James Rickards interviewed by James Turk

James Rickards is talking candidly with James Turk of GoldMoney.com, about economic issues around the world, especially the Euro countries, the US and China. A common thread throughout the interview is the impact on the value and uses of gold. He also speculates freely about what various outcomes might look like as politicians wrestle with ways to create a needed solution and still be reelected. The interview took place during August 2011 and is still relevant.

Economic Condition Review

Here at the end of the 3Q2011 all eyes are focused on the European Union (EU), the European Central Bank (ECB), the International Monetary Fund (IMF), the Federal Reserve Bank (FRB), and now laser like focus on the 17 European Monetary Union (EMU) parliaments who are individually considering their agreement to further assistance for Greece. The process is complicated by the complexity of the euro currency experiment. It is also complicated by the number of politicians in positions of influence. I hope cynicism is reaching high tide. The danger is extreme if there is not a plan developed to corral the ripple effects from what is expected to be substantial losses to major banks who are Greece's sovereign debt owners. One danger is that there is a known lack of adequate reserve capital at several European banks due to their investment in the sovereign debt of Greece and other over indebted countries. Compounding the problem is the lack of detailed information about credit default swaps intended to hedge risk on Greek debt. Lack of information deepens the fear.

The probability of Greece's default is high as reflected in the yields for their debt. Greek 2 year bonds yield 65.24% and their 10 year debt costs them 22.67% as of 9/29/2011. For reference, 10 year bond yields in other EMU countries are Germany at 2.01%, Italy at 5.58% and Portugal at 11.16%. The US Treasury 10 year is at 2.00%. The problem is how to contain the eventual wreck.

Economic Condition Review: June 2011

The last economic review I did for the blog was in January 2011. At that time conditions for the US economy felt hopeful with corporations getting ready to announce good to great business results and guardedly optimistic business outlook messages. Food and energy inflation were an established factor in the US and the rest of the world. QE2 was adding fuel to inflation and to the prices for most commodities, especially the money hedges, gold and silver. The US$ was weakening, reaching a recent low near 73 (see graph below). A review of the weekly market data for January 14 is linked here. Company share prices elevated for much of the early part of earnings season before hitting a ceiling in mid February and suffering a March pullback in sympathy with Japan's enormous tragedy trio, earthquake, tsunami and nuclear power plant catastrophe's. The US markets recovered to the year-to-date high at the end of May.

Now in June, the world is captivated with concern about the bank and sovereign debt crisis in Greece. The concern is over the terms by which it will be resolved and when. The political forces are at work, the ECB, the IMF, and the US Fed are all applying pressure. The Financial Times describes the situation as "A Defining Moment for Greek Debt". A play on words since the article is about the definitions given to what everyone perceives to be a 'credit event' in Greek sovereign debt, involving credit default swaps. Eurozone forces feel the resolution is to deepen the austerity of the Greeks putting the problem on the back of labor as well as insisting that the government sell prime assets, such as state owned transportation and valuable land assets. Bloomberg describes the situation here. The proposals are being met with resistance from Greek labor unions. It remains to be seen how the government decides what to vote. Will they shun the political force representing the banking/eurozone interests or will they adopt an Iceland type reform to protect their assets from fire sale and force losses on the financial system. If they choose the latter, the potential exists for wide ranging credit related losses for European banks and possibly other money center banks around the world too.

The US Fed has announced they do plan to end QE2 as planned at the end of June. Until then, they are still in the markets supporting asset prices. A widely held view, that I share, is that there will be some form of market manipulation choreographed by the Fed until they get enough political support for the next QE. It will take a good financial scare to move the political will, so this is the time to be patient, waiting to take on risk. John Hussman writes that more QE will be politically aggressive in the face of a discouraged populace and critical global community. In addition, the lack of evidence that QE has been successful would support its abandonment. But the final decision likely revolves around the determination of Fed Chairman Bernanke to maintain the practice.

One Eye on the Euro

Here is a part of an interview dated May 23, 2011 and published in the online Der Spiegel, with Jean-Claude Juncker, the prime minister of Luxembourg and president of the Euro Group. To me, he is disguising his fear about the potential for another financial crisis if there were a technical default by Greece. A default will trigger credit default swap (CDS) claims. It seems that Juncker is acknowledging the danger in his veiled warnings of "the banks in Germany and Europe, would have an enormous problem -- with incalculable consequences for the financial market." and also "we would be letting a genie out of the bottle without knowing in what direction it will be flying." One alternative being discussed and getting traction is not technically a default. It calls for the current debt issuer to offer a voluntary restructuring of their debt with Greece. In other words, the lender says to Greece before you default let's agree on a new debt agreement that keeps you a sovereign nation for a couple more years and prevents a default from igniting a potentially widespread financial crisis. That would accomplish what Greece needs and prevent the world from experiencing another financial crisis in the immediate future.

