A foolish decision is haunting both North America and Europe. I refer to the decision by the American and European elites to bailout their big banks without addressing the underlying cause of the financial crisis, the trade deficits. The fact is that trade-deficit countries accumulate debt in return for mercantilist-produced baubles. The result of the bail-outs was an immense transfer of bad debts from banking sectors to governments. The result of the continuing trade deficits is that the underlying debt problem will continue to grow.
In America, the transfer of bad debts from banks to governments was first realized with the $700 billion TARP bill, and was followed up with the Federal Reserve buying $1 trillion of soon-to-be-worthless mortgage-backed securities and the U.S. government subsidizing purchases of used residences.
In Europe, the decision to transfer bad debts from banks to governments is playing out now with the $1 trillion rescue plan known as "Le Tarpe," for the banks that have loaned money to Europe's three most heavily indebted trade-deficit governments. It will continue with the upcoming purchases by the European Central bank of junk-bonds issued by Greece.
As a result of ignoring Asian and German mercantilism, trade-deficit countries on both continents will be mired in the perpetual depression which, Keynes predicted, comes to countries that permit trade deficits. Specifically, in his magnum opus (The General Theory of Employment Interest and Money) Keynes pointed out:
A favorable [trade] balance, provided it is not too large, will prove extremely stimulating; whilst an unfavorable balance may soon produce a state of persistent depression. (p. 338)
Just as the Great Depression did not alleviate until policy makers figured out that governments need to maintain a growing money supply, the current stagnation in Europe and North America will not end until American and European policy makers figure out that governments need to maintain relatively balanced trade. Unfortunately, most American economists, including President Obama's advisors, are such free-trade ideologues that they are still impervious to this reality.
But not all American economists are free-trade ideologues. Peter Navarro is one of the first of our premier economists to see where all of this is going. In an excellent May 15 commentary, he laid out a realistic case that the euro may be dead and that gold is probably the best investment at the moment because we are heading toward a "de facto" gold standard. He succinctly explained why the euro bail out will fail:
The euro will continue to decline because “Le Tarpe” will either lead to a massive boost in the euro money supply OR a collapse of the euro if countries that want to borrow “Le Tarpe” funds refuse to agree to the conditions of accepting the money. There is NO third option so the euro must fall!
He explained that this will not only affect U.S. exports to Europe, but also China's currency policy. He wrote:
China won’t revalue the yuan at this time because as the dollar is rising, so, too, is the yuan. This hurts Chinese exports to Europe – its largest market. Ergo, there is no way China would allow further strengthening of the yuan to the euro by strengthening the yuan relative to the dollar!!! (If you don’t understand this one, please re-read until you do. It is the single most important dynamic right now in the global recovery besides the euro collapse itself.)
He predicts a possible return to a "de facto" gold standard, not because of the theoretical advantages of a gold standard over flexible exchange rates, but because the two alternatives, the euro and the dollar, are both in trouble:
The decline in the euro boosts gold and silver prices by raising the probability that gold and silver will be de facto “reserve currencies” in a world where high sovereign debt levels in both the U.S. and Europe make the dollar and euro less attractive as reserve currencies over time.
Although he does not endorse a bearish scenario as being more likely than a bullish scenario, he does see it as a distinct possibility. He summarizes it thus:
The bearish scenario is this: Europe stagnates as “Le Tarpe” fails because of political pressures that were not present in the U.S., i.e., while the U.S. could make demands on Citi and AIG et al, the Eurozone bigwigs can’t bend Greece and Portugal and Spain to their will. China implodes on a combination of collapsing real estate and stock market bubbles coupled with a fall in exports to the Europe. The U.S. continues to be leached by Chinese mercantilism while it loses its export growth in Europe while internally states like California and Illinois undertake contractionary measures that ripple across the nation.
Unlike Navarro, I can't see any alternative to the bearish scenario, unless either (1) Asia, led by China, were to suddenly change its successful strategy of stealing industry from both Europe and the United States, and or (2) American and European elites were to switch from their unilateral free trade policies to balanced trade policies. Neither solution is likely at the moment.
Disclosure: I own a gold mining stock