The Collapse of the Euro - A Scenario

The following from the Huffington Post by Simon Johnson and Peter Boone gives a scenario for the collapse of the Euro.  Basically, the exit of Greece from the Euro will result in huge losses on Greek debt that will put the remainder of the Euro in jeopardy.  This coupled with the eventual run on the banks will cause too many problems for the Euro to handle leading to the abandonment of the currency.  Although dire the scenario is not unreasonable.  Text in italics is the article, the text in bold is my emphasis.

In every economic crisis there comes a moment of clarity. In Europe soon, millions of people will wake up to realize that the euro-as-we-know-it is gone. Economic chaos awaits them.

To understand why, first strip away your illusions. Europe's crisis to date is a series of supposedly "decisive" turning points that each turned out to be just another step down a steep hill. Greece's upcoming election on June 17 is another such moment. While the so-called "pro-bailout" forces may prevail in terms of parliamentary seats, some form of new currency will soon flood the streets of Athens. It is already nearly impossible to save Greek membership in the euro area: depositors flee banks, taxpayers delay tax payments, and companies postpone paying their suppliers -- either because they can't pay or because they expect soon to be able to pay in cheap drachma.

The troika of the European Commission (EC), European Central Bank (ECB), and International Monetary Fund (IMF) has proved unable to restore the prospect of recovery in Greece, and any new lending program would run into the same difficulties. In apparent frustration, the head of the IMF, Christine Lagarde, remarked last week, "As far as Athens is concerned, I also think about all those people who are trying to escape tax all the time."

Ms. Lagarde's empathy is wearing thin and this is unfortunate -- particularly as the Greek failure mostly demonstrates how wrong a single currency is for Europe. The Greek backlash reflects the enormous pain and difficulty that comes with trying to arrange "internal devaluations" (a euphemism for big wage and spending cuts) in order to restore competitiveness and repay an excessive debt level.

Faced with five years of recession, more than 20 percent unemployment, further cuts to come, and a stream of failed promises from politicians inside and outside the country, a political backlash seems only natural. With IMF leaders, EC officials, and financial journalists floating the idea of a "Greek exit" from the euro, who can now invest in or sign long-term contracts in Greece? Greece's economy can only get worse.

Some European politicians are now telling us that an orderly exit for Greece is feasible under current conditions, and Greece will be the only nation that leaves. They are wrong. Greece's exit is simply another step in a chain of events that leads towards a chaotic dissolution of the euro zone.

During the next stage of the crisis, Europe's electorate will be rudely awakened to the large financial risks which have been foisted upon them in failed attempts to keep the single currency alive. When Greece quits the euro, its government will default on approximately 121 billion euros of debt to official creditors, and about 27 billion euros owed to the IMF.

More importantly and less known to German taxpayers, Greece will also default on 155 billion euros directly owed to the euro system (comprised of the ECB and the 17 national central banks in the euro zone). This includes 110 billion euros provided automatically to Greece through the Target2 payments system -- which handles settlements between central banks for countries using the euro. As depositors and lenders flee Greek banks, someone needs to finance that capital flight, otherwise Greek banks would fail. This role is taken on by other euro area central banks, which have quietly lent large funds, with the balances reported in the Target2 account. The vast bulk of this lending is, in practice, done by the Bundesbank since capital flight mostly goes to Germany, although all members of the euro system share the losses if there are defaults.

The ECB has always vehemently denied that it has taken an excessive amount of risk despite its increasingly relaxed lending policies. But between Target2 and direct bond purchases alone, the euro system claims on troubled periphery countries are now approximately 1.1 trillion euros (this is our estimate based on available official data). This amounts to over 200 percent of the (broadly defined) capital of the euro system. No responsible bank would claim these sums are minor risks to its capital or to taxpayers. These claims also amount to 43 percent of German Gross Domestic Product, which is now around 2.57 trillion euros. With Greece proving that all this financing is deeply risky, the euro system will appear far more fragile and dangerous to taxpayers and investors.

