Sunday, May 13, 2012

Europe Votes Out Austerity: Sets The Stage For The Real Crisis

It is fascinating to watch what is taking place around the world today in the political arena and then try to extrapolate forward what it means for both the markets and the global economy moving forward.

Since the European debt crisis hit in the spring of 2009, the Eurozone has essentially tried to do "the right thing." The right thing means that they would try and solve the problems like adults - cutting government spending in countries where the bond markets were in revolt. The alternative would be to allow governments to continue spending recklessly and allow the European Central Bank to print an endless amount of money to purchase the debt (the United States strategy).

By choosing to cut spending, known as austerity, it means immediate pain for those inside the country. When an economy is in recession like Greece and the government is forced to cut spending during the slow down it creates a spiraling effect of additional pain leading to additional cuts needed.

This has taken place not only in Greece, but in Portugal, Ireland, Spain, Italy, and France. The most recent election in France created a major change in the landscape of how policy will be driven moving forward. The people chose to elect a President, Francois Hollande, who promised to immediately reduce the pain of austerity and go after "the rich" through massive tax increases.

There are tremors now running through the political landscape of both Greece and Germany where the people are calling for the same action - a reduction in austerity, meaning a reduction in the immediate pain.

Our world is set up to provide people will immediate pleasure. The barrage of information that comes forth on a daily basis through televisions, radio, phones, iPads, or social media provides headlines on how someone plans to "fix" the problem now. It is the way we have become wired as a civilization.

The deflationist argument has been that the political voice of the people would never allow governments to continue reckless spending financed by a printing press. However, something very dangerous has taken place in the global economy that has set the stage for this to unfold on a dramatic scale.

America has chosen the second path discussed above. They have chosen to push government spending full throttle in combination with quantitative easing programs (printing money to purchase the government debt). The United States appears to have recovered from the financial crisis far better than Europe with its stock market soaring higher, interest rates at low levels, and all levels of borrowers coming back into the market to take a taste of the free money.

The people in Europe have watched this process taken place and are now angry at their politicians for forcing them to suffer. They see the "magical" economic formula the United States has created and they now want a taste of the brew. 

Ironically, while they have been facing severe short term pain over the past 18 months the austerity programs and cleansing of their banking system were actually setting the stage for real economic growth in the coming years.

This week there have even been calls inside Germany, one of the lone voices opposed to additional quantitative easing problems, to ease up on the austerity restrictions and allow the ECB to enter the market with additional force.

The truth is that what the United States is doing is not helping its economy in any way. It is only postponing and increasing the size of the pain that will be felt when the real crisis arrives. If the Europeans need a model to look at for long term health and sustainability of an economy they should look to Iceland. Iceland allowed their banks to collapse, cut government spending, and cut taxes, taking massive short term pain when the financial crisis arrived in 2008. They were the only major economy in the world to do so. They purged the toxic debt from their system, devalued their currency, and started new with a strong foundation. Today their economy is roaring.

I have always felt that the ultimate conclusion to this experiment in monetary madness will be a global quantitative easing program aimed at alleviating the pressure of the massive debt build up we have created over the past 40 years. This final QE would cause the system to "break" and bring on the arrival of a completely new monetary system that will be created out of chaos.

This has happened about every 40 years throughout history. Our current monetary structure was created in 1971.

The question is: how much deflationary pain will be allowed before both the people and the politicians call for the central banks to "save them?" This thought experiment is playing out all across the Eurozone today. The people of Greece are now calling for a new political leader to guide them out of the shackles of austerity. Everyone agrees that they want to cut government spending, cut social programs, and increase taxes, as long as none of those things include their government aid or their taxes.

So far during this process we have seen that as soon as the people begin to feel pain they vote out the current politicians and bring in new electorates that promise them the pain will immediately be removed.

You must watch the events closely in Europe on the political front because they are moving every day toward giving the European Central Bank the green light to unleash a massive scale of quantitative easing.

This will be the rocket fuel that brings the precious metals toward the final stage of their bull market run. When Europe begins to print you will see them joined by Japan, the UK, China, and the United States in unison. It will be like watching the grand finale of a fireworks display, and the people around the world will then understand what happens when short term pain can no longer be pushed off until tomorrow.

I will continue to provide daily updates on the political movements in Europe in the "Today's Market News" tab at the top of the page.

3 comments:

  1. I wouldn't call a couple of % growth off of extremely low, lows 'roaring'

    Also Iceland is very different from any of the PIGGS... Iceland's default primarily affected individual account holders in the UK who parked money in Iceland banks to realize higher interest - no contagion risk.

    The PIGGS are a different story - if one goes more will go - and the counter parties are already insolvent banks - this would collapse these banks and spread contagion across the global financial system.

    This column is delusional - you simply don't have a clue

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  2. You can't compare Iceland to other debt/printing fueled nations at the present point because the other nations have not even begun their downturn. When Greece finally pulls the plug they are going to face a bank run, possibly shortages, and a massive decline in economic activity. Then we can compare how Iceland is doing compared to Greece. Same with Spain, Italy, Portugal, Japan, the UK, and the United States when their time comes.

    As for the contagion, I agree, there will be a lot of bankers, speculators, and those that depend on a QE fueled world that will lose a lot of money. Here's a question I always think about: What if the government leaders let the global derivatives market collapse on itself protecting all savings accounts and money market accounts?

    What if they then provided trillions of dollars to smaller healthy banks that have the ability to lend money to businesses to grow the economy and hire workers, instead of pumping money into an empty black hole of losses on toxic balance sheets? I understand that the process would not be easy and would create major pain, but if you project out where this story is going over the next 5 to 10 years it may end up with a happier ending.

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