After numerous jukes and headline rumors, the world finally received a so-called EU solution. After threatening with a total insolvency Greece situation, European leaders were able to talk bondholders into accepting a 50% haircut on Greek debt. Furthermore, the euro zone leaders agreed to increase the firepower of the European Financial Stability Facility. The markets reacted quite well to the news, even if it was just a knee-jerk reaction. The Dow surged 340 points, and is now on track for its biggest monthly percentage gain in nearly 25 years. Gold and silver also had big gains on the news.
On Thursday, gold futures for December delivery jumped $24.20 to settle at $1,747 per ounce, while silver futures gained $1.80 to close just above $35. With the EU plan crafted, where does gold and silver go from here? Unfortunately, the plan does not instantly solve the financial problems of Greece, let alone the world. The plan calls for the EFSF to be increased to 1 trillion euros, by leveraging the fund. The leverage could be done by two ways, either by loss guarantees to buyers of euro zone debt, or by a special purpose investment that will be created in the coming weeks, in hopes to attract investment from China. “The leverage could be up to one trillion euros under certain assumptions about market conditions and investors’ responsiveness in view of economic policies,” said Herman Van Rompuy, the president of the European Council.” This begs the question, how will more leverage solve the financial mess in the euro zone? Leveraged debt is what ignited and intensified the credit bubble. If anything, the EU plan provides more uncertainty about the long-term financial stability of markets. When uncertainty and debt rises, gold and silver tend to do the same.
Greece’s current debt burden is 160% of its GDP. The 50% haircut on Greek debt will reduce the country’s debt to 120% of GDP by 2020. Does this sound like an ideal situation? “Even if investors fully sign up to the plan, this would still be an unsustainably high level of debt,” said Jonathan Loynes, chief European economist at Capital Economics. “Accordingly, further Greek restructuring or defaults seem very likely in the future.” The EU plan sets the financial markets up for more disappointment and more money printing.
The EU plan also requires banks to hold higher quality assets on their books. Core tier one capital levels will be raised to 9%, which means that euro zone banks need to raise roughly 106 billion euros to meet the new levels. Banks may need to receive government support if they cannot raise the money on their own. The EU plan says that “guarantees on bank liabilities” may be needed to assist banks. The key question is, how will EU governments pay for all these actions? “European bank recapitalization remains an aspiration rather than a reality,” said Ian Gordon, a banking analyst at Evolution Securities in London.
I believe this is not the last bailout plan that Greece will receive. Greece already received one bailout of 110 billion euros in May 2010, and will likely need more bailouts going forward. Bailouts do not solve massive debts and spending problems that plague many countries. Attention is already focusing on Italy, which just saw its 10-year bond price at record levels. Gold and silver are hedges against the debt ridden world that we live in. As investors lose confidence in governments and countries, precious metal prices will continue to rise.