Jacek Rostowski, the Polish Finance Minister, recently warned that the calamity of a Greek default is likely to result in a flight from banks and sovereign debt across the periphery, and that -- to avoid a greater calamity -- all remaining member nations need to be provided with unlimited funding for at least 18 months. Mr. Rostowski expresses concern, however, that the ECB is not prepared to provide such a firewall, and no other entity has the capacity, legitimacy, or will to do so.

We agree: Once it dawns on people that the ECB already has a large amount of credit risk on its books, it seems very unlikely that the ECB would start providing limitless funds to all other governments that face pressure from the bond market. The Greek trajectory of austerity-backlash-default is likely to be repeated elsewhere -- so why would the Germans want the ECB to double- or quadruple-down by suddenly ratcheting up loans to everyone else?

The most likely scenario is that the ECB will reluctantly and haltingly provide funds to other nations -- an on-again, off-again pattern of support -- and that simply won't be enough to stabilize the situation. Having seen the destruction of a Greek exit, and knowing that both the ECB and German taxpayers will not tolerate unlimited additional losses, investors and depositors will respond by fleeing banks in other peripheral countries and holding off on investment and spending.

Capital flight could last for months, leaving banks in the periphery short of liquidity and forcing them to contract credit -- pushing their economies into deeper recessions and their voters towards anger. Even as the ECB refuses to provide large amounts of visible funding, the automatic mechanics of Europe's payment system will mean the capital flight from Spain and Italy to German banks is transformed into larger and larger de facto loans by the Bundesbank to Banca d'Italia and Banco de Espana -- essentially to the Italian and Spanish states. German taxpayers will begin to see through this scheme and become afraid of further losses.

The end of the euro system looks like this. The periphery suffers ever deeper recessions -- failing to meet targets set by the troika -- and their public debt burdens will become more obviously unaffordable. The euro falls significantly against other currencies, but not in a manner that makes Europe more attractive as a place for investment.

Instead, there will be recognition that the ECB has lost control of monetary policy, is being forced to create credits to finance capital flight and prop up troubled sovereigns -- and that those credits may not get repaid in full. The world will no longer think of the euro as a safe currency; rather investors will shun bonds from the whole region, and even Germany may have trouble issuing debt at reasonable interest rates. Finally, German taxpayers will be suffering unacceptable inflation and an apparently uncontrollable looming bill to bail out their euro partners.

The simplest solution will be for Germany itself to leave the euro, forcing other nations to scramble and follow suit. Germany's guilt over past conflicts and a fear of losing the benefits from 60 years of European integration will no doubt postpone the inevitable. But here's the problem with postponing the inevitable -- when the dam finally breaks, the consequences will be that much more devastating since the debts will be larger and the antagonism will be more intense.

A disorderly break-up of the euro area will be far more damaging to global financial markets than the crisis of 2008. In fall 2008 the decision was whether or how governments should provide a back-stop to big banks and the creditors to those banks. Now some European governments face insolvency themselves. The European economy accounts for almost 1/3 of world GDP. Total euro sovereign debt outstanding comprises about $11 trillion, of which at least $4 trillion must be regarded as a near term risk for restructuring.

Europe's rich capital markets and banking system, including the market for 185 trillion dollars in outstanding euro-denominated derivative contracts, will be in turmoil and there will be large scale capital flight out of Europe into the United States and Asia. Who can be confident that our global megabanks are truly ready to withstand the likely losses? It is almost certain that large numbers of pensioners and households will find their savings are wiped out directly or inflation erodes what they saved all their lives. The potential for political turmoil and human hardship is staggering.

For the last three years Europe's politicians have promised to "do whatever it takes" to save the euro. It is now clear that this promise is beyond their capacity to keep -- because it requires steps that are unacceptable to their electorates. No one knows for sure how long they can delay the complete collapse of the euro, perhaps months or even several more years, but we are moving steadily to an ugly end.

Whenever nations fail in a crisis, the blame game starts. Some in Europe and the IMF's leadership are already covering their tracks, implying that corruption and those "Greeks not paying taxes" caused it all to fail. This is wrong: the euro system is generating miserable unemployment and deep recessions in Ireland, Italy, Greece, Portugal and Spain also. Despite Troika-sponsored adjustment programs, conditions continue to worsen in the periphery. We cannot blame corrupt Greek politicians for all that.

