Published DateBy the time you read this article, Greece will have voted in an election that many have dubbed a referendum on whether to stay in the European Monetary Union (EMU). Truth be told, it doesn't really matter who wins the election: Greece will leave the EMU, it's only a matter of when.
Austerity, code word for taking your medicine, doesn't sit well with anybody. The Greeks especially don't like it. As an ancient and learned society, they long ago realized that a day at the beach is worth more than a year at work. And who can disagree? Would you suffer through terrible economic privations so the Germans can continue to sell cheap stuff to everybody or return to the Drachma? A return to the Drachma, though disruptive, would make Greeks the masters of their own destiny. It's inevitable, and the sooner the better.
Spain, Portugal, Italy are likely not far behind. When they exit the EMU, what exactly is the end game? I haven't heard any political leader expose a set of goals, a plan of action or a desired outcome. Recently, the water pump on my truck failed. My goal was to get it fixed. My plan of action was to take it over to my friends at Valladares Transportation and Repair. The desired outcome was to have it function again. I'm happy to report that everything went as planned. What of our global debt crisis?
The reason there's no end game is that the folks running the global economy don't understand that the system itself is broken. The concensus is that the system is just fine; it's simply suffering from a bad case of the flu. They've not yet accepted the system is fundamentally flawed, despite the fact that every week brings new evidence that a global economy built on debt doesn't work. It was fun while it lasted, but it's time to move on. Move on to what is the question the world's bankers can't or don't want to answer. I, however, am more than happy to tell you.
Last week, an idea was floated to create a Supra-National European Debt Bank that would hold each of the EMU member countries' debt that exceeds 60 percent of their GDP. The thinking behind the debt bank is that, by combining everyone's debt, the rate charged by lenders would be less than what the weaker countries have to pay, though higher than Germany's ultra-low rate. Each country would be required to put up collateral equal to 20 percent of the debt transferred to the new debt bank. The only acceptable collateral would be...gold!
Here we have the architects of a plan to rescue the EMU acknowledging that when all else fails; only gold is real money. Deep in our hearts, we all know that anything that can be created by FIAT in unlimited quantities cannot really have any value. FIAT money only has value to the extent that the parties to a transaction have confidence in the issuers of the currency. What if you don't trust your counter party? You ask for payment in an asset that cannot be created on a whim. Historically, that asset has been gold. To understand the end game one only needs to follow where the money flows and where the gold is going.
As money is cascading out of Euros and into dollars, gold is flowing to central banks, especially those with current account surpluses, as well as into the hands of individuals worldwide. The Indian government has restricted gold ownership by their citizens, who have been buying gold to the detriment of consumer spending. In fact, many governments restrict gold ownership by their citizens because it can undermine the FIAT economy. Central banks, however, have no such restrictions.
In the U.S., we keep printing money. The amount of new money created in the last few years is unprecedented. Even the emperors of Rome didn't dare strike the hammer at the rate of our Treasury. So far, we've been lucky that the rest of the developed world is more messed up then we are. Fear of collapse in Europe has pushed money into the dollar, allowing the magical reality of low interest rates and money printing to co-exist. What happens when Europe is finished unwinding?
Whether or not the Euro survives, attention will turn to our balance sheet. Not a pretty sight. We borrow a third of our living expenses every month. Our debt is 100 percent of GDP. Our government is dysfunctional and we have $60 trillion in unfunded liabilities. The reality is that we only look good because Europe looks so bad. When the attention shifts, we've got problems.
Unless the Euro survives, global investors will be looking for a new reserve currency. China is preparing the Yuan to be that currency. While we argue over what heathcare plan sucks the least or which of the obscenely overfunded federal programs should be cut, China is accumulating gold, lots of it. Their goal, we suspect, is to accumulate an amount of gold equal to about 70 percent of their currency in circulation, putting them in rare company. Only the Swiss have as much gold.
So here's the end game.
The current monetary system will collapse. Gold will become a temporary bridge to some other reserve currency, likely the Yuan. The process will be very slow, taking decades to unfold. During the transitional period expect instability and uncertainly to be the norm, punctuated by periods of social unrest and occasional prosperity. Ultimately, the conclusion of the transition will seem as natural and inevitable as paying $200,000 for a useless education.
The process could unfold more quickly, though I put the chance of that at less than 5 percent. Should that happen, be well armed and well stocked. Good thing we live in New Hampshire.
In the meantime, convert your paper assets to hard assets. That doesn't mean sell everything and buy gold. But if you don't own gold, get some. If you don't own your own business, consider it. If all your money is in stocks and bonds, start diversifying into land, timber, oil and gas. Sure, you can own stocks and bonds, but just recognize that they are moving targets. What has worked for the last forty years of worldwide debt binging isn't going to work for the next 40. Don't kid yourself and don't listen to people telling you more of the same is going to solve your problems. As we now know, we haven't made money on paper assets or those inflated by paper (think your house) for 20 years. Why should it start working now?
Do you have an investment or economic question that might be of interest to you? Please feel free to e-mail us for a future column of Investments for the Rest of Us, published every other Wednesday in The Conway Daily Sun.