Vancouver Investment Advisor Ritch Wigham

The European Confusion

I won’t use the acronym..

The European Union is experiencing it’s first real on-shore crisis. The Mediterranean countries plus Portugal have created what may become a devastating set of circumstances for the common currency that the union adopted some years back.

In a nut shell the debt to GDP (gross domestic product) ratio that is used as a bellwether or gauge of a sovereign countries ability to re-pay its debt has been extended past that particular countries ability to re-pay that debt.

Greece is the first of these over-extended countries to come into crisis. The others are Italy, Portugal, Ireland and Spain. Pick your favourite for who comes after Greece. The problem with this Union is that Greece does not stand alone. Due to the common currency the other countries sharing that currency are forced to paddle in the same boat. So if Germany and France don’t come to some form of rescue it impacts them as well.

Originally (a few weeks ago) it was thought that the rest of Europe would come to the rescue of Greece and we would all move forward. A small bump in the road toward a better and stronger European Union. That has turned out to be “not” the case. The IMF (International Monetary Fund) had to be called in because as it turned out Greece was not the only problem for the stronger countries. It has turned out that due to “incestuous” cross borrowing contamination between the worst offenders that the intertwined borrowing of these countries has made it one larger pot of trouble. Greece owes Spain money but Spain also owes Greece money and they all owe each other money that none may be able to pay back. This creates a large problem because it is almost like one great big sovereign debt that has actually no ability to pay itself off. The fear then becomes how do you stop the domino effect of a series of countries, all with the same common currency paying off this debt?

At the moment the bond market is trying to distinguish between the debts of these laggards by penalizing with interest rates the debt of one country verses the other. I.e. Greece v. Germany. The problem with this is eventually how do you distinguish between the players if the common currency has to be devalued while some parts of Europe are solvent and others aren’t?

It is a certainty that at some point (especially if they feel like they are standing alone) France and Germany will not pay the debt of their profligate partners in this fragile union.

That is what the world is afraid of. What happens if the E.U. breaks down?

What happens is that some parts of Europe become insolvent and others regain their old currencies and move forward. The prospects of this are untold. I don’t believe any one can accurately measure what the ramifications of this will be. I can tell you that the whole world will pay and pay dearly. After the melt down of the last two years I don’t believe that the leading countries will let this happen. The pain of the recent past was too severe to have been forgotten this soon. What ever gains we have made to leave the “Recession” behind will not be jeopardized by what are the relatively minor problems of a relatively small country such as Greece. If the problems spread to the other countries in this group a series of events that can not be controlled, may be unleashed, and those effects would be even worse.

The way the world would have dealt with this if Greece had not been a part of the E.U. is it would have been to crush their currency, and impose severe borrowing penalties (interest rates) until Greece had at least started to fix their problems. Since Italy, Portugal, Spain and Ireland are also involved the only outcome is then for the common currency to be devalued and stiffer penalties being imposed on the borrowing costs of all of the countries collectively. This may not seem very palatable to Germany or France but they really do not have a great deal of choice in the matter unless they start the breakup of the E.U itself.

The conclusion then is that the Euro Dollar will decline and the pricing of commodities as we know it will change. Remember that the modest and as yet fragile recovery in the U.S. is largely based on a cheap U.S. dollar relative to the rest of the world. This is a fact that should not be lost on us hear in Canada as this is exactly the mechanism that we used when we allowed our dollar to trade down to the $.60 cent level to stimulate our economy in the 1990′s and early 2000′s

So if I was in Europe, what I would do is buy gold and essentially convert my holdings to U.S. dollars and understand that the U.S. period will do whatever it can to keep their currency relatively week while helping Europe through the IMF to keep their Union together and thus keep the current fragile world recovery in tact.

Till’ next time

Ritch

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