It is time for European and IMF officials, with support from the U.S. and others, to work on how to dismantle the euro area. While no dissolution will be truly orderly, there are means to reduce the chaos. Many technical, legal, and financial market issues could be worked out in advance. We need plans to deal with: the introduction of new currencies, multiple sovereign defaults, recapitalization of banks and insurance groups, and divvying up the assets and liabilities of the euro system. Some nations will soon need foreign reserves to backstop their new currencies. Most importantly, Europe needs to salvage its great achievements, including free trade and labor mobility across the continent, while extricating itself from this colossal error of a single currency.

Unfortunately for all of us, our politicians refuse to go there -- they hate to admit their mistakes and past incompetence, and in any case, the job of coordinating those seventeen discordant nations in the wind down of this currency regime is, perhaps, beyond reach.

Forget about a rescue in the form of the G20, the G8, the G7, a new European Union Treasury, the issue of Eurobonds, a large scale debt mutualization scheme, or any other bedtime story. We are each on our own.

Lloyd's of London is Preparing for the Collapse of the Euro

The realizations over the fate of Europe, Greece, and the Euro is becoming more dire.  Lloyd's now has a contingency plan that includes the collapse of the Euro.  Regardless of what happens Europe is in for an extended period of uncertainty concerning the fate of their monetary system.  This will make the US dollar strong relative to the Euro, but remember nothing about our own fiscal crisis has been solved yet.  Article is in italics.  The portion in bold is my emphasis.  From the BBC:

The insurance market Lloyd's of London is preparing contingency plans for the possibility of the euro collapsing, its chief executive has said.

With Greece facing new elections in June and anti-bailout feelings high, there are fears Athens may be forced to exit the eurozone.

In a Sunday Telegraph interview (highlight for a link to the original Telegraph article), Richard Ward said Lloyd's needs to "prepare for that eventuality".

He said that Lloyd's would settle claims using multiple currencies.

Mr Ward is one of the first bosses of a large UK business to admit he is planning for the end of the euro.

Lloyd's of London is a market in which syndicates meet brokers and agree to take on particular risks.

Greece has implemented tough austerity measures in return for two multi-billion-euro bailouts, but five years of recession has seen the Greek people become increasingly opposed to pro-austerity politicians.

Many analysts think that Greece may abandon the austerity measures and be forced out of the euro if the leftist bloc Syriza, which came second in Greece's 6 May election, wins on 17 June.

This could potentially trigger a run on banks not only in Greece but in other eurozone nations.

"We've got multi-currency functionality and we would switch to multi-currency settlement if the Greeks abandoned the euro and started using the drachma again," Mr Ward told the newspaper.

"I don't think that if Greece exited the euro it would lead to the collapse of the eurozone, but what we need to do is prepare for that eventuality."

He added: "I'm quite worried about Europe."

In March, Lloyd's announced a loss of £516m for 2011, saying it was its worst year for catastrophe claims such as the earthquake and tsunami in Japan and the earthquake in New Zealand.

Mr Ward's comments come as more and more politicians and business leaders talk of a Greek exit.

In an interview with the Guardian newspaper, the head of the International Monetary Fund urged Greeks to pay taxes.

Christine Lagarde also suggested it was payback time for Greece.

In addition to a Greek exit, investors are also worried about what would happen if other ailing economies like Spain and Italy followed suit.

On Friday, Spain's Bankia said it needed 19bn euros more from the government - the biggest bailout ever - as it and fellow regional banks struggle under a mountain of bad property debt.

Stocks have fallen over the past few weeks while on Friday the euro tumbled to under $1.25 for the first time since July 2010.

Charles Dumas - The Economies in Europe and Their Affects on the Markets

Tom Keene interviews Charles Dumas, the Chief Economist of Lombard Street Research.  Mr. Dumas does not mince any words about his position on Greece and what Germany and the rest of Europe are going to do.  As Mr. Dumas states, the situation in Europe is very serious and things will come to a head fairly soon.


From Bloomberg/Business Week:

Roubini Talks about the Financial Cliff, Recession, and the Stock Market

The following interview was published in USA Today.  Dr. Roubini is was always interesting and many times controversial.  This short interview gives some good detail on what is in reality a fairly serious economic situation in both Europe and the US.  

