Gold heats up as Athens burns

In the decades that preceded Greece's adoption of the euro in 2001 the country papered over its chronic inefficiency and lack of competitiveness with its northern neighbors through regular devaluations of its currency, the drachma. But as a prerequisite to join the Euro Zone, the dominant powers of the Continent, most notably Germany, required financial housecleaning and promises of fiscal discipline. When these goals were apparently met, the Greeks came aboard.

With the benefit of hindsight it is now widely understood that Greece, in common with some other 'Club Med' countries, 'distorted' its financials (largely through accounting gimmickry dreamed up on Wall Street) in order to qualify for entry. No doubt the influx of more than 100 million citizens from these countries swelled the economic heft of the Euro Zone. But these benefits came with a price.

At its core, the euro is a Germanic currency. Similarly the European Central Bank (ECB) has an institutionally Teutonic preference for sound money. Once within the euro, countries such as Greece, Spain, Portugal and Italy, were bestowed a monetary respectability that was previously unavailable to them. But they were no longer able to print their own money, and were therefore unable to camouflage their economic deficiencies with currency devaluation.

In the first decade of the 21st Century, the euro gathered strength as the economic power of the union increased and investors grew nervous about the fate of the dollar. As the relative value of the euro rose, the uncompetitive economies in the euro zone were conferred a wealth that their economies could not justify or maintain. In order to keep the wheel spinning these governments incurred ever greater amounts of debt. But, by issuing bonds denominated in the highly regarded euro, rather than their former currencies, borrowing costs for these nations came down. It was good fortune…while it lasted.

However, when the world's recession began, countries with the heaviest relative debt loads experienced the unforgiving brutality of reverse leverage. Now that payback time has arrived, not just individuals and corporations, but nations are threatened with default.

Originally, the Greek rescue package was billed at $12 billion, then at $30 billion, with Germany providing the lion's share. Today, The Wall Street Journal reports that the rescue package for Greece will total some $133.14 billion over three years. According to IMF estimates, in 2009 the Greek economy accounts for just 2 percent of the European Union's. If the larger economies of Spain, Portugal and Italy need financial bailouts, the sums involved may amount to trillions of dollars.

Following World War I, Germany was crippled by the payment of the massive war reparations which forced it to print many millions of deutsche marks. The result was the notorious 'Weimar Inflation,' which at its height pushed the price of a single loaf of bread to 1 Trillion deutsche marks. In the end, many Germans fired their heating boilers with paper currency, which was cheaper than coal or wood. Gold however, held its value. As a result, its local purchasing power rose dramatically. It was said that at one point a single one-ounce gold coin could buy an entire city block of Frankfurt.

While the current round of printing by the Federal Reserve and other major central banks does not yet match the relative speed and intensity undertaken in Weimar Germany, there are many indications that we are headed in that direction. The world is now awash with excess paper currency which threatens heightened inflation on a global scale. But inflation is not the only problem. Financial collapse once thought impossible now is looming.

If the number of countries needing bailouts continues to grow, the amount of new paper money that will likely be issued will skyrocket from today's levels. Debt ratios of the UK and the US are among the worst in the developed world. Should they require financial rescue, the bill may very well reach tens of trillions of dollars. If that happens investors will likely demand gold with extreme urgency.

Athens and the seats of power of other profligate governments appear ready to crumble under the heat of the political austerity brought on by the threat of financial collapse. As a result, gold seems to be heating up.

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