NIA New Email - 11/07/11

European Debt Crisis Facts and Truth

The mainstream media as of late has been focusing its total attention on the sovereign debt crisis in Europe and seemingly has forgotten that we have a much larger debt crisis in the U.S. that hasn't gone away and is only getting worse. Many global economists have been saying in recent weeks that if the European Central Bank (ECB) only went the way of the Federal Reserve, eurozone nations wouldn't be in the desperate situation they are in today. NIA believes that the ECB has already been acting just like the Fed, just not to the same extent.

Mario Draghi just took over as the new President of the ECB and as his first act in office, Draghi lowered the ECB's benchmark interest rate by 0.25% to 1.25%. The ECB's interest rate of 1.25%, while not quite as low as the Fed Funds Rate of 0% to 0.25%, is still very inflationary. The ECB's primary stated objective has always been maintaining price stability and containing inflation. However, with all of the rioting and civil unrest that took place in Greece in response to major austerity cuts, public officials in countries like Spain have been putting pressure on the ECB to abandon their objective to maintain price stability and instead focus on helping fuel growth.

In May of 2010, eurozone countries along with the International Monetary Fund (IMF) agreed to rescue Greece from default by giving them a €110 billion loan. Of the €110 billion loan, eurozone countries agreed to contribute €80 billion of the funds, including Germany providing €29.3 billion and France providing €22 billion. The IMF agreed to contribute the remaining €30 billion.

Unfortunately for Greece, their bond yields have been skyrocketing and they have been finding it difficult to raise money on their own. Greece is now in need of additional rescue funds. In July of 2011, after Greece's two year bond yield rose as high as 40.46%, European leaders negotiated in Brussels a deal to provide Greece with a new bailout of €109 billion in rescue loans. After this deal was announced, Greece's two year bond yield declined to 25.66% in just two days.

In August, Greece's two year bond yield started to surge once again, surpassing July's high of 40.46%. In mid-September, Moody's downgraded the credit ratings for the eight largest Greek banks, sending the two year bond yield to a new high in September of 84.52%. In early October 2011, Greece raised their 2011 budget deficit estimate as a percentage of GDP to 8.5%, well short of the 7.6% target that Greece promised to meet as a condition of the bailout package agreed to in July.

In late-October, European leaders abandoned their proposal from July and announced a new shocking bailout plan for Greece. Not only did they agree to give Greece new rescue funding of €130 billion, but in an additional part of the agreement, banks holding Greek bonds have agreed to accept a 50% haircut on the money they are owed by Greece. Greece Prime Minister George Papandreou, instead of accepting the deal on his own, announced that he was going to hold a referendum so that Greek citizens can vote on the deal.

Papandreou's proposed referendum infuriated leaders of Germany and France, who expressed their frustrations with Papandreou and threatened to pull the plug on the bailout deal. Greek bond investors once again panicked, sending the two year yield all the way up to a new high of 107.26%. Papandreou later announced that he was canceling the referendum, but still faced calls from the opposition to resign. Papandreou survived a confidence vote this weekend but is planning to soon step down to allow the creation of a new national unity government.

NIA believes that the best decision for Greece and its citizens would be to turn down the new bailout deal and declare bankruptcy. Greece would be best off leaving the eurozone and creating their own fiat currency. The bailouts are doing nothing to help the citizens of Greece, they are only helping the German and French banks that recklessly purchased Greek bonds at artificially low interest rates. If Greece declares bankruptcy, the country won't self-destruct. All of their infrastructure will still exist, but their debts will be eliminated and Greek citizens will enjoy a higher standard of living.

The only good news to come out of the European debt crisis so far is that the banks are willing to accept a 50% haircut on their Greek bonds. If the U.S. is going to survive its debt crisis without creating hyperinflation, it will need to convince its creditors to take an even larger haircut on U.S. treasuries. Unfortunately for Americans, the U.S. will never admit that it can't pay back its debts. The U.S. debt crisis is even worse than Greece, but the U.S. has a printing press that it will use to pay back China, Japan, and our other creditors, which will steal the remaining purchasing power of American citizens who don't have their savings in gold and silver.

The uncertainties and fears surrounding Greece are now spreading to Italy, which saw its 10 year bond yield skyrocket in recent days to a new Euro-era high today of 6.66%. Greece's liquidity problems began last year after their 10 year bond yield rose above 6%. Many people believe that Italy is becoming the next Greece and is now at risk of defaulting on its debt.

Even though Italy's debt to GDP ratio is 120%, the second highest out of eurozone countries behind Greece, Italy's budget deficit as a percentage of GDP is among the lowest in the eurozone at only 3.9%. It is insane for Italy's 10 year bond yield to be 6.66% with the U.S. 10 year bond at only 2.04%. The U.S. has no chance of ever balancing its budget and will likely see its deficit explode to new highs in the years ahead. Italy, on the other hand, could realistically balance its budget if it implements reform measures to cut spending.

NIA believes that Italy's 10 year bond yield is near a short-term peak because everybody has become negative on Italy all at once. It will likely decline back below 6% in the near future as Italy implements more austerity cuts. America's strategy to grow its way out of its own debt crisis will only create massive price inflation without any real economic growth. Before long, U.S. bond yields will surge faster than anybody has ever seen in history. In a few months, the media will forget about Italy and focus their attention on the U.S.

Although a 10 year bond yield for Italy above 6% may be a new high for the Euro-era, Italy's 10 year bond yield averaged well above 6% for many decades before the eurozone was created. Italy made a major mistake by joining the eurozone. Before joining the eurozone, Italy was able to survive even when their 10 year yield reached a high of 13.75% in 1995. After joining the eurozone, Italy was able to borrow money at interest rates that were manipulated to artificially low levels by the ECB. If Italy's bond yields were still being set by the free market this past decade, they would have no where near the level of debt they do today.

Many investors selling Italian bonds are now buying German bonds, because Germany has a low debt to GDP ratio and one of the world's largest manufacturing bases. German 10 year bond yields are now 1.78%, a record 488 basis points below Italy. This huge spread will not last and NIA believes investors are making a mistake by buying German debt over Italian debt. There is no chance of Italy being allowed to default on its debt. If Italy ever gets to the very edge of insolvency, Germany and France will allow the ECB to monetize Italy's debt. If Italy went bankrupt, many of the largest banks in Germany and France would fail. The ECB will not allow this to happen.

As bad as things are in Europe today, with the media making it seem like Euro Armageddon is fast approaching, you would expect the Euro to currently be collapsing on a daily basis. The Euro, which ended last year at $1.34, has risen so far in 2011 to $1.38. This shows that even with all of the inflation being created by the ECB, it is nothing compared to the inflation being created by the Fed. The U.S. is lucky for the European debt crisis because it is taking attention away from our problems and allowing the Fed to secretly prepare QE3 while our bond yields are still near record lows.

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