The interview is in italics and bold is my emphasis.  From USA Today:

Q: Where are we in the economic recovery?A: There is an overall slowdown of global growth. Europe is in a recession in the periphery countries, and it's getting worse. There is a double-dip recession in the UK, sluggish growth in Japan, and the data from many emerging markets are also suggesting a slowdown in China, Russia, Brazil, India and places like Turkey, Mexico and South Africa.


Q: What about the U.S.
A: We have positive economic growth, but it's below trend — barely 2%. Job creation is still anemic. The recovery is still anemic because the painful process of de-leveraging has not even started in the public sector. And next year there will be some fiscal drag because of the fiscal cliff that's coming up.


Q: Explain what you mean by fiscal cliff.
A: Many things are expiring at year end. All the tax cuts on income, on dividends, on capital gains, on estates. There's an expiration of the payroll tax (cut). There is a reduction or expiration of transfer payments to state and local governments, to unemployment benefits. There is the expiration of infrastructure spending, and then there are the automatic cuts on discretionary spending, which came about because we failed to reach an agreement for reducing the budget deficit.The point is, all this is expiring at year end, and the hole will be $600 billion, or about 4% of GDP, and then we plunge into a nasty recession. Now, some items may be continued (if the Republicans and Democrats can agree to extend) but a realistic assessment is a fiscal drag. Even if the cliff is not a free fall because some items won't expire in an agreement, there will still be the beginnings of a fiscal drag, because you reduce disposable income by raising taxes, and (by) cutting transfer payments, you reduce aggregate demand by reducing government spending.


Q: What about Europe?
A: The European recession is getting worse. There's fiscal austerity that, in the short run, makes the recession worse. Second, the value of the euro is too strong for the countries on the periphery that have lost competitiveness. Third, you have a credit crunch because the periphery banks don't have enough capital, and they will be forced to cut credit. Fourth, you have the effects of high oil prices, and Europe depends 100% on oil imports. And now politics in Europe are an issue, as we saw from the Greek elections, French elections, the Italian elections and German elections, and the collapse of the government in the Netherlands.


Q: Wow. How long will this sustain?
A. You have on one side austerity fatigue, because these countries are finding that austerity makes the recession worse. The austerity fatigue is spreading to France and the Netherlands. On the other side, you have bailout fatigue in places like Germany or Finland or Austria. These Germans tell me, 'These Greeks have a big fat Greek wedding not for a weekend, but for the last 20 years. We give them one bailout, then a second bailout. We cut their foreign debt by 75% in the debt restructuring, and they still don't want to do any fiscal austerity and structural reforms.' So they say, 'Enough is enough, let's pull the plug.' "


Q: What will happen to Greece?
A: The risk is that you'll have Greece exiting the eurozone with all the collateral damage. Also the risk is that many other countries will find it difficult to do austerity. There is a significant sociopolitical and policy uncertainty in Europe that affects the global markets. So, to me, the eurozone looks like a slow motion train wreck. Slow motion is not going to collapse overnight. But Greece is not going to be the only country that's going to restructure. Greece by next year might exit the eurozone. If one or two of the smaller countries restructure their debt and exit, like Portugal or Cyprus, the eurozone survives. But if the contagion spreads through Italy and Spain, the third- and fourth-largest economies, it could lead to a breakup of the eurozone three or four years down the road.


Q: So, how does all of this affect the U.S.?
A: First, there is huge exposure of U.S. companies to Europe because they have factories and businesses there. If Europe goes into recession, the profits of these multinationals are cut. About half of all the profits of U.S. S&P 500 firms are coming from their foreign operations, many of them in Europe. Second, whenever there is risk of disorderly financial conditions in Europe, there is not just a sharp correction of European stock markets, but also of U.S. markets. When Greece was first in trouble in the spring of 2010, you had a 20% correction in the European stock market, and a similar correction in the U.S., in Asia, in emerging markets. Same thing last year between August and October. So financial contagion becomes instantaneous because of sentiment, exposure of U.S. financial institutions to European ones, and because of these links between the U.S. businesses and their own activities in Europe. No country is an island.


