As the European debt crisis continues to spiral out of control (breaking through all the much touted “firewalls” of a few months ago), the situation for American bonds has improved – exactly as TBP predicted back in November . Foreign investment, scared to death of losses due to Greece (which is in a depression) and now Spain, has few places left to flood for long term stability. Of the currencies with historical stability, the U.S. is the largest that remains now that Switzerland has decided to destroy their own currency by attempting to backstop the Swiss Franc to Euro exchange rate at 1.20:1 . As a result of this situation, U.S. bonds have reached a record low yield of ~1.4%, well below the historical average of approximately 4.5 – 7% over the last decade and a half. Incidentally, at an average rate of 2% the outstanding American debt of $15.7 trillion requires an interest payment of only $314 billion. If the bond yield rises back to historical levels of ~5%, the interest payment increases to $785 billion, or roughly equal to the entire Obama stimulus package from 2009 – this amount will continually come due every single year.
Before we all quietly shuffle ourselves into the bomb shelter, let’s keep an eye on what is likely to happen in Europe over the next few months and what impact this might have on the United States.
- Greece is likely to drop out of the Euro, particularly if they elect an anti-austerity government on June 18. While ‘main stream’ polls suggest that the ‘center’ parties are currently leading , it is more likely that the fringes will recapture the majority as the Greeks sink deeper and deeper. At this point, June 18 is light years away and Greece could completely fold at any time. The Greeks have also instituted a sort of ‘polling ban’ that will be in effect until election day – at the time of the last known poll, Syriza (Coalition of the Radical Left) was in the lead.
- After Greece has finally fallen off the bus and has been run over six or seven times, Spain will take the forefront. The Spanish government is facing a shortfall of approximately $400 billion [3a], which far exceeds the $5 billion or so remaining in their existing bailout fund . In order to attempt to secure an additional bailout package, Spain had proposed stuffing their banks with garbage mortgages (sound familiar?) to inflate them into looking healthy enough to secure the additional funding. The EU has rejected this plan , leading to a spike in Spanish borrowing rates to 6.675% .
- When Spain is done, it will be Portugal’s and Italy’s turn in the spotlight (and perhaps Ireland’s) and their own economic situations aren’t any better. In other words, the EU has a crisis that it cannot possibly contain, despite all of the rosy dialogue coming out of Brussels, unless they manage to convince the ECB to crank up the printing presses to the tune of several trillions of Euros. Either way, Europe is about to hit a brick wall – the only question is whether they slam into the wall at 100 mph or 99 mph. In the end, it makes no difference. At this point, you might as well put the pedal to the metal and enjoy the ride.
- The shiny, new European Stability Mechanism (another bailout fund/firewall) is due to open early next week and is expected to be capitalized to the tune of approximately $620 billion [6a]. This fund is being touted as the latest and greatest aside from Eurobonds (which Germany has flatly rejected considering they would wind up being the sole collateral for the entire EU), but will more than likely be a minimum of five times too small to rescue Europe, which will be needing trillions in injected capital to stay afloat.
- Whenever Greece exits the Euro (and I predict that it likely will sometime this summer or fall), the already creeping contagion will spread like wildfire. Within Europe, the weakest economies will be dragged down even further and ultimately be facing a currency collapse. No amount of stability mechanisms or bailouts will be able to stop the spread – all we can hope is that the less and less effective central bank actions will stem the flow briefly to allow us time to breathe a few more breaths.
- During this time, U.S. Treasury bond yields will drop as investors demand less and less in return for storing their money in the last perceived “safe haven.” It is even possible that U.S. bond yields turn negative (the investor pays the Treasury for the privilege of Americans holding their money) – this is already beginning to happen on German bonds [6b].
- As Treasury bond yields drop, the dollar will appear to be strengthened until the European contagion eventually spreads into American banks. This seems unavoidable and economic problems will eventually arrive in the United States if Europe collapses simply due to the amount of trade which occurs between Europe and American companies. Several states will be hit hard. China can’t possibly make up the difference and are currently suffering their own economic problems , although to be fair it could be due to all those ghost cities and malls being built that nobody lives in to fraudulently prop up the construction industry . As the dollar appears stronger, gold and silver will drop in price – the early stages of this are currently happening as silver hovers around $28/oz, down from $34/oz several weeks ago.
- The strengthening of the dollar will open what most economists will refer to as a “deflationary window.” In other words, the value of paper currency will increase somewhat for a period of time and the purchasing power held by the average consumer will improve. This is likely to be the case as recessions are inherently deflationary. Central banks will abuse this opportunity to crank the printing presses up yet again to monetize sovereign debt. This will be possible because in a deflationary environment, the velocity of money will remain low, preventing a flood of currency into the consumer markets and hurting purchasing power. (The larger problem with this temporary ‘fix’ is that when Lehman collapsed and the 2008/2009 recession was triggered, the Fed expanded its balance sheet by some 300%. In order to ‘fix’ a crisis of equal or greater magnitude than Lehman, a similar increase would be necessary – in this case, an expansion from $2.7 trillion to upwards of $5 trillion. When the deflationary period ends, the Fed won’t be able to pull all of this money back in by raising interest rates. This will trigger an inflationary period.) [Hat tip: John Mauldin]
- To “fix” this problem, the media and many financial “experts” have placed their hope in fairy investments such as Facebook. This, perhaps more than anything else, spells why the long term economic outlook for the U.S. appears grim – we are counting on public corporations such as Facebook, which produces absolutely nothing, to drag the stock market along forever praying that nobody pulls back to curtain to expose the scam. At least if Disney fails you’re left with a massive amount of movies, theme parks, roller coasters, and other tangible items which have intrinsic value. If Facebook fails, we’re left with a $60 billion hole that will be filled with a few server farms and a gigantic pile of advertising contracts. At least we’ll be able to burn the contracts for warmth. (Facebook, by the way, has lost 29% of its value in the week or so since it opened – I don’t feel the least bit sorry for any idiot who decided to invest. Go cry to somebody else.)
The moment foreign (and domestic) investors realize that the long term outlook for the U.S. dollar is in no better shape than the Euro, investment will pull out of the Treasury and move into gold or other tangibles. Historically, banking collapses come in waves – not in simple, one-off events. When the European dominoes begin to fall, the wave will spread across the ocean and risk catching Japan, China, and the other major economies of the world totally and completely unprepared. Major sovereign defaults are coming.
Large sovereign defaults entail the collapse of the entire banking system and inherently trigger a “reset” – whatever system emerges on the other side is anybody’s guess. Historically, the major economies have managed to insulated themselves against the smaller sovereign defaults of the past and have remained relatively unscathed and this is the reason the current fractional reserve banking system continues to chug along. However, when major sovereign defaults occur worldwide in rapid succession, the credit markets the economy survives on won’t just slow down as they did in 2008 and 2009 – they stop. No lending for mortgages, farmers, trucking companies, construction, industrial goods, or retail.
In the worst case, that means no products on the shelves, no gas at the corner station, no food brought in from the fields, no car or home loans, no industrial financing for projects, no welfare, social security, or food stamps. The economy will be purely local and based on whatever you can produce with your own two hands. There’s no telling how long such a scenario might last – a month? A year?
Let’s not delude ourselves: If the euro falls apart, so will the European Union, triggering a global economic crisis on a scale that most people alive today have never experienced. – Joschka Fischer, former vice-Chancellor of Germany (2012)
When and if these things come to pass, that will be the time to start shuffling into the bomb shelter. For now, it may be very, very wise to begin thinking about how you’re going to build it – when the dominoes begin to fall, it’s going to be too late.
In love of liberty,
The Bulletproof Patriot