Gold opened nearly unchanged this morning after strong gains yesterday as silver also held its ground. Stocks have been mixed while the world turns to Slovakia to determine the future of the global financial system as we know it. Strange as that may sound, the small eastern European country is the only one of the 17 Euro Zone members which has not yet ratified the agreement to increase the EU bailout fund. Slovakian officials will tackle the bill today in what is expected to be a heavily contested vote.
For a sense of what is truly at stake, we turn to European Central Bank President Jean-Claude Trichet, who said today that “The crisis has reached a systemic dimension…” and that “Sovereign stress has moved from smaller economies to some of the larger countries. The crisis is systemic and must be tackled decisively.”
Unfortunately, tackling it decisively means throwing more money at the problem; a strategy that is becoming less and less appetizing for voters across Europe. Though 16 of the 17 member states have ratified the agreement to expand the bailout fund in an attempt to stop debt contagion, Slovakia has yet to act and as such is currently holding the future of the Euro in the balance.
Just yesterday, French President Nicolas Sarkozy and German Chancellor Angela Merkel announced that decisive action would and must be taken before the G20 meeting on November 3rd. Though they were vague about the specifics of the plan, it’s clear that it must involve some loan guarantees to banks and sovereign governments. Without such guarantees, the laundry list of credit downgrades and surging bond yields threaten to freeze European credit markets completely, which would effectively destroy the collective currency.
At this stage in the crisis, there seem to be two possible outcomes worth considering in terms of their effects on the gold market. If Slovakia does not ratify the agreement, or if the political will to continue bailing out banks and governments decreases enough as to make the bailout plan unsustainable, the Euro will likely cease to exist as we know it. This is a catastrophic scenario, as it would instantly cripple the second largest economy in the world. Trade barriers would shoot up across Europe, and there would be a scramble to revalue local currencies, sending shocks through global markets.
In this scenario, gold’s chief role would be as a safe haven play for investors looking to ride out the storm. Though the dollar would likely benefit in the short term, it would put even more long term downward pressure on the greenback as US exports would suffer immensely in the face of a failed European Union. It’s hard to say how much gold could benefit from this type of outcome. What is clear is that compared to the carnage that would likely occur in global equity markets, gold would likely fare much better.
On the other hand, it’s probably more likely that either Slovakia will ratify the agreement and the bailout fund will be expanded, or that French and German leaders will pick up the slack and figure out another method for injecting cash into the failing system. There is so much riding on the long term stability of the Euro that it’s hard to imagine it falling by the wayside without nearly all resources and options being expended in attempts to save it. The problem with this approach, of course, is that it involves massive bailout funds and cash injections, many of which would be made by countries that are already in debt. As is always the case with this sort of economic intervention, this would be extremely inflationary and destructive to the value of the Euro in the global markets over the long term. This is the scenario in which gold is really set to shine. Collectively, the Dollar and the Euro are the only investments competing with gold as mainstays for wealth preservation. As both currencies suffer in the face of increasing money supplies and debt levels, gold is set to reap the benefits of years of desperate fiscal measures. Each time another bailout is announced, each time another dollar is borrowed, each downgrade, each crisis, and each shock to the global markets, gold’s long term growth potential increases a little more.
Mike Getlin is Executive Vice President of Merit Financial, home to America's fastest growing physical gold IRA company. Please send comments or questions to firstname.lastname@example.org.