from: Casey Dispatch...

The Operation to Bail Out the World

Two days ago in New York, US Treasury Secretary Timothy Geithner uttered the words, "There is no chance that the major countries of Europe will let their institutions be at risk in the eyes of the market."

He then went on to relate that Germany's increasingly beleaguered Angela Merkel has committed, along with the other strong eurozone countries (read: Germany), to do whatever it takes to assure that they were "not going to have a Lehman Brothers."

Translated from bureaucratese, what the Sec. Treasury was telling us in the first instance was not that the European banks are at risk of failing - they clearly are - but rather that the eurozone governments will do whatever it takes to mask that stark reality from "the market."

As to assessing the scale of the risk, there is an excellent >

Namely, it is that the Sec. Treasury, Merkel, and leaders from the other eurozone countries are determined to not allow Greece or the other not-so-little PIIGS to default.

What a relief, to hear Geithner and Merkel be so confident that such a bailout can be organized and made to stick. I mean, when individuals of this caliber state things as if a fait accompli, how can we not believe them?

(Well, there was that time that Geithner emphatically stressed that the US government could never

Allowing for just a smidgen of skepticism, we have to pause if only momentarily to reflect on what has to happen in order to honor the PIIGS pledge or, put another way, just how such an operation to save the world might proceed.

For instance, to avoid default, interest rates on Greek debt (as well as on the other PIIGS) must return to levels that the country's recalcitrant government will actually be able to keep up with.

Historically, yields on the debt issued by a reasonably stable country would be somewhere below 5%. At that level, the cost of servicing such debt is considered manageable. Unfortunately - as you can see in the chart of interest rates on two-year Greek government paper - at better than 50%, Greek rates are somewhat more elevated than that.

On viewing that very same chart, our own Bud Conrad commented:

Soaring interest rates on two-year Greek debt clearly indicate there is no confidence in the Greek government, or in the ability of the stronger countries of the eurozone to fix the situation there, and so the debt has moved into the category of being destructive. The big drop from 75% to 50% from the positive statements from the three big government institutions on Thursday gave a big boost to the equity markets in Europe that followed through to the US. Greece is over the cliff, but it is unlikely to last.

Meanwhile, interest rates on one-year Greek government debt are even worse at 108%, but down from 145%:

src="http://www.caseyresearch.com/sites/default/files/resize/image4_13-490x351.jpg" border="0" height="351" width="490" />

Looking at the soaring cost of Greek credit default swaps (CDS), we see that the market is now rating the probability of a default by Greece at 98%:

David again.

And it's not just the CDS traders, but the average people and the businesses they run, that are starting to run for cover. In this next chart, one can see the accelerating move out of European banks by household and corporate depositors.

Again quoting Bud, "This is looking like the beginning of the end of the euro."

Now, I'm not going to delve once again into the eurozone's structural flaws - flaws of the sort that leave German taxpayers paying for early-retiring Greeks - and why those flaws assure its eventual demise, at least as now constituted. In that the demise of the euro is inevitable, talking about it is akin to having a conversation about whether the sun will set this evening.

What is worth considering, however, is what actions the government(s) might take to try to keep the wheels from falling off, even as they do fall off. Understanding those actions might give us a chance to anticipate market reactions and related investment opportunities.

Still lending a hand, here's Bud:

Germany is activating its bank bailout program that was used in the 2008 crisis, obviously preparing for default. German banks holding Greek debt will take at least 50% haircuts on the debt, and the German government will be faced with supporting them.

The first point is that the Greek bailouts haven't worked. I expected that this would not be resolved positively in 2010. Despite the short-term positive news that the next tranche of $8 B is supposed to be delivered by October, I think the confidence has been lost in ever returning the current debt to full value. They are beyond fixing now, even though they will get another round of funds. The other dominoes are likely to fall as investors move to CDS against the possibility of defaults in the other countries.

Investment opportunity? Short European banks. You might want to consider shorting the euro. This service is not designed to go into specific investment recommendations, but there are a range of options - from futures and options markets to inverse euro ETFs or even long-dollar ETFs (such as UUP), as the dollar should benefit as the outflow from the eurozone continues.

Of course, one of the best trades remains to buy gold and silver on the sort of pullback we saw this week. As I write, gold is trading back over $1,800; anyone care to bet that it will trade at $1,900 long before it hits $1,700?

Other actions we can expect to see - and in fact already have seen - is for the US to firmly grab hold of the European tar baby. After all, it's not like we have any problems of our own.

And so this week, the Fed announced that it was once again firing up the operations required to swap dollars created out of thin air for collateral denominated in euros, which is to say backed by nothing and no one. The last time around that such operations were carried out on any scale, in 2008, the Fed shipped $600 billion to Europe.

(Interestingly, much of that money made its way back to the US to buy up Treasuries, helping to keep Treasury auctions humming and interest rates low. The technical phrase for such operations is, "You scratch my back, and I'll scratch yours.")

While the markets were fooled by the "big announcement" - with Greek government yields falling (as you can see in the charts above), the stock markets rallying, and the barometer metal of gold falling - any happy thoughts engendered by the notion that the Yanks are riding once again to the rescue are certain to be short-lived.

