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Making money from junkies

February 16, 2010
Bangkok, Thailand

The popular press has been bandying a lot of cute acronyms for the ‘sick’ European countries. I have seen PIIGS, STUPIDs, and DUHs… and while the individual circumstances of each country are different, they all have one thing in common–

Their obligations far exceed their assets, and they have to borrow money just to pay interest on the money that they’ve already borrowed.

We don’t need a new acronym because there’s already a word for it: junkie. Before too long, the entire euro zone may be heading in this direction… in fact, while the final nail may be a long way off, markets are clearly starting to build a coffin for the euro.

To give credit where credit is due, I believe that Doug Casey and Jim Rogers were among the first well-known figures to declare the euro ‘doomed’ from its inception.

Their idea, long dismissed as a delusional paranoia for the better part of a decade, is now cascading through financial markets as a distinct possibility.

I came to my own conclusions a few years ago when I was traveling through Europe looking for cheap property; I didn’t find any. European costs are much higher than most of the world, and one of the chief reasons is that the governments tax everyone and everything to death.

Yet, despite the high taxes, most European governments were still run budget deficits to pay for legions of useless, omnipresent government workers and social welfare program.

I remember the day very clearly when I came to this realization– I was sitting on a train bound for Giulianova on the Adriatic coast with a gorgeous Italian girl, and the newspaper headline she was reading said “Italy’s budget deficit to exceed the EU limit of 3% of GDP”

That was in 2004 when times were good. I remember thinking to myself, ‘How are these people going to make it during a down cycle when they can’t get their act together during the up cycle?’

More importantly, since European tax rates are among the highest in the world, and the individual governments of the eurozone cannot simply print more money at will, the only way out of a fiscal pinch is to borrow.

It seems so strange that Italy, which collects 43.4% of GDP in tax revenue, can’t figure out a way to make ends meet… and because it cannot realistically squeeze out too much more tax revenue, the government must borrow compulsively.

Italy’s debt level is now well-over 100% of GDP, and investors are rightfully worried.  Given the even more dire situation in Greece, markets are now finally starting to question the legitimacy of the common currency euro zone.

Like all fiat currencies, the euro is fundamentally toxic. It is in a unique situation, though. Unlike the US, European governments don’t have room to raise taxes because their taxes are already so high. What’s more, they have many more social welfare programs and lack the political will to cut them.

That makes Europe first in line for judgment day.

The junkie countries like Greece and Italy will be the catalyst– they refuse to cut their budgets with any serious meaning, and are thus unable to raise any more debt capital from the markets.

That only leaves the prospect of a bailout from Europe’s stronger nations… except that even Germany and France cannot withstand the brunt of multiple bailouts. Obviously, if Greece is bailed out, Spain, Italy, etc. will line up with hat in hand as well.

And while the Greeks may be holding mass demonstrations to protest budget cuts, what will happen when the French start rioting in the streets to protest Greek bailouts?

European financial solidarity cannot stand, and there is no long-term solution except for a breakup of the eurozone. For now, the politically expedient answer is the current dog and pony show– bureaucrats gripping hands in a charade that is long on theatrics, short on substance.

Eventually, though, and it will have to be soon, something has to give. Greece is going to run out of money in a few weeks… so it’s either bailout or default. Neither will be pretty for the euro in the medium term.

The euro may rise briefly if Germany and the ECB signal a bailout, but the long-term implications of the moral hazard will be detrimental for the single currency.

One way to invest is to short the euro against gold and silver (XAUEUR and XAGEUR); I recommended this trade two months ago, and each has returned about 8% so far. I expect precious metals to keep rising against the euro, and to hold their value even if the world resuffers another deflationary cycle.

Another implication to consider is the effect on the Swiss franc; the Swiss do not want their currency to appreciate too much against the euro, and the government there has a history of intervening when necessary, so it may be worth opening a short position on the franc in the next few weeks.

Lastly, the implications for the US dollar and yen are significant. Until the global financial system agrees on another safe haven that can absorb massive capital inflows, the dollar and yen should see continued appreciation against the euro until the market’s anti-euro fever has bottomed out.

More on this in future letters. Happy investing.

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About the author: Simon Black is an international investor, entrepreneur, permanent traveler, free man, and founder of Sovereign Man. His free daily e-letter and crash course is about using the experiences from his life and travels to help you achieve more freedom.

Comments on this entry are closed.

  • http://NONE REX

    Hi simon, a few articles ago you ahd mentioned about the intrusive body scanners at the airports!?! I haev a friend who works at an airport that currently has one of these intrusive amchines and he told me the following. If you want to avoid going through it, tell the security people that you suffered a rotator cuff injury and because you have no insurance, you cannot get it taken care of. For those of you who do not know what a rotator cuff injury is, this injury prohibits a person from raising your arm(s) all the way up. depending on how bad the injury is, some can only raise it up half way and to go through the x-ray machines (that infuses bubbles in between your DNA, (no joke) which we are not sure what the potential harmful side effects are going to be) a person has to raise both arms above their head. BEWARE! Make sure to not raise or lift anything with this arm of your choosing because you will want to make sure that your story is true.

    I am sure many of you know that the airports (in the U.S.) have many undercover government personel watching, as they appear to be travelers, and if you use this ruse then make sure you do not use this arm in assisting your overhead luggage placement too. If one of these thugs is observing your situation and they follow you into the plane and see you raising that same arm above your head for whatever reason then you may be getting some unwanted attention if you know what I mean.

    As I always tell my cat, “There is more than one way to skin a dog!”

  • JT

    Not really related to the post, though I’m a citizen of one of the EU junkies… but I watched a flick that reminded me of you man – Tailor of Panama…

  • Joe

    I like your thoughts on the overly indebted Greece and Italy and how it effects the Euro, but I think you fail to consider the Greece (California) and the Italy (Illinois) in the US. The soon-too-arrive necessary bailing out by the FED printing presses will also effect the US dollar too.
    There may be just a delay in the loss of confidence of the US dollar, but it’s coming, and the Yen belongs to a nation that has maintained zero interests rates and quanitive easing for some time, and is losing it’s job force to old age and market shares to China.
    I think China could surprise the Financial markets with a ……… Not really sure, but it will involve their currency and their new bond market.
    You have some thought on this I’m sure, and would love to hear them. Joe

  • brian

    OK, I’ll bite. PIIGS I know, but the other acronyms escape me, and nothing comes up on Google save a link to this article. Who are they?

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