History books may one day look back on last Friday, August 5th, 2011, as a turning point for the global economy. Over the weekend, the news has spread like wildfire that the credit of the United States has been downgraded from its triple-A status for the first time ever. Though most analysts knew this was coming, it’s still sending shockwaves through global markets. Markets throughout Asia traded lower by over 3% last night, and Dow Futures were down over 270 points at last check. This continues what has become the worst free fall in global stock markets since the financial crisis in 2008.
Gold traded above $1700 per ounce for the first time this morning as investors began clamoring for any shelter from the storm. The question now is whether or not the worst is behind us. If the markets are speaking the truth, it certainly is not. What’s interesting is that this credit downgrade does not come as a surprise and has really been priced into the markets for several weeks. So that leaves us asking what’s really driving this carnage in the stock market and these massive leaps in the price of gold. The real fear is of a sort of chain reaction involving Europe, the Fed, and the global reserve currency system. The US credit downgrade is really a small symptom of a much larger and more dangerous situation.
Let’s take a step back for a moment. If we look to the peak of the global financial meltdown in 2008, we can recall watching the most severe liquidity crisis in nearly a century unfold before our eyes. There was panicked selling in stock markets around the world, trillions of dollars worth of unfunded government bailout programs rolled out almost overnight, and massive failures of some of the largest financial institutions the world has ever seen. In short, it looked to be a global financial Armageddon. Then what happened? Well, not much. Though unemployment has remained stubbornly high and consumer confidence has followed the housing market down the drain, stock and bond markets recovered nicely. In fact, by the beginning of 2011 they stabilized at nearly 90% of their pre-crisis highs. That simply does not fit with the severity of the crisis. If it sounds too good to be true…there is probably a reality check on its way. That’s exactly what’s happening now.
When the mortgage and real estate bubble burst in 2008, the massive losses were passed through default swaps onto the balance sheets of the world’s largest banks and insurers. Those financial institutions in turn passed that debt onto sovereign governments, both here and in Europe, as the companies were deemed “too big to fail.” Now those losses have combined with unsustainable fiscal policies to create the most massive sovereign debt loads the world has ever seen. The result: exactly what you are watching as we speak. The cornerstone nations of the world economy are going bankrupt at a staggering rate. Though the money they injected into the system did temporarily buoy the global economy, the life vest has run out of air and the markets are finally sinking. Ufortunately, though governments here and in Europe bailed out the banks, there is no one left to return the favor and bail out the governments.
Just this morning, word came out of Europe that the European Central Bank will continue bond purchases, extending the program to include Italian and Spanish paper. This is a European replica of the quantitative easing programs implemented here at home. This is putting enormous downward pressure on the already sinking Euro. The Fed will meet in Washington tomorrow to decide whether or not they will inject even more money into the failing system here at home. My bet, with the Dow down over 12% in just over 2 weeks, is that they will. Both of these programs will be enormously price positive for gold.
If we imagine for a moment a situation in which the world’s two most important currencies are dealt a simultaneous death blow, coupled with massive panicked selling in stock markets, added to the looming threat of a debt induced global meltdown, would that not be the perfect storm for gold prices? All that gold needs is a lack of other viable investments. With the Euro, the Dollar and global stock markets in simultaneous freefall, where else can wealth be saved?
Remember that in 1980, gold more than doubled in value in less than two months, and that was in an economic situation much less dire than this one. Keep in mind that it was not just the US debt that was downgraded Friday. It was a downgrade on the issuer of the most important currency in the history of modern economics. The entire world’s currency reserves, the currency of international trade, the currency of the most important economy on the planet, the almighty US Dollar was downgraded. Most analysts no longer believe gold can top out at $2000 per ounce. The consensus is building, that $2000 gold is probably just the beginning.