A Melman Minute — November 17, 2011

Only the most vivid optimist looking at the financial world through a pair of rose-coloured glasses could fail to see that the European crisis is beginning to spread in truly ominous ways.

I would like to offer a personal analogy. Several years ago, my wife and I had the pleasure of having a delightful dog named “Jasper”. Jasper was one of those ideal four-legged friends who brought companionship and delight to our family. Unfortunately, during the last year of his life, we noticed a swelling on his abdomen and rushed him to the vet. After a thorough examination, she told us there was little to be done other than to keep him as comfortable as possible.

During the next several weeks, we noticed that the number of such swellings began to grow as they spread through his abdomen until, finally, he could no longer walk and we had to take him to the vet’s office for that final journey.

Over the past few days, like Jasper’s swellings, the areas of contagion in the European economic crisis are now beginning to spread to nations which previously seemed immune to such ‘diseases’. What began as a banking crisis in 2008 which directly affected Iceland and Ireland quickly became a debt crisis involving Greece which suddenly began to draw headlines due to that nation’s national debt which was enormous in relation to the country’s productivity.

We were first assured that the crisis had been ‘contained’ by quick action from the European central Bank , but Greece failed to prosper and one crisis followed upon another in that troubled nation. Then, quite suddenly, rumours began to spread that Portugal, Italy and Spain might be in trouble, but those rumours were quickly denied, despite the fact that Portugal required a temporary rescue operation. It was at this point, about mid-2011, that matters began to accelerate.

First, we learned that the level of national debt in each of Spain and Italy dwarfed that of Greece and if those two nations failed to honour their debt, the monetary authorities might not be able to offer solutions to resolve the situation and, sure enough, borrowing rates for both those nations suddenly soared far above rates being offered by economically sounder nations such as Germany and France. When rates in Italy soared to above 7%, making a shambles of any attempt to balance that nation’s budget, panic began to spread. Now, this morning, Spain’s borrowing rate has just touched 6.95% and the added interest costs will make that nation’s attempts to balance its budget appear destined to failure. But that is only the beginning.

In a series of stunning reports we have recently learned that once highly-regarded France - Europe’s second-largest economy - is suddenly entering a period of suspicion about their finances as well and their own borrowing rates for ten-year debt paper have doubled from near two percent to just under four percent. But that is hardly all the bad news.

In quick succession, a parade of nations once thought to be high on the financial stability list began to report difficulties. By yesterday the new roster included Austria, the Netherlands, Finland and, as mentioned, France. These items were then followed by a report that the currency of Hungary, not part of the Euro group of nations, was accelerating to the downside, raising fears of inflation and Hungary night be forced to raise their interest rates which could set up the beginnings of an interest-rate war.

To top matters off, one of the only realistic hopes to get out of the growing quagmire would be for European economies to take off with a rush, thereby increasing taxation revenues while decreasing unemployment, but the opposite seems to be happening as financial sources in Frankfurt just offered the evaluation that, “...The Euro-Zone economy barely grew in the third quarter 2011 despite a temporary bounce in Germany and France, raising fears that the Euro bloc may already be sliding into recession as businesses and consumers cut back on spending in response to Europe’s escalating debt crisis.”

We at TMR believe the heart of the crisis lies in the fact that one European nation after another bought into the socialist creed that the government owes everyone a living, that they must provide free education, free medical care, free retirement incomes, free legal services, all public infrastructure services and an enormous body of regulatory ‘services’ to the general populace as well as reward armies of civil servants with ultra-generous vacation and retirement schemes. All of this must be accomplished no matter what the cost in relation to their nation’s ability to raise valid taxation revenues. The result has been a series of deficit budgets that have caused debt to pile upon debt until finally we have reached the present point where one nation after another has suddenly come to the realization that they are not able to repay that debt.

In order to continue the appearance of fiscal stability, there has been a series of announcements regarding bailouts from a host of organizations such as the European Central Bank and the IMF (International Monetary Fund), as well as other, sounder nations such as Germany. However, it is now beginning to appear that the growing crisis may exceed even those bodies and nations’ ability to provide liquidity to the system.

It is a deepening quagmire, now affecting a host of international banks which for many years have been blindly purchasing debt paper from these nations which now appear to be on the edge of outright default, thereby risking their own capital structures to the point of outright failure themselves.

To make matters worse, Fitch, one of America’s important bond rating agencies, just announced yesterday that in their judgement, the European crisis and its effects could spill over into the American financial systems, both government and private, leaving the United States government’s own issuance of debt paper subject to potential downgrading.

When the financial markets heard that beautiful piece of news, they sold off sharply with the Dow Industrials falling almost 200 points, most of the decline coming late in the session.

In somewhat contradictory fashion, the price of gold actually declined late yesterday and in overnight trading prior to this morning’s openings. We attribute this decline to the typical rush into the US Dollar when other crises loom and this added strength in the Greenback causes all dollar-denominated prices to decline, at least in the short term.

As if all of that was not a sufficient list of problems, the price of Crude Oil (see chart) surged through the $103 level yesterday, kindling new fears of price inflation in America and elsewhere.

All in all, it is not a pretty picture but it is one which, in our opinion, confirms our belief that the future of the precious metals’ prices will contain many more surprises to the upside than the downside.

Regrettably, we must depart early this morning prior to the market openings en route to Montreal for the Cambridge House Resource Conference of November 18-19 where I will be presenting a paper entitled “An Economic Perfect storm” as well as participating in the opening panel on November 18. We invite anyone in the Montreal area to join us for what appears to be a most timely conference, given the array of problems noted above.

If possible, we will transmit a short “Melman Minute” Friday morning, but our next scheduled report will be on Monday, November 21

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