Q: What are you expecting from the markets in the next year and how do you invest in the face of this?
A: We see it being flat for the rest of the year, like it was flat last year, given all these uncertainties and given there is a fiscal cliff and there is more gridlock. I don't expect the stock market to tank this year. But I don't see, from current levels, much upside. The emerging markets are a long-term story. Their growth rate in the long run is 6%, while in advanced economies (including the U.S.) is 2%, 2.5%. So if you are willing to invest for the long run, yes on emerging markets. But if you're thinking about what's going to happen in the next few months, no country is an island. 

The Financial Cliff and its Effects on the Markets

It should come as no surprise that the paralysis in Washington DC will eventually bleed over into the markets requiring investors to start taking more defensive positions.  This should keep rates relatively low and the markets weak until there is more clarity offered by our friends on the Potomac.

Article is in italics and bold is my emphasis.  From CNN Money.com:

 As if the debt crisis in Europe and a slow economic recovery aren't enough to deal with this year.

Now, investors and businesses are being served another whopping scoop of "who the hell knows?" because of paralysis in Congress over the so-called fiscal cliff.

The going assumption is that lawmakers will wait until after Election Day to deal with the $7 trillion worth of tax hikes and spending cuts set to take effect in January.

Most observers believe Congress at the last minute will postpone them and punt real policy decisions to 2013.

But markets and businesses might not wait to react. In fact, they may start to behave defensively well before the end of the year.

Some experts, like independent economist Allan Sinai of Decision Economics, believe that the stock market, already pressured by Europe, could sell-off without signs of progress on a legislative deal by summer.

Mohamed El-Erian, CEO of investment firm Pimco, predicted in a May 3 Washington Post commentary that global markets "will be looking for signals that our politicians understand the severity of the situation" within weeks or months. "If clear signals are not forthcoming, markets could react early to the looming trouble," he wrote.

Komal Sri-Kumar, chief global strategist at investment firm TCW, believes that "nervousness" will pervade markets starting in August.

And it will grow over time.

Investors will realize they may not get a clear sense of fiscal policy even after the election, Sri-Kumar said. If Congress looks like it will deliberate -- or dither -- until the end of the year, managers of investment portfolios will worry they won't have time to adjust their positions.

Consequently, Sri-Kumar sees record low rates on Treasuries continuing, as investors seek safety. On the equity side, investors may start to shift money into dividend-paying stocks in the consumer, utilities and health care sectors, he said.

Mari Adam, a certified financial planner in Boca Raton, Fla., is concerned about how investors will respond to the uncertainty.

"You can't even put probabilities on it," Adam said. "Brinksmanship is creating a very toxic environment."

Many people were left feeling that the "country is becoming ungovernable" after last summer's debt ceiling debate, she said. "Those who used to be confident about the country's future are less so because of the self-inflicted wounds in Congress."

Adam also sees many clients -- both seniors who rely on investment income to supplement Social Security and younger investors who should be taking investment risks -- clinging to bonds that yield next to nothing.

"If this is where we're starting, it's not very encouraging," she said.

That's in the market. On the frontlines of the economy, some businesses may also react to the outsized uncertainty about taxes and spending.

Specifically, those that rely on federal government spending, said Joe Minarik, senior vice president of the Committee for Economic Development.

He puts defense contractors in that category, since they would feel the effects of a scheduled 10% cut in defense spending next year.

Other businesses not directly affected by spending cuts may be less worried about the fiscal cliff this year.

Broadly speaking, however, it's very hard for any business to make hiring and investment plans without knowing what's happening with fiscal policy.

"That's a recipe for paralysis in decision making," said IHS Global Insight's chief U.S. economist Nigel Gault, who thinks the effects of fiscal cliff uncertainty will come later in 2012. "The natural response is to be more cautious. It could slow things down." 

The Mis-management of Risk

Art carden, a funny economist - who woulda thunk it.

It is important to keep your various risks in perspective.

