Thursday, May 13, 2010

Jim Rickards on the Euro bail out (part 2)

The Euro-bailout and guarantee fund will fail. There are several reasons for this. The initial problem is that governments have borrowed too much and the debt burdens are non-sustainable. How can you solve a debt problem with more debt? All that the program does is to substitute EU debt for the debt of Greece, Portugal, Spain and others. You are replacing national debt with multilateral debt but it's all still debt. And so-called money creation by the ECB is just another form of debt because Euros issued by the ECB are simply paper liabilities of the ECB itself, so-called "notes" so even the money is just debt. Any possible repayment of the debt involves deep austerity, spending cuts, layoffs, higher taxes, reduced benefits and other actions which will definitely cause a depression in Europe and perhaps 25% unemployment throughout the Euro-zone.

The alternative is to print money which will lead to hyperinflation and the collapse of the Euro. So there are no good outcomes. The G20 and the IMF will try to reliquify the system and create new money through the issuance of SDR's. At the same time, people will try to protect their wealth by buying gold. So as paper currencies collapse, the money system will become a foot race between SDR's and gold. Large hedge funds are completely unimpressed with the umbrella for the reasons noted above. They are shorting the Euro and buying gold.

There is one other flaw in the EU plan. In 1992, when George Soros attacked the Bank of England, he did so by selling Sterling and buying dollars. This forced the Bank of England to do the opposite which was to buy Sterling and sell dollars. Since the Bank of England had a finite amount of dollars to sell, Soros knew he could beat them by buying more than they had. However, he needed real money to do this and he was perhaps the only speculator in the world at that time with that much money. Today you do not need money to destroy national finances, you can do this by the creation of synthetic short positions in Euros through the use of credit default swaps (CDS) and other derivative instruments. Goldman Sachs are experts at this. And they can create CDS in potentially infinite amounts since there is no regulation and no margin requirements. In effect, Goldman could create a short position equal to ten times the amount of Euros in the guarantee fund. Goldman can create synthetic short positions faster than the ECB can print money. Therefore, the ECB's plan is doomed to fail because they cannot beat the speculators who can use CDS instead of real money.

- Jim Rickards

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