The situation in Greece and some of the other PIIG nations may be bad, but it seems small compared with other threats to the world financial system. Neither a Greek nor a Portuguese exit would end the euro, even though it would end the participation of those nations. The trials and tribulations of Italy and Spain are a serious threat, and it remains to be seen what will happen there.
Far more ominous, however, are the problems that will soon be arising in France. It is a "core" euro nation, and one of the key promoters of the common currency. Since the euro crisis picked up steam, France has been strongly hinting that the ECB should act more like the Federal Reserve. That was true even under the supposedly conservative Nicholas Sarkozy. But, he's been very careful to restrain himself, given the known sentiment of the German public toward massive money printing.
Sarkozy's main opponent, French Socialist candidate, François Hollande, has no such restraint. French elections are scheduled for April 22, 2012, with runoffs set for May 6, 2012. Hollande has a huge lead. It is unlikely that Sarkozy has any chance of catching up. Hollande has promised to rip up the recent eurozone fiscal responsibility pact. That is an accord so important to Germany, that the nation has made participation in bailouts contingent upon it.
Mr. Hollande thinks growth is more important than stability. He wants massive new spending. Socialists are vague on how they will cut to pay for the spending, but claim they will balance the budget in France. Fat chance. France will run a much larger deficit under a Socialist administration than ever before. The possibility that Hollande will win has led German Chancellor Angela Merkel to take the unprecedented step of actively campaigning for Sarkozy. German political support, however, is not likely to help him.
If Hollande gets elected, and he probably will, bond buyers will be less than eager to purchase French bonds. Yet, France will need bond buyers, more than ever, to fund its spending plans. It will join its southern neighbors in a desperate need for cash. Where will that cash come from? There is simple answer. The ECB is going to be pressured into printing more money. The central banks of Germany, Netherlands and Finland won't be happy. But, it doesn't matter. They will be outvoted.
Hollande's intention to void the previously agreed upon "euro fiscal pact" will lead nations, like Germany, to refuse further participation in bailouts. As we have repeatedly seen, central bankers, like politicians, prefer to kick troubles down the road into the future. So, the ECB is likely to engage in more LTROs and/or money printing through bond buying, or the European economy is going to slow down dramatically. Either way, the euro will be depreciating rapidly.
It seems to me that we are going to see the return of German marks, Finnish markkas, and Dutch guilders sooner than anyone now thinks. These currencies will have to be held out as joint legal tender alongside the euro, if the entire eurozone is to be saved from complete implosion. Although it may well be many years before anyone can formally withdraw from the eurozone, the euro will depreciate rapidly against any such new currencies.
But, a falling euro is exactly what fiscally irresponsible nations want. Meanwhile, haven currencies into which savings can be placed are exactly what the doctor ordered for the more responsible eurozone nations. The issuance of new national currencies, however, can only be done by the stronger euro nations, as opposed to the weaker ones. If the weak members did it, the new currency would immediately collapse to zero. But, with a falling euro, fiscally irresponsible governments will be able to pay debts at a discount. The big losers will be individuals who hold euro-denominated debt and equities that are not immediately converted to the new currencies.
But, will the "mad" money printer, Fed Chairman Ben Bernanke and his crew allow America to be left behind in a currency race to the bottom? Not likely. The money printers are still very much in charge at the Federal Reserve. They will print and print. Of that, there is no doubt. A big fall in the euro will eventually be challenged by an even deeper debasement of the U.S. dollar. The question, for dollar denominated investors, is really one of timing.
The two events may find themselves separated in time, however short that might be. That provides a window that long-term investors can use to escape from the dollar. Right now, prices of all but the most risky stocks and bonds are extraordinarily high, not only in America, but all over the world. The most probable outlook for company earnings going forward is not pretty anywhere. Cost cutting has run its course. There is not much chance that earnings can rise substantially. Its a bad time to buy, and seems like a good time to sell.
Top on the selling list are equities and lower-quality bond issues. Precious metals are another story. It is difficult to say how they'll react. Remember, when gold and silver prices sunk deeply after the collapse of Lehman Brothers? But, as the stock market was collapsing far deeper, between January and March 2009, the metals took off into the stratosphere. Money printing is guaranteed in Europe and America, and, probably, elsewhere also. That will eventually send precious metals to the moon, regardless of the best efforts of the market manipulators at the New York Fed.
But, for a few weeks, they may be on fire sale, during a period of extremely heightened volatility. It would be nice to use that period of time to sequentially buy low and sell high, day by day, week by week, or the like. Sober experience, however, tells us that although many may have a streak of good luck, even a long one, the vast majority of short-term traders lose money. Without tight connections to the Fed and ECB, we don't know and cannot know exactly how events are going to play out.
Even the most well connected firms, such as the Fed primary dealers, are going to have great difficulty in trading the upcoming ultra-volatile environment. The indecision of politicians causes central banks to lose a great deal of control over events. It is entirely likely, for example, that precious metals could run up sharply, then go into a sharp downdraft, finally, embark on their long-term continued large increase in price.
