The Great Western Crackup

By Peter Schiff

From World War II until very recently, the West – specifically Europe and the United States – was on a course for greater centralization, greater integration, and greater economic intervention. But this consensus is breaking down. In Europe, the euro has gone from steadily adding new members to now facing the prospect of having its weaker members quit. In America, the US Congressional Supercommittee has now officially failed in its mandate to bring even meager cuts to the bleeding US deficit.

This is the beginning of the end. Both the EU and US are politically paralyzed, seeming only to be able to make compromises that involve more spending, more debt, and more central planning. The results are all too predictable to free-market thinkers: bailouts leading to moral hazard, low interest rates leading to ballooning debt, and eventually a cascade of systemic failures – leading to more bailouts.

This was confirmed yet again on Wednesday when central bankers on both sides of the Atlantic announced a coordinated tidal wave of new money to bailout the Western banking system yet again. Now, we’re left with a world where the only thing you can trust is the gold and silver in your pocket.

Like Lemmings Off a Cliff

The poison of Keynesianism has left the politicians unable to even listen to free-market solutions. Personally, I have found it nearly impossible to find a Keynesian professor or official to debate me – even though (or perhaps because) I have a track record of accurate economic predictions. You would think at least one of them would want to tell me why I’m wrong… to offer some excuses for their failure to predict the dot-com bubble, the housing bubble, or anything that has come after that.

This is just an illustration of what we, as investors and citizens, are facing. The halls of power, the media, and academia are completely closed off from reality. They’re clutching their theories and hoping that they don’t end up having to work for a living like the rest of us.

Europe

I have repeatedly stated that the fact that Germany has been resistant to printing more euros is the main argument in favor of the euro. Of course, the mainstream consensus is the opposite. The same people who pushed for entitlement programs that Western nations couldn’t afford are now arguing that the EU must use the power of the printing press to “help” bankrupt Greece, Italy, Spain, and others. Really, this is just a secret tax on those who chose to save for a rainy day, and it will lead the euro on the road to ruin just like the US dollar.

If Greece, Italy, et al, can’t take the austerity that comes with staying in the euro, they should withdraw and see how the bond markets treat them without the implicit backing of Northern Europe. Either way, they must be made to face the market consequences of their previous spending.

Unfortunately, with this past Tuesday’s announcement that the EU would provide another $10.7 billion bailout to Greece and Wednesday’s bank bailout announcement, there is no sign that Europe’s politicians are going to allow market forces to play out. Instead, repeated bailouts will ensure that other ailing economies, like Italy or Portugal, do not make the necessary cuts in time to avoid needing their own bailouts. And no one, save perhaps China, can afford to bail out the likes of Italy.

Thus, like pulling off a bandaid, the politicians have made the euro crisis more painful by drawing it out. This means more risk and more volatility for investors, causing them to abandon the supranational currency in droves.

America

Abandoning the euro looks like a wise course of action, but it becomes extremely unwise when you buy dollars instead. Remember, my concern with Europe is that they have started down a path that may lead them to the sorry state of the US. If you’re worried that your refrigerator doesn’t get as cold as it used to, you don’t move your perishables to another fridge that won’t even turn on!

The current state of the dollar is the nightmare scenario for the euro: no significant member-states are thriving, bailouts are assumed and given without significant debate, and the money supply is growing rapidly to cover the debts. At worst, the EU could be facing a rump euro comprised of the healthier Northern economies or years of debt monetization to try to “save” the PIIGS. But the US has already spent decades monetizing its debt and is now facing a ‘game over’ scenario. Remember, the EU might be going along with the latest bank bailout scheme, but the US Fed spearheaded it and the swaps are denominated in dollars.

The failure of the Congressional Supercommittee shows how laughable Washington – and, by extension, the dollar – has become. The Federal Reserve is frantically buying Treasuries at auction to make up for wilting demand from foreign creditors, such that it may soon hold 20% of all outstanding Treasury debt. Meanwhile, the Supercommittee failed in its meager mandate to slow the growth of new spending by $100 billion a year, barely a dent in an annual deficit that runs over $1 trillion a year – not to mention the $15 trillion in debt already accumulated. The failure caused ratings agency Fitch to downgrade its outlook on US credit, potentially joining S&P soon in stripping the US of its AAA. Perhaps the analysts at Fitch realize that if the Fed were to stop buying Treasuries, say because consumer prices started rising too quickly to ignore, then rising interest rates would add additional trillions to the debt problem, making default inevitable. Or maybe they’re starting to realize that getting paid back the whole coupon in worthless dollars is just another form of default.

In short, the US is going to be mired in economic depression for the foreseeable future, with no reform efforts likely, and so the Fed will continue printing as much as it can to paper over the problem. This is tremendously bearish for the dollar, even moreso than a euro facing the loss of a few weak member-states.

The Buck Stops Here

The knee-jerk buying of US dollars, which has sent metals prices on a roller coaster this fall, represents pure market manipulation by the Fed. Private buyers and foreign governments were selling dollars and Treasuries before this recent market action sent confusing signals. We saw a short rally, but on Wednesday’s bank bailout news, dollar selling resumed. Overall, the trend remains: the Fed will continue to buy a greater and greater share of US debt until all the new money it’s printing sends inflation into the double digits.

So, in a world where the two major reserve currencies are both faltering, where is global capital going to find safety?

A look at history sees periods of monetary debasement and market mania followed by a return to more fundamental values. Every successful civilization in history has relied on sound money to grow, always in the form of precious metals. With globalization, we live in a world where investors don’t have to live with their governments’ bad choices. Allocating a portion of your portfolio to precious metals means being able to sit on the sidelines and laugh at the comedy of the sovereign debt crisis. It means that when new dollars or euros are printed, your metals simply go up in price.

That is the ultimate resolution to this crisis. More banks, institutions, and individual investors will simply withdraw from the fiat money system and rely on precious metals as their reserve asset. As they do so, the fiat system will be all the weaker for the those left behind. After this period of uncertainty, a new consensus is sure to form, and the 24% run up this year alone indicates that gold may play a central role.

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