The Euro sank this morning, dragging global stocks down with it. The glimmer of hope that came last week when Italy’s new Prime Minister, Mario Monti took over control of the Italian government has passed and borrowing costs are on the rise again. This time, Spain’s bond yields are surging as well, highlighting the severity of the contagion which threatens to dismantle the entire Euro Zone. The falling European currency made the dollar stronger in comparison which has taken a chunk out of gold prices this morning, pushing them down to the lower end of the current trading range. The question now: What’s next?
Europe took a different approach than the US in terms of how policy makers chose to manage the 2008 financial crisis and its aftermath. While the US essentially printed over $1 trillion and shoved the money into the system with utter disregard for the consequences, Europe has taken a more conservative approach. Of course the problem now is that the approach they have taken is not working. Voices across the Atlantic are calling more and more for cash injections into the European financial system, similar to those used by the Federal Reserve here in the US.
The truth is that there is simply not enough economic growth in Europe to cover the current spending levels. At this point, they are not even close to a meaningful solution. Germany is favoring a cut, cut, cut approach in which deficits and borrowing are decreased through lower spending, despite the fact that the EU economy is dying fast. France on the other hand is favoring cash injections and inflationary monetary policy to try and jumpstart growth. So which way will they go?
The problem with the European Union is that they have a shared monetary policy, but no unified fiscal policy. More specifically, the European Central Bank controls the monetary policy (interest rates and money creation) for the entire union, while each nation’s fiscal policy is set locally. This creates a situation in which fiscally conservative countries such as Germany are made to fund the monetary policy to support fledgling countries such as Italy and Greece (and Spain, and Portugal, Ireland etc.). So you would think that a nation such as Germany would opt to leave the union and stand on its own. The problem with that is the utter destruction that would occur across financial markets if the Euro began to collapse.
Thus the Entire EU is stuck between a rock and a hard place. They can preach about cutting spending and reigning in failing states, but in the end they will be forced to pony up the cash or risk utter collapse of the global economy. At some point, we have to assume the printing presses will fire up and there will be a European equivalent of quantitative easing.
In fact it has already started. The European Central Bank has been buying Spanish and Italian bonds in an attempt to drive down interest rates and borrowing costs. The problem is that the billions they have poured in have hardly made a dent. Italian bond yields shot right back above 7% yesterday despite the ECB’s action. To stop the contagion, EU officials will probably have to do something drastic and announce a much more aggressive program. Don’t forget that the quantitative easing programs in the US drove gold up by more than 20% in a very short time. It doesn’t take an economics degree to figure out what’s going to happen to gold if the printing presses on both sides of the Atlantic are running at the same time.
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 email@example.com.