Europe Claims to Have a Plan…Again

10-Oct (USAGOLD) — Gold is pressuring the upper end of the recent range in the wake of the latest in a long string of pledges and promise that a plan to save Europe will be forthcoming. The euro rebounded and stocks firmed on improved risk appetite after French President Sarkozy and German Chancellor Merkel vowed a coordinated “master plan” in response to the eurozone debt/banking crisis by the end of the month. Haven’t we heard similar promises of plans in recent months? The plan now seems to be about inserting an adjective ahead of the word “plan” to make the market think that EU policymakers are getting serious. Nonetheless, it probably bought Europe an additional 3-weeks of time.

The latest plan is expected to include bank recapitalization and perhaps a restructuring of Greek debt. “Restructuring” is a polite way of saying Greece will default. Of course the announcement lacked specifics, the most important being, where’s the money going to come from? The EU summit that was scheduled for 17-Oct was pushed back to 23-Oct, presumably to provide an additional week to finalize the details of the plan.

Last week the ECB took a more accommodative stance, indicating that the central bank would initiate a new €40 bln covered bond purchase program. This came on the heels of the Bank of England’s £75 bln expansion of its asset purchase plan. Meanwhile, the Fed remains fully engaged in its own quantitative easing programs. Perhaps therein lies the answer to that all important question about the source of the money…they’re going to print it. BoE governor Mervyn King stated quite succinctly last week, “We’re creating money because there’s not enough money in the economy.” Well that’s not entirely true, there’s adequate money in the system, it’s just all being held in reserves against the latest anticipated catastrophe…a Greek default and potential contagion.

Essentially the new plan is the same plan that has been in place since the financial crisis began 3-years ago. Governments and central banks respond with extraordinarily low interest rates, a flood of liquidity and debt monetization. The argument in favor of this response is that such measures have been successful in staving-off a complete collapse of the global financial system. However, such measures have also resulted in rather unprecedented market volatility and may well be condemning at least the industrialized nations of the West to anemic growth and high unemployment for years to come. It has become a game of lesser-evils, with the West concluding that the Japanese scenario of a lost decade — or more accurately decadeS — is more tolerable than the political mayhem and systemmic risks that would be expected in the event of a true breakdown of the financial system.

The problem is that in responding to a debt crisis by creating more debt and more currency, we get stuck in a vicious cycle of perpetual slow growth and high unemployment, requiring ever-more monetary response. That’s a grim assessment, and the growth risks are already being confirmed by the central banks that recently initiated policy responses. The debt burden increases, currencies are competitively devalued, which in turn creates increased demand for hard assets like gold.