While most have been predicting the death of the dollar, I have been predicting the possible death of the Euro. It is too early to know exactly how the Euro crisis will play out, but the odds are high that the Euro will not survive in its present form.
The most likely scenario for Europe, I think, could look something like this:
Over the coming months or years, Greece will be forced to break from the Euro Zone and return to the Drachma as its national currency. Greece will then allow its currency to float and seek its true market level, which would result in a major devaluation and a De facto default on creditors.
All those with loans outstanding to Greece would be forced to write down these loans, and the losses could be huge. French banks hold a lot of Greek debt and would come under heavy attack from speculators. The subsequent fall in French bank stocks (Just last week European bank stocks fell dramatically. The Bank of Scotland, one of the world's largest banks, fell 11%. The European stock markets are down eight weeks in a row, and Italy's debt has reached 100% of GDP) would then create a liquidity squeeze, much like what happened with Lehman Bros.
The world financial community would try to rally around the banking system in an effort to save it; but at a tremendous cost. Greece would no longer be able to borrow after defaulting, and the country would be forced to live on tax receipts alone. The result would be the same kind of austerity measures they've been trying to avoid?only two to three times worse. Meanwhile creditors would be licking their wounds after having taken a beating on Greek bonds. Money would again become tight in Europe as creditors pulled in their risk lending and an inevitable economic contraction set in.
As governments and creditors assessed the damage, the market would likely turn to the next weakest link, and begin to attack that country's banking system causing a furious selling off of financial stocks there, forcing yet another country to part with the Euro and reestablish their own currency substantially devalued levels. The likely candidates for this domino effect are Ireland, Portugal, even perhaps Italy and Spain.
If this is the outcome, after the smoke cleared the Euro would be represented by only the strongest, most solvent nations. Europe would be split in two, divided into a group of strong nations (the haves), and a recession torn group of financially weak nations who would then make up Europe's have-nots.
America, I believe, would only be affected indirectly by this deconstruction. The turmoil of this experience would obviously lead to a contraction in world growth, a reduced appetite for risk, and stagnation in many areas of the world. But I would not expect to see the dollar decline in this period. In fact it should rise, except possibly against an eventual new Euro. And I do not think this kind of process would lead to a major decline in growth here in America, although we could experience a technical recession. But once the readjustment process ran its course, growth would pick up once again.
The biggest change for everyone in the world, including the US, would be in the way we live. All of us would have to rely far less on credit and depend more on savings?something many today know nothing about. Higher bank capital requirements will be the standard worldwide for years to come. This is a good thing and would eventually lead us back to bank reserves more consistent with a gold standard's reserve requirements.
In the aftermath of such events the world would seek a currency it could trust; one that wouldn't be easily devalued or inflated away. In a tumultuous environment like the one I describe above, gold together with silver and other metals would have the best chance of evolving as the new currency of choice by people and businesses all over the world.
This is just one of many possible chains of events rattling around in my brain lately. The worst case scenario would be if in the middle of one of these currency and debt crises, people threw up their hands and rejected all paper money. If that happened, the entire international fiat system would quickly collapse.
Post Script:
As this goes to print a back-up plan has just been announced by France, who is owed a load of money by Greece. France will refinance Greece's debt if the austerity plan is voted down later this week, and maybe even if it isn't. The rescue package, which several of the stronger European nations will participate in, amounts to taking the 5 year notes owed by Greece and refinancing them over 30 years at substantially lower rates. This is a De facto default?creditors will not get their principle repaid as promised. This is also an indirect tax on the citizens of those nations, since it is a subsidy.
While this type of bailout is typical, and usually stops the bleeding, the problem has not been solved. The problem is that Greece is spending more than it is taking in. Every day it must borrow more money to make up the shortfall. Obviously creditors want Greece to cut spending to the level of its income and stop borrowing. But Greek citizens do not want to pay their bills by accepting less benefits and paying more taxes.
The resolution will come only if Greece balances its books, or its creditors say "enough!" Restructuring debt is merely a stop gap measure. Each and every month Greece will go back to its creditors seeking more money. The question is, when will the answer be, "no?"
About the Author
Paul Nathan is a contributing commentator for Kitco.com, the largest gold site in the world. Prior to that, he wrote a column called "Dollars And Sense", and for the Foundation for Economic Education. Paul has been posting his weekly commentary and market update since 2004 on his subscriber-based web site paulnathan.biz. His recently released book, "The New Gold Standard," has become the go-to text on the topic for academics and investors.
Paul has had the privilege of meeting Ayn Rand and Ludwig von Mises, taking classes from Alan Greenspan, and participating in economic and monetary meetings with authors, central bankers, and congressmen. He fought for the legalization of gold for all American's in 1975. Through it all he has been a lifelong gold and stock trader.
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