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Tuesday, 13 December 2011

The European sovereign debt crisis is barely beginning.

It will come as no surprise to those of us who remember the 1970's and 80's but government intervention prolongs recession and depression. But looking back to the 1920's and 1930's it is possible to see what the likely outcome of government intervention through 'stimulus packages' will be for us.



Europe’s leaders met recently to try and resolve Europe’s ongoing crisis. The markets themselves are indicating what the outcome in Europe will be. They are all starting to break down, which indicates that Europe will NOT solve its crisis.

For one thing, Europe continues to refuse to deal with the real problem. That problem is that Europe never created a fiscal union to begin with. In short, they left all the member states’ debts out there on the table and did not create a unified debt structure in the way of Eurobonds, like U.S. Treasury bonds. That was a fatal mistake, one of many. They continue to neglect that one mistake and even now refuse to create Eurobonds. So that ill-conceived foundation for the euro persists.

Moreover, the agreement they are supposedly hammering out this weekend is merely going to make matters worse. Unbelievably, France and Germany are moving to exercise direct control over the national budgets of other European Union member states. That’s effectively asking countries such as Spain, Italy, Portugal, Greece and all others to give up their sovereignty to France and Germany.

Even if those countries agree now, down the road it’s just going to seal the fate of the European Union because very simply, there is no way those countries will kowtow for long to Germany and France.

And to top it all off, the European Central Bank (ECB) continues to refuse to print money, which although inflationary, is the one thing that could really help. It would allow the ECB to create a Eurobond market, which would relieve pressure on the bankrupt European countries.

There is no end to Europe’s problems in sight. Perhaps a glimmer of hope here and there, but no resolution. Which is precisely what the markets are telling you! Europe’s crisis is leading to a flight of capital into the dollar, more so than into commodities. When the sovereign debt crisis hits the United States and the world’s reserve currency, the U.S. dollar — that’s when you will see the true next leg up in commodities.

Some stock investors never seem to learn. They hope and pray for a new government rescue from Washington or Brussels. They wait with bated breath for each official sign of money printing, interest-rate cuts, or financial bailouts.

Then, as soon as something is finally announced, they breathe a sigh of relief, applaud with enthusiasm, even buy a stock or two.

But it's a fool's game. Because within a few months — or even just a few days — the government rescue crumbles, investors run for cover, and, ironically, they begin a whole new cycle of hoping and praying for the NEXT big rescue. Just this year alone, European authorities have held 19 high-level emergency meetings ... proposed dozens of rescue packages ... and delivered an endless stream of promises.

Since the crisis began, we've seen four PIIGS bailouts (Greece twice, Ireland and Portugal) ... the creation of two European bailout funds (ESFS and ESM) ... plus countless central bank interventions to buy sinking PIIGS bonds.

What have they gained from all this? Nothing! In fact ...

The Danger of Systemic Collapse Is Far Greater Today Than at Almost Any Time Since the Debt Crisis Began

The European Union is the biggest economy in the world — close to $15 trillion in GDP. When it sinks, so does the U.S. and much of the world. European banks are roughly THREE times larger than U.S. banks. When they're forced to cut their lending drastically, global capital shortages hit hard. Most frightening of all, the U.S. has committed most of the same mistakes as Europe — the same kind of massive debts, deficits, and failed bailouts. And now the European Union is crumbling, threatening a systemic collapse far larger than the near meltdown witnessed in the wake of the Lehman Brothers collapse in 2008.

How do I know a dangerous new meltdown is so likely?

Because that's what the objective data proves. In fact, to measure and track this danger as accurately as possible, I use the Debt Danger Index for Europe. This index is based on the total cost of insuring against sovereign debt defaults in each of five key countries — Belgium, France, Germany, Italy, and Spain.

So it directly reflects the danger of European debt disasters, regardless of the sentiment in the stock market. Reason: Unlike stock market investors, sellers of these specialized insurance contracts see through the hype and hoopla of government bailouts and rescues.

If the danger of debt default is rising, they charge a higher premium for the insurance and my index goes up. If the danger of default is subsiding, they charge a lower premium and the index goes down. Now, just look at how the Debt Danger Index has surged:


Four years ago, before the U.S. housing bust and the Greek debt crisis, the sovereign debts of large European countries were considered beyond reproach. Default was unthinkable. And any talk of wholesale collapse was considered science fiction. So the cost of insuring against default was a pittance:

To insure a $50-million portfolio — allocated equally among sovereign bonds of Belgium, France, Germany, Italy, and Spain — the total cost was a meager $28,649 per year. Care to venture a guess as to how much it costs now?

The cost of insuring the same $50-million portfolio today is a whopping $2,258,200 per year, or 78.8 times more!

In other words, based on the market for these insurance contracts, the danger of a wholesale European debt disaster — with the potential to melt down the global banking system — is now nearly 79 times greater today than it was four years ago.

Massive Policy Failure

What about all the trillions of dollars and euros committed to money printing, bailouts, and guarantees? What did they do to stem the crisis? Nothing, absolutely nothing!

Quite the contrary, even the most massive and dramatic government interventions only made the crisis worse. Want proof?

Then take a look at the timeline in the chart below. It's the same Debt Danger Index I showed you in the previous chart, but this time zeroing in on just the last two years:


Here's a timeline of the four most important government actions:

April 2010 — the first Greek bailout. What did it do? Nothing! The Debt Danger Index was rising at a steady pace before the bailout announcement ... and it continued to do so after the announcement.

May 2010 — the $1 trillion European bailout fund (EFSF). Now, THIS was supposed to be the be-all, end-all Mother of All Bailouts. Instead, it was the cue for a whole new wave of the crisis … and the Debt Danger Index promptly resumed its steep rise.

July 2011 — the second Greek bailout. Finally a solution? Of course not! Instead of reducing the Debt Danger Index, it merely helped drive it sharply higher.

This past Friday, December 9, 2011 — Europe's "new fiscal pact." The grand bargain that markets were praying for? Far from it!

The European Central Bank will NOT provide the money printing that investors were hoping for. England will NOT sign on to the deal. And even most of the countries that DO join the pact — including big movers and shakers like France and Germany — are merely making the same old promises that they've already broken repeatedly in the past.

The debt crisis is barely beginning but already nations have shown that they lack the political will to make the right decision, even if it may cause political difficulties, that is to cut government expenditure and start paying down debt.

The longer they try to avoid doing so the worse the situation is going to get.