There is a significant chance that the Euro itself will collapse in the coming
weeks or months. Although the highly likely Greek government default may act as
the trigger, the collapse of the European Monetary Union (EMU) and its currency
is a quite different event from a single minor member defaulting on its debts.
As discussed herein, the potential rapid annihilation of what used to be a
global reserve currency could lead to one of the fastest and sharpest
redistributions of wealth in financial history. If catastrophe takes down
Europe's economy and banking system, then we may see repeated tidal waves of
business collapse and spiking unemployment spreading out from the EU, and
slamming into the already weak but tightly interlinked economies of the US,
Japan, Canada, Australia and others.
At the same time there will be enormous windfall profits for some governments
and for many millions of individual citizens. For many, whether they gain - or
are destroyed - will be more or less happenstance. However, if we see the waves
coming and are prepared, there are personal steps we can take to change whether
we are likely to be one of the victims or one of the beneficiaries.
We'll get back to how that wealth redistribution could occur, and who would
benefit and who would lose - but first and foremost, keep in mind that while
there is a strong chance of currency disaster - it is not preordained. In an
attempt to avoid global depression, the governments involved are working
feverishly to keep the Euro from collapsing (keeping in mind the distinction
between the entire European Monetary Union and Greece). When making your
financial preparations, be sure to take into consideration this keen motivation,
as well as that every aspect of the "rules" is determined by these governments.
It is worth noting that changing every banking, accounting and money-related
regulation or law before a collapse, is considerably easier than dealing with
global depression post-collapse. Most of all, never forget that through the
monetary creation ability of the collective central banks, there is an
effectively infinite supply of money to work with.
When considering this extraordinary motivation and the full power of
governments, there is a quite respectable chance that we are instead entering a
period of rapid change in how the global order is structured, rather than total
collapse. It isn't "game over" for the Euro - YET - as there are a powerful set
of governmental tools available that can fight what looks to be inevitable under
the current rules. It should also be noted that the preservation of the Euro is
not necessarily the "good" outcome - far from it - as it could instead lock into
place dysfunctional economies, hollow banking systems, long-term high rates of
unemployment and the systemic Financial Repression of investors, all under the
control of an increasingly powerful international State that grows ever less
responsive to voters in individual nations.
However, the remaining lifespan of the Euro and the European experiment could
nonetheless be measured in weeks by the time you read this. What history
teaches us is that mistakes and accidents do happen. This is particularly
likely to be true in times of enormous stress when crises are rippling back and
forth around the world, and when the vast scale and complexity of the problems
exceed the abilities of the leaders and their advisors. Greece could default
any day, absent some swift and major changes - and Portugal, Ireland, Italy and
Spain could be put fully into "play" with dizzying speed when Greece goes down.
There is a desperate need for a unified approach in defusing the crisis, but
Germany is in disagreement with France, while the United States with its crucial
control of the dollar is in disagreement with both. While the Treasury
Secretary and Chairman of the Federal Reserve are fully engaged, most of the
leadership of the United States seems more concerned with partisan politics and
seeking political advantage for the 2012 presidential elections rather than such
details as the looming potential for an economic collapse of the West,
accompanied by rising national security risks.
Perhaps the biggest variables of all are what choices will be made by China
and a few other select powers. Financial writers are notoriously myopic when it
comes to the geostrategic, and often forget that there is much more to power and
history than income statements and the simple extrapolation of the current world
order into the indefinite future. Yes, China could act as a savior of sorts for
the West in order to keep its export markets going, or it could meekly accept
being dealt a crippling economic blow if its markets for exports collapse.
Or China could with calculated self-interest seize the moment of its rivals'
greatest collective vulnerability to make a decisive move for global ascendency,
putting a deliberate knife into the back of the EU and the US economies. It is
a moment of vulnerability that a resurgent and energy-rich Russia - or radical
elements within Islam - might also try to seize in an attempt to change the
global power structure. Weakening empires at vulnerable moments have
historically attracted wolves, rather than helping hands from those peoples whom
the empire has been attempting to hold down as second-class nations.
The future is in play as Greece teeters on the brink, and while it is highly
desirable to "game" the scenarios in advance, be profoundly skeptical of anyone
claiming knowledge with 100% certainty of what will be coming next. The
governing concept is volatility, and the likelihood of a sharp change that may
turn the familiar status quo upside down - whether currency meltdown, increasing
control by the national governments and international organizations, or global
power struggle - rather than the certainty of which particular sharp change it
will be. The scenario we will explore in this article is of currency meltdown,
and how personal wealth would be rapidly redistributed.
A Speculative Exploration Of Euro Meltdown
(Part of what follows was first published as "German Windfall Profits From
Exiting The Euro" in April of 2010, when the question of the survival of the
Euro was first rising to prominence. Much new analysis has been added as well,
particularly regarding currency speculation considerations and precious
metals.)