SPIEGEL: The country's debt burden is so large that even tough austerity programs and loans are not enough to pull it out of the crisis. Why don't you finally admit that Greece is broke?
Juncker: Greece is not broke. That is what the experienced experts with the International Monetary Fund and the European Central Bank tell us. I am firmly convinced that, in a joint effort, we can lead Greece out of the crisis.
SPIEGEL: The total debt amounts to almost 160 percent of Greece's economic output. With such a debt burden, how is the country ever supposed to make any headway?
Juncker: The United States and Japan also have high debt levels, and yet no one would claim that those countries are bankrupt.
SPIEGEL: But Japan and the United States have their own currencies, which they can devalue, if necessary.
Juncker: That option is not open to Greece -- I'll acknowledge that. Nevertheless, it doesn't mean that the government is powerless. On the contrary, Greece can bolster its competitiveness, and it can pursue a reasonable economic policy and generate more growth.
SPIEGEL: Hope springs eternal.
Juncker: No, I am just considering the alternatives. If Greece were to declare a national bankruptcy tomorrow, the country would have no access to the international financial market for years to come, and its most important creditors, the banks in Germany and Europe, would have an enormous problem -- with incalculable consequences for the financial market.
SPIEGEL: But you exaggerate. The European lenders are in a better position than two years ago, and now many countries have established their own bailout instruments to protect against bank crashes.
Juncker: I would be cautious in that regard. We are still at the epicenter of a global crisis. We are dealing with largely irrational markets, nervous investors and rating agencies whose conclusions don't always make complete sense. I'll stick to my argument: In the case of a national bankruptcy with a subsequent debt restructuring, we would be letting a genie out of the bottle without knowing in which direction it would be flying.

Greece Debt is a Disaster, But for Who?

Martin Wolf appears on Yahoo Tech Ticker to describe his understanding of the debt problem of Greece and how it might impact investors and the government entities who have provided emergency bailout loans. One unknown is, who are the investors who get hurt. Wolf speculates that a debt crisis is less damaging when it is anticipated, like in the case of Greece. He feels that the debt holders are preparing now. Let's hope with him that the creditors to Greece are prepared for an inevitable writedown! He does not mention the potential contagion caused by credit default swaps being triggered and we learn again that they are useless in a default when one of the counter parties is unable to meet their obligation in the default of debt. Unfortunately, there is too little transparency in this market. The fact that the risk is not spoken about explicitly, and officials talk in couched terms about "massive contagion" and "incalculable consequences", should alert informed investors about the fragility of the resolution of the Greek debt. It may be a small contributor to world GDP, but it is now in position to be very influential to the stability of a financial system that has not recovered from the crisis it generated in 2008.

More Analysis of Greek Debt

This from Credit Suisse:
• We still think it unlikely that Greece would leave the euro: Greek net foreign liabilities are high at 88% of GDP (rising to c180% if Greece left the euro with a devaluation of c50%); cheap ECB loans are 33% of Greek banks' funding: without this, the loan book might have to fall c20%; a Greek exit could trigger capital flight from peripheral to core Europe, requiring considerable deleveraging in the periphery; the ECB owns cEu50bn of Greek bonds and the EU/IMF have lent Greece Eu53bn; leaving the euro could mean leaving the EU.
• We also think on balance Greece would choose to avoid early debt restructuring, given that: it would only be in a good bargaining position when it runs a primary budget surplus (vs. a 1% deficit this year); Greek banks' annual PPP is equivalent to 3% of loans, thus the longer the restructuring is postponed the less recapitalisation of banks is required; Greece has only a Eu27bn funding shortfall in 2012E.

Thinking About PIIGS

The debt crisis unfolding in Greece, and another probably coming up in Portugal and maybe even Spain, is interesting for me. It is an opportunity to deepen my understanding of what it means to be involved in a debt default which could be our experience someday in the United States. I have read the size of these economies, as a percent of the European Union (EU) GDP, is reported to be about 2% for Greece, Portugal is less at 1.5% and Spain is a meaningful 9%. So why all the fuss and worry over the two small economies?