But the bond market is not shutting Spain out.  At least not yet. Yields for Spanish 10-year notes are coming down in today’s trading. Apparently, the bond vigilantes did not get the Montoro memo. Although rates for Spanish 10-year note have risen steadily and approached the 7% danger zone leading up to the G7 meeting, yields declined 1.3 basis points to 6.4% in today’s trading. The market is discounting a coordinated effort by the ECB, EU and the IMF to stabilize the Eurozone and keep it intact. Last week, the EU offered to extend the deadline a year to 2014 for Spain to bring its deficit down to the EU limit of 3% of GDP. The Commission has also suggested that the ESM could provide direct funding to Spain, although that measure would require a change to the existing treaty and ratification by all 27 members. Even if these life-line measures were adopted, they may prove only to delay inevitable default.


Some near term relief may come from the ECB. Many analysts expect the ECB to cut its refi rate below its current 1% level within the next few weeks. A near-zero interest rate policy would ease pressure on those countries most in need of cheap refinancing. The ECB could also opt for another injection of liquidity into the entire region via long-term refinancing operations (LTROs), or some old fashioned bond-buying.  But these steps would also firmly establish a liquidity trap in which no amount of added liquidity to the banking system provides marginal output.  This is the problem with the Keynesian obsession with too much money. It is simply impossible to print your way to prosperity with more and more fiat currency. But that is precisely what progressive central bankers tend to do when facing an economic downturn.  Apparently, the urge to ease is powerful and overwhelming.


But intervention fails. It has always failed. And it will always fail. Fed intervention failed to reverse the economic slide in the 1930’s. In fact, according to Friedman and Schwartz, Federal Reserve actions deepened and extended the Great Recession. Today, near-zero interest rate and quantitative easing by the US central bank has failed to reverse the economic slide of the Great Recession. And the ECB has failed to ignite any economic recovery in the Eurozone. For example, the leading European economies, Germany, France, Italy and Spain account for 77 per cent of total Eurozone GDP, but in the past four quarters, Germany posted average quarter-over-quarter growth of 0.3 per cent, yielding an annualized rate of expansion of just1.2%, while most of Europe remains in recession.  France posted average quarterly growth of just 0.1 per cent in the year up to April, an annualized rate of expansion of just 0.4 per cent. France recorded zero quarterly growth in 1Q2012. Spain and Italy have been a drain. Spain is officially in recession with an average quarter-on-quarter decline of 0.1 per cent since the second quarter of 2011.  Italy is in its third consecutive quarter of negative growth, with an average quarterly rate of minus 0.35 per cent over the year to April 1.  Utterly underwhelming.


So what does the continuing saga of the Eurozone debt crisis mean for investors? Well, for one thing, the markets will remain volatile for some time yet. There will be more gnashing of teeth as European welfare state economies contend the realities of long term unsustainable deficit spending and oppressive tax regimes. The options for countries with 150% debt/GDP become fewer and worse. The central planners will resort to ever more debasement of the currency at the expense of individual purchasing power and increased demand. Weaker demand in Europe for American exports will dampen the sluggish (and jobless) US recovery. Funds will flow out of the Euro and out of stocks and into “safer” assets and currencies such as the Dollar, the Swissy and gold.


We can see that the concerns over the Euro crisis and also concerns over an uptick in the latest US unemployment rate have caused the ‘Fear Index” for stocks to jump. The “Fear Index” is the CBOE Market Volatility index, which trades by the symbol VIX. The VIX is quoted in percentage points and translates to the expected movement in the S&P 500 index over the upcoming 30-day period, which is then annualized.  The VIX has an inverse relationship to stock prices. That is, when the VIX trades up, stocks tend to decline. The higher the VIX climbs, the lower go stocks. The VIX is indicating we are in for some more volatile times in stocks.



We can also see that gold has outperformed the S&P 500, and is less volatile than the broad stock index. Recent volatility has erased earlier gains of the S&P 500. The VIX is portending rougher weather ahead for stocks. At the same time, gold has regained some luster. Gold will climb higher if the ECB decides to resume its bond-buying program.



So where will the smart money go as the European debt crisis plays out?  The smart money will buy gold. Gold is a store of value. Gold benefits from government intervention in the credit markets.  Gold increases in value as new fiat money is printed.  Gold appreciates in times of economic uncertainty.  At today’s prices, gold is a bargain.


Responsible citizens and prudent investors protect themselves and their wealth against the ambitions of over-reaching government authority and debasement of the currency by owning gold. Gold is honest money. 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.


The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and economic uncertainty?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio has outperformed the DJIA and the S&P 500 by more than 3:1 over the last several years. Follow @TheGoldSpec   Subscribe at our web site  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055

-- Posted Tuesday, 5 June 2012 | Digg This Article | Source:

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