Germany is a nation that fears inflation for good historical reason, and
among the nations of the world, Germany places a particularly high priority on
price stability. Yet, so long as Germany remains in the European Economic and
Monetary Union (EMU) with the euro as its currency, Germany may not be in
control of its own inflation. In particular, the current crisis with Greece -
and the crises that may follow with other nations such as Portugal, Italy, Spain
and Ireland - may prove disastrous for German investors and taxpayers. For so
long as it remains in the EMU, Germany may have no effective choice but to bail
out countries that have been running up huge deficits – despite Germany itself
not having the economic capacity to do this for all of Europe on an indefinite
basis, let alone the political will to do so (as reinforced by recent German
elections).
If the Euro collapses, it may create an enormous financial windfall for
millions of individual Germans, as well as German companies, not to mention the
German government. While leaving the monetary union is still far from certain,
as Germany also has strong economic and political incentives to stay in the EMU,
in this article we will say “what if” and explore some of the startling benefits
for nations and individuals of quickly exiting a failing monetary union – as
well as the many perils. But while the specifics of this article are primarily
about Germany, the implications go far beyond Germans and Germany (although
there are very important implications for arbitrage opportunities with German
companies). That is, in this world of financial crisis and sovereign debt
crisis, there are powerful related wealth and financial security implications
for individuals in every country.
(Please remember that the European Economic and Monetary Union (the EMU) is
not the same thing as the European Union (the EU), and Germany may potentially
leave the monetary EMU without exiting the political EU.)
The German Government Windfall
First let's consider the current German government situation. Total
outstanding government debt in Germany is equal to about 1.7 trillion euros, and
as of 2009, equaled about 77% of the German GDP (according to the CIA World
Factbook). Now let's assume that Germany does exit the economic and monetary
union, and when it does so, it creates new Deutsche marks that are exchangeable
one for one at the valuation for euros as of that exit date. After the exit of
Germany, let's make the reasonable assumption that Germany's economy remains
strong, at least relative to much of the rest of Europe. Let's also assume that
with Germany exiting, and perhaps France exiting behind it, that the European
Monetary Union is left with the weaker members, whose ability to repay their
debts looks highly questionable to the world in general and investors in
particular. So the euro plunges.
For our scenario, we’ll assume an immediate sharp drop of the euro in the
neighborhood of 30-40% when Germany exits the EMU, relative to the new Deutsche
mark. This value differential is assumed to rapidly increase as an inflation
differential builds, and more strong nations leave the euro. After the passage
of a period of time – and it could be weeks or it could be years – we'll assume
the currency exchange rate is now 10 euros for every Deutsche mark. In other
words, we'll assume that the euro loses 90% of its value relative to the
Deutsche mark. (This assumption is not a precise projection, and there are
cases for higher and lower projections, but it does have the virtues of being a
round number and reasonable.)
With this scenario, Germany's euro-denominated national debt is now worth 10%
of what it was when we look at things in Deutsche mark terms rather than the
euro. Keep in mind also that the German government's income from taxes is in
Deutsche marks, rather than euros. Germany is now repaying debt at 10 cents on
the dollar (so to speak) and the value of its outstanding debt has fallen from
1.7 trillion euros down to 170 million Deutsche marks – a 90% reduction in net
debt. Thus, German national debt (ignoring any new debt issuance) as a
percentage of the German economy has dropped from 77% of German GDP down to 7.7%
of German GDP.
How much of that extraordinary benefit is realized in practice depends on
what happens with German contract law internally. It is highly likely that if
Germany leaves the European Economic and Monetary Union and replaces the euro
with a new Deutsche mark, that there will be a wholesale statutory revision of
internal German contracts, such that what was once payable in euros is now
payable in the new Deutsche marks. If this happens, it will minimize many of the
internal effects such as the value of German bonds held by a German bank, and
this may keep the German banking systems’ government bond portfolio from being
effectively wiped out. However, this probably won’t apply on an international
basis, except in the unlikely event that Germany can get full reciprocity from
other nations (with German investors who hold euro-denominated investments in
other nations receiving payments in Deutsche marks instead of euros). Therefore,
international transactions are where the major transfers of wealth are likely to
occur, and Germany may reap a major windfall profit with foreign investors in
government bonds, while not enjoying a windfall at all with domestic investors.
(The key principle discussed above is that repegging a currency under
statutory law has quite different internal legal consequences than does ordinary
inflation domestically destroying the purchasing power of a currency.)
The Economic Essence & A Race For The Exits
Germany repaying euro-denominated debts when it is no longer in the EMU
illuminates two essential elements of sovereign debt. The first is whether the
debt will be repaid, and the second is how much the repayments will be worth.
International investors in German debt identified Germany as being a financially
responsible nation that pays its bills, and they are quite likely to have every
euro of debt repaid to them (particularly under the circumstances outlined in
this article.)
