What Happens If The Euro Goes Bust, And Why The Fed Will Actively Intervene To Stop It

In short, many things could happen next.  Including bank runs (which I hope for because they are much less destructive.)  We also could see a full fledged collapse in the Euro.  Which would beg the question: what would happen next?

If the Euro currency (note:  I am talking about the price of Euro going to 0) fails, much of that capital will go to the US dollar to buy US denominated assets.  Why?  Three reasons really.

  • The US dollar has been the reserve currency of the world for the past 100 years, and to trust in past trends is prudent—institutional investors are first paid to preserve capital, and paid second to take intelligent risks to grow capital.
  • The second reason is volume.  Europe is a $14 (US dollar) economy.  If the capital in the European economy leaves, it has options on where to go—United States or not United States—but non-US trades will become very crowded very quickly.  To put it in context, spending $1 Euro to buy $0.10 Yuan is less palatable than spending $1 Euro to buy $0.50 US.
  • The third reason, more ominously, is the greater fool theory.  If I can buy an asset that I expect others to buy, even though I am buying it over-priced, I will buy it.

If the Euro currency collapses, the US dollar rallies, stocks and commodities fall, treasuries and/or gold rallies, and we go into deflation.  And this, deflation, is precisely the reason the Fed will do its best to prevent a collapse in the Euro.

Here is what we know.  1)In the great depression, deflation occurred.  2)Unforeseen deflation causes debt to be more difficult to repay.

It is the combination of these two facts that the Fed will do everything in its power to intervene in preventing a collapse in the Euro.

This Fed Board of Directors, as any board would, doesn’t want to be tarnished with allowing the second great depression to happen.  Deflation is ubiquitous—it happens throughout the economy due to technological innovation—but when it occurs en-macro, via a collapse in monetary models, the Fed is responsible for it.

The second reason the Fed will do its mightiest to prevent a collapse of the Euro is the amount of our debt.

Our debt is now $15+ trillion.  If deflation comes to the US dollar, the strain of that debt load will become severe, and that strain may warrant a full fledged collapse in the last bulwark fiat currency of the modern economy.  And if that is the case, there is only one monetary system left—the gold standard.

Conclusion
I am a trained economist.  I prescribe to the Keynesian school of economics because I believe good policy can fight against recessions.  I disagree with governments that have budget deficits during positive GDP growth.  I party with Misses economists, which I think gives me a more correct view of how an economy functions.

All that being said, I am here to teach you how a modern economy functions.  As well as to say:  Fed, fire them big guns.

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