Last week, with liquidity concerns reaching a crisis
point for Europe, central banks around the world, led by the U.S. Federal
Reserve, stepped in to provide emergency measures to insure that the
financial gears continue to turn. At the same time, the European Central Bank
(ECB) yielded to political pressure to rescue the world's second currency by
using an IMF smokescreen to circumvent its own prohibition against making
loans directly to member countries. Lastly, Germany indicated possible
agreement to provide more bailout funds if Eurozone countries would agree to
yield more fiscal sovereignty to German control. Taken together these
measures have certainly provided some relief to markets, as the current rally
attests, but the long term ramifications are harder to assess.
For decades, European banks have been acquiring what
are known as "Eurodollars," which are simply U.S.
dollars held by non-U.S. residents. To a large extent, these funds are
the result of excess numbers of greenbacks sloshing around the world due to
U.S. trade deficits. Trillions of Eurodollars are deposited at European
banks, which are usually loaned out on a fractional basis. To redeem these
loans, European banks need a steady stream of dollars which they
traditionally get in the London-based Eurodollar interbank market. However,
as the euro crisis has evolved, U.S. banks have correctly become distrustful
of Eurozone bank's exposure to the collapsing sovereign bond market, and have
reduced overseas dollar lending. While the ECB can print euros, only the U.S.
Fed can print U.S. dollars. Hence the emergence of a dollar liquidity crisis.
Wisely and promptly, in a desperate rescue attempt
the Fed agreed with the ECB to a new central bank swap of U.S. dollars for
euros at a fixed exchange rate. The ECB was able to provide the dollar
liquidity to dollar hungry Eurozone banks. This, in turn, lowered the cost of
all other dollar swaps. The relief sent the Dow up 400 points in a single
day. From our perspective, by swapping dollars for euros the Federal Reserve
is actually taking risk off the table, and the move, in my opinion, does not
present a worsening of U.S. finances. However, should the euro collapse,
U.S. taxpayers will be on the hook yet again.
But liquidity alone will do little to solve the
underlying insolvency of many European nations, which may only be absolved
through massive debt forgiveness. However, that problem was swept under
the rug yet again by deft political maneuvers.
The ECB was founded on Germanic lines and forbidden,
by treaty, to salvage member nations directly. Germany did not want to create
a political structure whereby insolvent member nations could easily turn to
the central bank for a bailout. To get around this restriction in the current
crisis, the ECB suggested it would lend money to the IMF, which is entitled
to lend to member nations, and who will in turn make loans that the ECB
cannot. As with the dollar swaps the news was greeted with great relief by
world stock markets. However, IMF lending would expose non-Eurozone nations
to the credit risk of insolvent and soon-to-be downgraded Eurozone sovereign
debt. But these risks have been ignored in the face of a global stock rally.
Throughout the whole crisis, Germany has played a
subtle but ruthless game. It has used the prospect of an international
currency collapse as a means to extend German control over Eurozone governments.
To my thinking, this is the latest incarnation of its long held pursuit of a
European Empire. This naked exhibition of national self-interest over
European cooperation has magnified uncertainty, and it has occurred with the
silent endorsement of the UK, which had in the past consistently opposed such
power plays. It appears that times have definitely changed, and that fears of
an emboldened Germany have not passed into the new century.
In order to win for itself
as many economic cards as possible, we can expect Germany to continue playing
economic brinksmanship. The high stakes game will continue creating extreme
market volatility. Various bodies such as the Fed, ECB, EU, IMF and G-20
likely will continue to issue calming statements in the hope that more smoke
and mirrors will cover a building crisis of confidence in paper currencies
and sovereign debt. Meanwhile, greatly increased liquidity threatens high
In such an environment, precious metals remain a
hedge against inflation and a form of insurance against possible catastrophe.
Euro Pacific Capital, Inc.
John Browne is a former member of the UK
Parliament and a current senior market strategist for Euro Pacific Capital. Click here to learn more about Euro
Pacific's gold & silver investment options. For a great primer on
economics, be sure to pick up a copy of Peter Schiff's hit economic parable, How an Economy Grows and Why It Crashes