However, Germany didn’t actually borrow in its own currency, but rather in
the currency of a monetary union. Therefore, while it is an unintended
consequence, the EMU monetary crisis creates a windfall profit opportunity in
that if Germany exits the EMU, it has a one time opportunity to effectively
repay its external debts in drachmas and liras rather than marks. This windfall
opportunity will carry its own accelerant, because the exit of Germany would
shift the burden to France. France would now face the choice between carrying
much of Europe’s financial burden on its back – or making its own exit from the
euro, and reaping its own windfall profit, much like Germany. This exit would
of course accelerate the destruction of the euro, which would increase the size
of Germany’s windfall.
There is indeed a chance that if France thinks Germany is about to exit, then
French national interest may require it to exit first. Being the first to exit
means reaping the maximum windfall profits from the destruction of the value of
a nation’s national debt.
Now this is certainly not to say that there won't be any economic chaos and
turmoil in Germany, or that the resulting potential shrinkage of the German
economy may not more than offset this fantastic windfall, or perhaps much more
than offset it (with the same holding true of France). All else being equal,
the German and French governments would strongly prefer that there were no
monetary crises with their monetary union partners. The one time debt windfall
from the destruction of the value of the euro may not provide anywhere close to
enough value to voluntarily “cheat” bond investors.
However, if Germany feels it is forced to exit the economic and monetary
union, the debt windfall effect provides a powerful incentive to do it sooner
rather than later. The lower the euro falls, the greater the damage to Germany,
and the less the benefits of the windfall. If things are right on the edge –
the greater the chance that France will strike first, and reap the
disproportionate benefits of being the first strong power to leave. Taken in
combination, this means that while Germany will likely continue to do everything
it can to avoid having to drop the Euro, if and when it decides an exit is
inevitable – Germany will have powerful financial incentives to move with
breathtaking speed in destroying the euro. As will France.
Which leads us to the next essential point: that which applies to a nation
also applies to individuals and companies. And this debt windfall – if it
occurs – will likely leave some German companies and individuals much wealthier
than they were before the crisis, even if Germany as a whole becomes somewhat
poorer.
Two Individuals And The Redistribution Of Wealth
Let's consider two hypothetical German individuals, Dieter and Gretchen, and
examine how the collapse of the euro relative to the new Deutsche mark affects
each of their personal situations. We'll say that Dieter, the first individual,
recently retired after having responsibly paid down all his personal debts, and
that his life savings consists of having accumulated a bond portfolio with
holdings in blue chip European companies as well as various government bonds,
with a value of 500,000 euros. And we'll say that while his income is coming in
the form of euros from outside of Germany, Dieter pays his bills in the new
Deutsche marks within Germany. Furthermore, let's be charitable and say that
despite the global financial crisis, none of the corporate and government bonds
in Dieter’s portfolio actually default.
Once the euro has collapsed relative to the Deutsche mark, the income that
Dieter has coming in falls by 90% in purchasing power terms. For instance, if
he was earning an average of 5%, or 25,000 euros per year in interest, these
payments would now have a purchasing power of 2,500 Deutsche marks.
Simultaneously, the principal value of Dieter’s savings has fallen from the
500,000 euros down to 50,000 Deutsche marks.
After a lifetime of work, what was a very comfortable financial safety margin
has now almost entirely disappeared. So that instead of ample bond interest
payments to finance holidays abroad, Dieter finds himself relying on the public
pension plan in an already stressed Germany with very little money available on
interest income on his portfolio, and with the capital value of the portfolio
itself only worth 10% of what it was terms of what he consumes in his native
Germany.
Gretchen, our second individual, owns a small company that does business
primarily in Germany, but has funding from a United Kingdom bank denominated in
euro terms. With the Euro's collapse, Gretchen sees the income from her
business transform into Deutsche marks even as her debts must still be repaid in
euros. Euros which are now worth only one tenth of a Deutsche mark each. So if
70% of the value of Gretchen’s company was in fact borrowed funds, this 90%
reduction in the value of the euro means that 90% of the value of her company's
debt has been destroyed to the direct benefit of Gretchen. So her effective
equity in the company has gone from 30% of assets to 93% of assets. As a direct
result of what happened with Greece and then Germany, Gretchen experiences a
fantastic increase in wealth from the very same factors that are devastating the
value of Dieter’s life savings.
When we look at these two situations, what we can plainly see is that there
is a massive redistribution of wealth that goes on when we have monetary crises.
Millions of innocent people who've been playing by the rules and responsibly
saving and investing are financially devastated. Other millions of people are
enjoying lucrative profits and tax-advantaged surges in their personal net
worth. With the distinguishing factors in this case being 1) whether they owe
debt or own the debt of others; 2) the currency that is their source of income;
and 3) the currency in which they pay their bills.
Winners & Losers, Currency Speculation & The Deadly Counterattacks,
and Multifaceted Personal Strategies For Multiple problems
The 2nd half of this article is continued at the link below. Subjects
include winners and losers among German corporations and individuals; how
potentially record-setting government interventions from three directions could
prove disastrous for currency speculators attempting to profit from the fall of
the Euro; and the importance of balanced strategies for individual investors in
a deeply uncertain future, with precious metals likely being one of several
components - but not the only component.
