Markets in a ‘new danger zone’ warns World Bank chief as gold soars

Posted on 15 August 2011 with 4 comments from readers

If anybody thought last week’s financial market volatility was the end of the downturn then World Bank chief Robert Zoellick has delivered a powerful warning that markets are now in a ‘new danger zone’.

In a speech in Sydney he noted that recent instability had ’caused many market participants to lose confidence in economic leadership of some of the key countries’. This is a clear swipe at Germany and France whose shaky handling of the eurozone debt crisis leaves investors unsure which way to jump.

Euro QE

What is needed is a European version of quantitative easing with the European Central Bank buying up the bonds of the bankrupt PIIGS and flooding the market with new eurobonds. This would be inflationary but avoid the looming banking collapse, as it did in the US three years ago.

For the money that the PIIGS has accumulated in debt is mainly owed to German and French banks and if they go bankrupt they will pull down the European banking system too.

European leaders of course know this but they appear domestically compromised by political forces that prevent them taking action. Only another crisis will finally convince these people but by then it may be too late.

Such brinkmanship is going to keep markets highly volatile and liable to huge sell-offs that discount the worst case scenario even if it never finally happens. Meanwhile, in the US all the Fed can do is watch incredulously as Europe repeats the errors of 1931 or is powerless to prevent them.

In 2008 the Federal Reserve flooded the whole global banking system with money. It may yet have to do the same again if the eurozone fails to get its act together. Can that be done?

The mood in Washington is very different than it was in 2008 and who knows how US politicians will react to problems in Europe on this scale. A retreat into the splendid isolation of the inter-war years is perfectly possible.

Slow reaction

However in Europe there are also powerful lobbies favoring more austerity as an alternative method of balancing the books. The problem is that austerity contracts GDP – the latest figures show Greek GDP down almost seven per cent – and makes it harder for countries to repay debts, not easier, forcing them into bankruptcy.

Now bankrupt nations are a serious business, more so than the collapse of Lehman Brothers on Wall Street. Even if the eurozone is up to this challenge it has enormous implications for investors.

Gold and silver are the clear winners either way. Monetize the eurodebt and inflation soars and with it precious metals. Fail to act and the bond market implodes and money will rush into gold and silver as a safe haven.

No wonder gold hit a record high this month and silver is not so far behind.