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On the Homefront

The Euro-zone crisis has caused much speculation about the possible effects it could have on the US economy.  But most of it, such as this story, miss the real elephant in the room.  They mention the effect on trade with Europe, which makes up a fairly small part of our economy (especially Greece when taken alone).   There are two things we should be taking away from this that are a lot more troubling than that.

Currency Issues: Because of the devastating effect that this crisis is having on the Euro, many are remarking that the dollar is gaining strength.  This is not exactly correct.  A better way of describing the situation is to say that the dollar isn’t tanking as fast as other currencies.  To see this note that gold is up 7% against the dollar over the last 30 days.  So while a dollar buys more Euros, it buys less gold.  See this recent post by me if you haven’t already.  The concern about the exchange rate between here and Europe hurting US exports is small potatoes compared to the effects of explosive interest rates and inflation that could set in if people start to flee from currencies in general.  To make this worse, our government is likely to see the “strengthening dollar” as an invitation to inflate the currency more to alleviate our debt issues.  This, along with people scrambling for a safe haven for their assets as they flee European capital markets will put increased pressure on the existing currency bubble.

Debt:  The even bigger issue we should be worried about is that we are following the exact same path as Greece.   We are creating cradle-to-grave entitlements that we clearly can’t afford and that people will be very reluctant to give up.  We are destroying the rule of law and the associated property rights that have allowed us to be the most productive country on Earth.  We have demonstrated no ability to either control our government’s spending or generate additional revenue.  We are becoming a socialist country!  It sounds like inflammatory rhetoric but the parallels between us and Greece and every other European country are hard to ignore if you open your eyes and look at them. 

Now the real beauty of the free market isn’t that it never makes mistakes but that it learns from its mistakes.   All the loans that have been made to Greece over the last decade are now being exposed as a big mistake.   The people/banks that made these loans are now being punished by reality.  But the important thing to understand is that they are being punished for mistakes they made years ago.  The crisis in Greece is shining a spotlight on those mistakes.  So what does that mean for us?

Many have pointed out that we are on a pace to have Greece-like levels of debt in twenty years.  This may not seem that urgent, but if you are a trader who is watching what is happening in Greece right now and you are looking at the US, who is going in the exact same direction, are you going to wait until we get there to panic?  Probably not.  We can’t use 120% of GDP as a benchmark for debt problems and figure that as long as we stay under that, we’ll be fine.  Markets will be able to see that we are headed for that and they will collapse before we get there.  And there’s not that much breathing room between us and 120% as it is. 

So we’re going to get a short-term increase in demand for our securities as Europe continues to melt down.  But countries are going to have to learn from this and correct their fiscal situations.  We need to acknowledge that we can’t go on the way we are and make significant changes.  Changes of a magnitude that can’t be achieved by trimming things like “waste, fraud and abuse” around the edges of our budget.  I mean real cuts that people won’t like.  If we take the increased demand as an invitation to go further into debt and print more money, that demand won’t last long.  If we don’t learn from Greece, the markets will.

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