According to Reuters, today the Greek Prime Minister, George Papandreou, called for a referendum on the EU bailout plan that calls, among other things, for a 50% haircut by banks on Greek debt, and sets up a massive $1 trillion bailout fund. Polls show that 60% of the Greek people are against the EU summit plan. The result is clear cut and foreseeable.
When this referendum comes to a vote, Greeks are likely to vote against complying with the terms of Europe's bank bailout, and in favor of their own pockets, bringing back the issue of default. Without the "assistance" of the EU and the IMF Greece will not have enough Euros to pay its bills. It will surely default. The banks will lose, not 50% on their investments in Greek bonds, but 100%.
Europe will surely bail out its banks, nation by nation. Germany will bail out German banks. France will bail out French banks. And, so on. Austerity will be over. Greece will not pay its bills. It will default. But, what about the Euro? Can Greece simply default and stay in the Eurozone? It could. But, only if the other nations of Europe are willing to carry it. They aren't willing. So, Greece will be thrown out.
The fear of European debt default will bring the problem of an entire continent that likes to live beyond its means to the forefront. Western debt is a ticking time bomb. It arises out of the welfare states that have been built in western Europe and North America. But, creditors don't like to lose money. Financial markets will live in fear of the next defaulter. Spain? Italy? France? No one will know. They are all over indebted.
Fiat currencies are based upon debt. The central banks buy debt, usually from governments, and claim that this debt "backs" their bank notes. For example, the Federal Reserve buys treasuries in exchange for dollars, and tells the world that the dollar has value because it is "backed" by treasuries. But, treasuries can only be paid back with dollars, which are little pieces of paper called Federal Reserve Notes. They are "notes" because they, too, are debt. The United States, Europe and every other fiat currency issuing nation is backing debt with debt, in an incredible Ponzi scheme that hasalready lasted longer than anyone reasonably intelligent person could normally imagine.
Faith that debt can be paid with debt is, in essence, a contradiction in terms. Yet, human beings have such a strong desire for stability and such a strong need to believe in their leaders, that governments can convince them of almost anything, including the idea that debt backed by debt should be used as a medium of exchange. But, this situation can only exist so long as people continue to believe. Once people lose faith that in the merry-go-round, the Ponzi scheme must end.
What happens when people begin to question the idea that paper has the "value" that governments say it has. Faith in government bond debt, which is the foundation of all fiat currencies, will be lost after the Greeks default. People will wonder whether the United States and/or the UK, both of whom have big unstable debt situations worse than Europe, will default even though they never will. Both will print their way back into the Ponzi scheme. But, the Euro cannot be printed to infinity, because the people of Europe already know where that ends. They've seen it before.
The Euro cannot exist in the midst of intense Euro bond buying fear. For that reason, the ECB will be forced to step in, like the Federal Reserve, to monetize trillions of Euros worth of Italian, Spanish and, maybe, even post-bank-bailout French debt. It will either become a money printing machine like the Fed, or it will cease to exist. But, Germany, the Netherlands, Austria and even tiny Slovakia have had the collective memory of hyperinflation that Britons and Americans lack. They know hyperinflation is much worse than any depression. They will not allow the ECB to print endless reams of cash.
So, what will be the result? The Euro is going to end. There will be a return to national currencies. Human beings have a tendency to forget quickly, but for many years investors and banks will be allergic to bond-buying, whether we are talking about German bunds denominated in marks, treasuries denominated in dollars, or Spanish bonds denominated in pesetas. People will refuse to put their faith again in the bonds that burned them, and that means they will not trust fiat money, even if it is German fiat money.
Meanwhile, American and British policy makers have no experience with or understanding of the dangers of unlimited money printing. The Bank of England and Federal Reserve are almost certainly going to try to offset the downturn in Europe by printing untold trillions of pounds and dollars. Goldman Sachs' chief economist Hatzius will finally get his way. He said, a year or two ago, that the Federal Reserve needed to monetize something like $6 - $8 trillion in bonds to fully offset depressionary momentum. They will do that, and more.
This future is the one that logic and reason dictates. The pound sterling and US dollar will massively devalue. The Euro will no longer exist. Many European banks will be nationalized. The German mark will be reborn. The mark will probably start out strong, but the German economy will be battered, along with the rest of Europe, and that will be its weakness. By extrapolating current trends into the future, where should be invest money? The first answer is "buy precious metals", and that may also be the right answer. But, everyone has that in mind these days. What about other strategies? How can investors preserve or increase wealth in a coming time of turbulence and troubles? Any new ideas?
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.