The European Economic Crisis
by Monty Guild & Tony Danaher
Guild Investment Management, Inc.
May 14, 2010
Earlier this week, the markets cheered the announcement out of Europe of a bailout package by the European Union nations and the International Monetary Fund, and a decision by the European Central Bank to begin buying sovereign debt of weaker states. This bailout plan protects the sovereign bond markets for the short term, but does not solve any of the longer term problems in European bond, stock, and currency markets. In fact, they allow the problems to grow and fester without being addressed.
As we have repeatedly stated, the answer to the European problem is simple. Do not allow any social programs, especially entitlement programs to begin or continue unless there is money in hand to pay for them. The ability to borrow is NOT money in hand.
The specifics of the three-year aid package consist of €60 billion of emergency lending available quickly from the European Commission, €440 billion pledged by the finance ministers of sixteen Euro nations, plus a commitment from the IMF of at least half the European contribution (€250 billion).
A European government struggling to refinance its debts could first tap into the €60 billion Euro emergency fund. If that proved insufficient, it could borrow from the €440 billion fund guaranteed by other euro-zone governments. The IMF’s pledge of €250 billion is viewed by many as a last resort. In addition, the ECB began buying debt of weaker euro-zone countries in bond markets on Monday.
Even the U.S. got involved. The Federal Reserve reactivated a program that allows foreign central banks to swap their currencies for U.S. dollars, thus giving European nations access to more liquidity. Also, as the largest shareholder of the International Monetary Fund, the United States can also participate indirectly in loans the IMF makes to Greece and any other European country.
The nearly $1 trillion EU and IMF safety net announced has another name. It’s called quantitative easing…whatever the cost. In our opinion, the costs will be huge. The policymakers’ message is, to borrow from Marie Antoinette, “Let the future generations eat cake.”
OIL AND GOLD
Why is oil falling while gold is rising during the European sovereign crisis? Gold is rising because the quantitative easing is long term highly inflationary and destructive to the standard of living of every citizen of the developed world, especially Europe.
Oil is falling as investors fear the austerity measures that are required in Europe will shrink economic demand. No one disputes that oil is volatile, but it will in the long term rise very high from the current levels. We have a view that there is plenty of reason to use any short term decline to your long term advantage. Buying oil on dips below $70 per barrel seems wise in our opinion.
Demand for oil will not slacken in Asia. Demand will continue to grow rapidly. New autos, new electrical facilities, new heating, transportation, new construction and new manufacturing all require energy in China, Brazil, India, and many other locales.
This European episode only hastens the handover of economic power and influence to the Chinese, Indians, and others in the developing world.
IN OUR OPINION, THE RECENT EVENTS IN EUROPE ARE:
I. Bullish for gold short, medium, and long term.
II. Bullish for precious metals including silver, palladium and platinum short, medium, and long term.
III. Bullish for oil in the intermediate and long term. Investors should use the short term price declines to buy.
IV. Bullish for the currencies and stocks of countries which have strong and conservative fiscal policies over the intermediate and long term.
Why is the above bullish short term for everything except oil, currencies and stocks of conservatively managed growing countries? THE MARKETS TODAY ARE DOMINATED BY COMPUTER MODELS, WHICH LACK THE CAPACITY TO THINK. THEY ARE PROGRAMMED TO REACT BASED UPON PAST PATTERNS AND EVENTS, THEY ARE NOT PROGRAMMED TO ANTICIPATE FUTURE ECONOMIC EVENTS.
Over the short term, many quantitative / technical / derivative traders who lack a long-term analytical framework will sell oil, foreign markets, and currencies; while buying U.S. dollars or U.S. treasuries. They believe that the U.S. dollar is a safe haven and that economic growth in much of the developing world will stop when Europe has a problem.
This developed country centric model is incorrect today, as it was in 2007 through 2009 when China and India grew very rapidly while the U.S. and Europe declined. This developed country centric model is the underlying thesis for most derivative driven trading models. We predict that once again this quantitative/technical/derivative model will prove incorrect.
IN OUR OPINION, HOLDING GOLD IS VERY WISE
There will be no economic meltdown. Quantitative easing, which is being implemented in Europe, supplemented by the QE which is already taking place in the U.S. and many other parts of the developed world has highly predictable consequences.
When banking systems begin to perform their normal functions, the supply of money in circulation and velocity of money rise and the risks of deflation diminish. In the world outside of Europe, a resurgence of inflation is much more likely than an economic meltdown. As we write this memo, inflation is appearing in fast growing Asian countries. India currently has inflation in the high single digits. Brazil is fighting inflationary trends, and China has seen resurgence to nearly 4 percent in recent months.
The public is catching on to the old and oft-repeated notion that you have to pay for what you get…and that borrowing from future generations to spend lavishly in the current period is irresponsible, unwise, and even inane.
To confirm this point, I am including a link to a thoughtful and lengthy article from the May 12th NY Times. The article is entitled “Greece, Debt and a Lesson” by David Leonhardt.
New York Times Article
The New York Times has been seen by many to be a bastion of liberal economic thinking. This is one reason that we find the article interesting. It mentions repeatedly that the U.S. must come to grips with its deficits, and it further mentions that even liberal thinkers are aware of the need to cut spending. The writer favors higher taxes most voters prefer decreased government spending.
Mr. Leonhardt points out that Robert Greenstein, who is a leading liberal budget expert is recognizing this necessity. Here is a quote from the article. “Mr. Greenstein’s politics make him sympathetic to the worry that all the deficit talk will become and excuse to pull back on stimulus spending while unemployment remains high or to gut social programs. But he also knows the numbers well enough to understand that our Greece moment, whether it takes the form of a crisis or not, is coming.”
Clearly, the message is getting through to the public. More austerity and much more rationality in spending will be coming to a country near you. However, it may be some time before the needed rationality reaches even the august halls of the U.S. Congress. Senator Gregg of New Hampshire stated yesterday on TV that Congress did not yet understand the severity of the problem. Once they do awaken to the problem, further months or years will be wasted while they dither and debate before they take action to cut deficits.
In the interim, may we make a suggestion to you? HOLD ON TO YOUR GOLD, and buy more on any dips. The other parts of Europe and the U.S. will all have their ‘Greece Moment’ in the coming months and years. When they occur, you will be very grateful for the gold holdings that you possess.
© 2010 Monty Guild & Tony Danaher