Similar movements may happen in the equities markets. However, equity prices are already so bloated by government market manipulation policy, that they have little upside potential left. Europe and America are both economic basket cases. Potential wars with Iran and others are on the horizon. Very little has been done to solve problems that led to the 2008 banking implosion. As soon as market support (a/k/a the mass printing of officially "counterfeited" funny-money) ends, the stock market will tank.
In the coming ultra-high volatility atmosphere, it will be nearly impossible to time "ins," "outs," and "back ins" correctly. The most astute traders lose money in such conditions. It is better to simply avoid risk and stop trading. You could probably buy precious metals now, if you have a long-term view, because prices have a very long way up to go. But, a better policy may be to hold what you've bought, while waiting for lower prices. That could get frustrating, though, as prices may explode permanently, or at least seem to explode for a while, while you're waiting.
Cautious long-term investors will hold precious metals, at this point, while selling stocks and low-quality bonds. CDs should be allowed to mature without renewal. No one should commit funds to term deposits or bonds at the prevailing low rates. Investors will be better served by establishing liquid FDIC insured money market accounts at the highest interest paying bank they can find. This will provide the advantage of having ready cash for the next six months or so. That outweighs the probability of longer-term deep currency debasement.
Don't cry about selling stocks or bonds. People become too attached to investments. Divorce yourself from emotion and think logically. The bear market in junk bonds and equities has been masked by a massive level of currency debasement, and near-zero interest rates. This is especially true in America, but is also true in Europe. Outside of Fed funny-money, hundreds of billions of dollars have been moving out of equities. New money being earned, in the real economy, is not being invested in stocks.
Junk bonds are being levitated by the zero interest rate environment, and artificial economic stimulation. People are desperate for yield and are ignoring the high risks. They may continue to put money in such bonds, for a while, but the upside is limited and the downside is frightening. As soon as the default rate rises a bit, the junk bond boom will be over. It will collapse far more quickly than the real estate bubble ever did.
Higher default rates, and lower stock market participation going forward, is almost guaranteed. With few exceptions, companies are caught inside a vise, between higher commodity prices and customers with severe financial difficulties. Add to this the fact that, in most developed nations, aging of the population will cause the current trend of cashing out of the stock market to continue. Stocks and junk bonds are simply over-owned, and the unwinding of that condition is going to be painful for many.
In general, European stocks are no better than American stocks. But, all things have their price. Once the exchange value of the euro collapses, southern European stocks should be much cheaper, at least in other currencies, and, therefore, worth buying. Banks react to cash flow issues by selling assets, many of which are now being held off the market. That means that they will sell stocks, as well as distressed real estate in prime warm weather locations, such as the Mediterranean coast of Greece, Italy and Spain. Such real estate will be a very good value if the banks stop holding it off the market.
If we concentrated solely on equities, eastern European, Russian, and Ukrainian markets may well provide better opportunities than Europe. Both Russia, and Ukraine, are fast growing emerging market economies that depend on external investors to fuel their stock values. Russia is almost completely dependent upon Europe. Oil and gas prices are likely to fall for a while, as Euroland implodes, with demand drying up as it did in 2008. Russian equities should become very cheap. Ukraine is also a big commodity exporter and should also take a hit.
Russia, and Ukraine, are not easy nations for westerners to understand. But, you don't need to speak Russian or become an expert on the Russian market to invest in ETFs that can provide broad exposure. These include the SPDR S&P Russia ETF (RBL), Market Vectors Russia ETF (RSX), and the iShares MSCI Russia Capped Index Fund (ERUS).
Palladium is likely to take a much deeper hit than the other precious metals if the Russians are faced with low oil prices, because they are likely to sell stockpiles. If palladium or any other precious metals do take a big hit, it will be an excellent time to buy. There are a lot of ETFs, including but not limited to the iShares gold trust (IAU), ETFS physical silver trust (SIVR), platinum trust (PPLT), palladium trust (PALL) etc., that provide exposure to the rise and fall of precious metal prices. However, prospective buyers should carefully read the prospectus before investing. Many analysts have raised questions about them.
If you don't like what you read, you can invest in a simpler vehicle like the Sprott gold (PHYS) and silver (PSLV) trusts. These are sure to have the gold and silver they claim to have. A platinum and palladium trust is on the way from Sprott. People who intend to keep their metals for 5-10 years, can avoid paper promises altogether and buy physical coins or bars. Or, you can invest in the shares of mining companies. These tend to leverage the bullion price changes. Examples include Newmont Mining (NEM), Hecla Mining (HL), Randgold (GOLD), Barrick Gold (ABX), Yamana (AUY) and others.
Most mining companies have proven reserves that imply a very low per-ounce price for gold and other metals. But, mining is a risky business. Just because it is theoretically in the ground doesn't mean that you can get it out of the ground without problems. Stocks have management error risk, overcompensation risk, and political risk. Even companies that have no political risk, such as Hecla, which operates mostly in North America, can be risky. For example, the Lucky Friday mine was recently closed for a year by U.S. safety inspectors. What stock investor could have anticipated that, without having first inspected the company's mine shafts?
Disclosure: I am long SIVR.