The Real Issue of Greece Leaving the Euro - A Run on the Banks

Could anything else go wrong in Greece?  There is austerity which drove the economy into a Depression, there is widespread civil unrest, fears that Greece will exit the Euro, and now a possible run on the banks.  Can anything else go wrong?  From Ambrose Evans-Pritchard at the UK Telegraph:

Economists warned that the Greek financial system could crumble within weeks or days unless the European Central Bank steps up support.

President Karolos Papoulias told party leaders that banks had lost €700m in withdrawals on Monday alone as citizens rush to pre-empt capital controls and a much-feared return to the Drachma.

He cited central bank warnings that "great fear" might soon escalate to panic. The leaked details lend credence to claims that capital flight by both savers and firms have reached €4bn a week since the triumph of anti-bailout parties on May 6.

Steen Jakobsen from Danske Bank said outflows are becoming unstoppable, not helped by open talk in EU circles of `technical’ plans for Greek withdrawal.

"This has a self-fulfilling prophecy built into it and I don’t think we can get to June. The fuse is burning and the only two options now are a controlled explosion where Germany steps in to ensure an orderly exit, or an uncontrolled explosion," he said.

The growing alarm comes as judge Panagiotis Pikrammenos was picked as Greece’s caretaker leader until the next vote on June 17. Polls show the Left-wing Syriza leader Alexis Tsipras emerging as clear victor.

Mr Tsipras has vowed to tear up the EU-IMF bail-out `Memorandum’, exhorting German Chancellor Angela Merkel to "stop playing poker with the lives of people". The Greek impasse has rattled markets, with the FTSE 100 down 0.6pc to 5,405 yesterday. Spanish lender Bankia fell 11pc in Madrid. Gold tumbled $17 to a ten-month low of $1,540 on dollar strength.

The crisis is replicating the pattern of fixed-exchange ruptures through history. Britain was forced off the Gold Standard in 1931 after pay-cut protests in the navy triggered capital flight.

Greek banks have lost 30pc of their deposits since late 2009. The total fell to €171bn in March. "The surprise is that there is still so much left. I can’t believe it will stay much longer," said Simon Ward from Henderson Global Investors.

The ECB is holding the line with an estimated €100bn of Emergency Liquidity Assistance (ELA) for lenders, channeled through Greece’s central bank. Supplicants must pawn their loan book in exchange. "The risk is that banks will run out of collateral since these are low quality assets with haircuts of 50pc or more. The ECB could relax the rules but they would have to take an active decision to do so," said Mr Ward.

JP Morgan said Greek banks have already exhausted their collateral. A refusal by the ECB to ease rules would amount to expulsion, forcing Greece "to issue its own money."

The ECB said it had stopped routine operations with certain Greek banks with depleted capital buffers, but underscored that they are still able to access the ELA scheme.

There is already a political storm in Germany over "junk collateral", as well as anger over the Bundesbank’s €645bn exposure to Club Med debtors through the ECB’s internal `Target2’ payments nexus. Mr Ward said it would be hard to justify to German taxpayers why the Bundesbank should lend more to "austerity-resistant Greeks" so that they can squirrel money abroad.

Julian Callow from Barclays Capital said the ECB risks grave contagion if it lets go of Greek banks. "We have reached the point where the ECB needs to come in with massive intervention and outright quantitative easing," he said.

Slow capital loss from Club Med is showing up in the ECB’s Target2 data. The central banks of Italy and Spain have built up liabilities of €279bn and €284bn, partly reflecting bank withdrawals. This is owed to Germany, Netherlands, Luxembourg, and Finland.

Italy’s banking lobby said foreign deposits at Italian banks were down 20pc in March. The good news is that the Libor-OIS spread -- the "stress gauge" for banks -- has not risen in this latest spasm of the crisis, suggesting that Club Med deposit flight remains modest for now. That could change fast if a Greek exit shatters the sanctity of monetary union.

What is the Fiscal Cliff? - In Case You Don't Like to Read

Yahoo - Daily Ticker

May 15, 2012

What is the Fiscal Cliff?