How can I say that with a degree of confidence matching even that of Geithner?

Well, besides the fact that the US is riding in on the proverbial dead horse of a fiat currency backed by a government whose own revenue deficits are almost Greek-like, it is that the pushing around of stacks of currencies - no matter who they are issued by - does absolutely nothing to diminish either the underlying sovereign debt that is the pounding heart of the crisis or resolve the structural issues to which I earlier alluded.

Interestingly, or should I say "predictably," US banks are also grabbing hold of the European tar baby. The following excerpt is an article entitled

If there are lessons to be derived from all of this, they might be:

1. As we have predicted, the leadership of the eurozone economies is doing everything it can to try to keep the euro from failing. As is always the case, the US is happy to engage itself in Europe's problems, once again confirming this crisis as being both sovereign and global in nature.
2. The US dollar may benefit for a time from the European exodus, but as the US financial house is in no better shape, it would be foolish to be optimistic about the longer-term outlook of the dollar.
3. There are powerful forces at work in today's world - forces which, like those weighing on tectonic plates, are ready to snap at a moment's notice. If the volatility index returns to anything close to recent lows, back up the truck on the long side.
4. This is far from over. At this point, statements delivered with confidence by Geithner, Merkel, or any of the other players at the top of the smelly sovereign heap should be treated as bald-faced lies. For obvious reasons, th ey are talking their books, hoping against hope that some sort of miracle will appear and make everything good. But absent the defaults and restructurings that they are trying so hard to avoid, their hopes are false hopes.

Playing the broken record, buy gold and silver and related investments on dips; bet on volatility; expect the eurozone to hit a wall; and in time, the fiat monetary system with the US dollar as its foundation to be tossed out in favor of something based on something more tangible than political promises. As the problems ricochet around the world, and the contagion spreads to the US, betting on US interest rates rising from today's unsustainable low levels will prove to be the trade that just keeps giving.

Relevant to that last point, the Chinese are becoming vocal about their intentions to diversify out of US Treasuries and into things more tangible. Quoting an article by Ambrose Evans-Pritchard entitled

"The incremental parts of our of our foreign reserve holdings should be invested in physical assets," said Li Daokui at the World Economic Forum in the very rainy city of Dalian - former Port Arthur from Russian colonial days.

"We would like to buy stakes in Boeing, Intel, and Apple, and maybe we should invest in these types of companies in a proactive way."

"Once the US Treasury market stabilizes we can liquidate more of our holdings of Treasuries," he said.

To my knowledge, this is the first time that a top adviser to China's central bank has uttered the word "liquidate". Until now the policy has been to diversify slowly by investing the fresh $200bn accumulated each quarter into other currencies and assets - chiefly AAA euro debt from Germany, France and the hard core.

As Doug Casey has often commented, once the dollars held overseas - in sum, estimated at something like $7 trillion - begin flooding back into the US, that will only worsen the coming inflation in the United States.

Of course, if the US could get its fiscal and monetary houses back in order, perhaps such an eventuality could be avoided, but that is a very big "if." And on that topic, I turn the page over to Bud Conrad while I go fishing about in my email inbox for Friday Funnies.

Deficit Borrowing Is Right Back on Track

By Bud Conrad

With all the political hullabaloo around raising the debt ceiling, one might've thought the world would come to an end if it didn't happen. It wouldn't have, and both parties knew it. But the Democrats had to pretend that creating a higher limit was a dire necessity, and the Republicans had to pretend that they opposed it.

One thing we might have hoped for was that the contentious wrangling over the issue might have served as a catalyst for actually moderating the rate of government spending. Alas, no luck there. Once the ceiling was raised, Washington got right back to business as usual, furiously racking up debt to compensate for money it wants but doesn't have.

In fact, the government managed to go $250 billion further into hock in a single day - the day after the new limit went into effect. Don't know how they did that. But chances are, most of it went to pay back the civil service pension funds from which the Treasury had borrowed in order to keep the engine running during the flatline period in the chart below.

Whatever the case, the federal government is now right back on track to shove us $15 trillion into the hole by year's end (figures taken from the official website, >http://sg2.caseyresearch.com/wf/click?c=flkojQoVnV4U9n9PwF8wibXq%2F8JL1n1%2BeRHxW0SD9QRWtRfbT%2BUuJ%2FYfCMhniCIEzC%2FV0ipkfj1JdVydsqc4ulVgP6HxdV77GZQMVcKzfjI%3D&rp=Kpv%2F37B0esXEGpterEOfMCgdd0YUUwtELfttfVdZIdYksrMVd4bD17tBc2RSr2R8&up=rbkHj%2BCq8sUBxy8N%2Fijcg%2FSUrO3LgKu2dY%2FJWGss12c%3D&u=ddz8FbY5TbGLz9fsEnZ_hw%2Fh14" src="http://www.caseyresearch.com/sites/default/files/resize/image7_5-490x356.jpg" border="0" height="356" width="490" />

(Click on image to enlarge)