As the deadline by which the next Greek bailout must be funded is now less than a month away, there seems to be little consensus on the path forward for Europe. As the entire region (and especially the German public) grows weary from bailout fatigue, the debt situation in several major euro zone countries has shown virtually no improvement. For the first time since the onset of the crisis some are saying the EU would be better off letting Greece exit the currency union; the idea being that the European economy has now gained enough strength to weather the storm that would ensue.
One voice that has remained staunchly in support of a “save Greece at all costs” approach is that of German Chancellor Angela Merkel. She told a student group last week that the costs of a Greek exit from the EU would be “incalculable”. In short, she’s right. Here’s why: The fragile stability and equilibrium that the greater European economy has achieved over the last several months is not sustainable without life support from the European Central Bank.
In a debt crisis, it’s all about the bond yields. In other words, it’s all about how much it costs deeply indebted countries to borrow enough to keep the daily functions of government running. Countries like Spain, Portugal and Italy have enjoyed borrowing costs that have been made artificially low by intervention from the ECB. In short, the central bank has been loaning money at a rate of roughly 1% for the purpose of buying European sovereign debt which is paying a 5% yield!
For comparison, imagine your credit card company was actually paying you 4% APR on the money you spent instead of charging you interest! You may feel pretty good about your personal spending ability, but it wouldn’t bode well for the credit card company. In this case, the credit card company is the European Central Bank. These monetary policies are clearly not sustainable, and they raise significant question as the region’s long term stability once off financial life support. Clearly any sense of improvement in the EU economy should be taken with a grain of salt considering the massive intervention taking place in the bond market.
What makes the prospect of a Greek default even more terrifying is the reality of the cash outflow situation already occurring. Euros have been flying out of Italian and Spanish banks as concerns grow about the future stability of those nations. If Greece is allowed to exit the union, there will have to be unimaginable controls put in place to keep people from moving all money out of the failing Greek banking system. The mess would send a signal to people with cash in Italian, German and Portuguese banks that they better get their money out before it’s too late. It would be the mother of all bank runs. The German central bank is currently owed over half a trillion euros in cash imbalances caused by individuals in other nations moving money into German banks which they believe are more secure. Even today, the perception is that a euro in Germany is worth more than a euro in Italy. That is a catastrophic reality for the currency union. If Greece fails, it will become infinitely worse.
All in all the future of the European economy is in serious jeopardy, and those in power know it. That’s why Chancellor Merkel, despite public opinion to the contrary, believes that Greece must be saved. As unpleasant as it may be for European citizens favoring more responsible fiscal policies, the bailouts must continue. While that is unfortunate for the future value of the euro, it stands to drive gold prices much higher over the long term. Remember that a high dollar valuation against the euro is hard on American exports and makes the cost of repaying the debt accrued by the US government that much more expensive. As we have seen over the last few years, a significant devaluation in one major currency tends to force other nations to devalue their own money in turn. As goes the euro, shall go the Yen, the Yuan, the Pound and the dollar eventually.
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.