What is the financial cliff?  At the end of this year the Bush tax cuts expire and large spending cuts occur on January 1, 2013.  Anyone hear of 1936 - 1937 when FDR increased taxes and through the country back into a depression.  Italics is the article and the material in bold is my emphasis.  CNN Money.com - 

So what is the fiscal cliff? The phrase was coined by Federal Reserve Chairman Ben Bernanke to describe the simultaneous onset of tax increases and spending cuts that will be triggered on Jan. 1 unless Congress acts.

Combined the policies would take $7 trillion out of the economy over 10 years -- about $500 billion of which would occur in 2013.

Such measures include the expiration of the Bush tax cuts, middle class protection from the Alternative Minimum Tax, and more than 50 "temporary" tax breaks for individuals and businesses that have been on the books for years.

They also include nearly $1 trillion in blunt spending cuts across many areas of the federal budget. These include significant bites out of defense and non-defense spending.

A number of stimulus measures -- such as the payroll tax cut and extended unemployment benefits -- will also be ending.

What's the risk to the economy? Economists predict the United States could fall back into recession if the expiring tax cuts and impending spending cuts take effect all at once.

On the other hand, simply extending the tax policies and canceling the spending cuts could add more than $7 trillion to the country's debt over 10 years. While that would boost growth in 2013, it would hurt the economy by the end of the decade.

That's why fiscal experts hope lawmakers will take a more finessed approach to both supporting the economy and reducing deficits over time.

Can't Ben Bernanke help? Not according to Ben Bernanke.

On more than one occasion, the Fed chairman has all but beggedlawmakers not to mess this one up.

"[I]f no action were to be taken, the size of the fiscal cliff is such that there's I think absolutely no chance that the Federal Reserve ... could or would have any ability whatsoever to offset ... that effect on the economy," Bernanke said recently.

So what's Congress going to do about it? Excellent question. Unfortunately there's no answer yet.

Given that it's an election year, and the balance of power between the parties is up for grabs, many observers expect lawmakers won't even begin to address the fiscal cliff in earnest until after Nov. 6.

Dealing with the fiscal policy pile-up in less than seven weeks will be a hot mess. Indeed, former Republican Sen. Alan Simpson is predicting the lame-duck session of Congress will be "chaos."

One potential outcome: A package that extends some tax cuts and postpones some spending cuts, effectively punting the real debate to the new Congress in 2013.

House Budget Chairman Paul Ryan, a leading Republican on fiscal policy, has said publicly that he would welcome that outcome if it were proposed by President Obama.

And a temporary package to buy time also seems to be the default expectation among many on Capitol Hill.

The terms of that package could very well be determined in tandem with the debate over raising the debt ceiling, which will make things messier still.

What's at stake in a debt ceiling showdown? When and how the debt ceiling is raised will matter.

Last year, the fight was ugly and protracted. The end result: a first-ever downgrade of the U.S. credit rating by Standard & Poor's, which cited political brinksmanship as the chief cause, and one of the most volatile weeks in recent history for world stock markets.

There's no reason to believe this year would be any different if the fight again becomes ugly and protracted, especially since it may get tangled up with the fiscal cliff debate, which will also weigh on investors and credit rating agencies. 

Why is the Price of Gold Declining? 

The following is a good explanation of why the price of gold is declining.  Many believe that it should be increasing in price because of uncertainty in Europe and the US.  But, ultimately the price of gold is tied to inflation fears.  The article is in italics and the part in bold is my highlighting.  From CNN Money:

So much for gold being a safe investment in times of market volatility.

The yellow metal has pulled back sharply in the past month and a half on Europe fears -- just like stocks. At about $1,560 an ounce, gold is 13% below its 2012 high of near $1,800 back in March. Gold prices are now down slightly year-to-date.

For any investor who views gold as an alternate currency and believes that the metal's price should move higher thanks to turmoil in Europe and worries that the euro would completely unravel if Greece exits the eurozone, think again.

Gold bugs may be forgetting that gold really thrives during times when inflation fears are running rampant. This is not one of those times. The sluggish U.S. job market, slowing growth in China and recession in much of Europe all scream global economic weakness.

"Inflation is modest because of significant unemployment, The case for gold is when the economy is getting better," said Barry Ritholtz, CEO of Fusion IQ, a New York-based research firm. "Right now, gold is less than an ideal investment."

Yes, gold surged to an all-time high (not adjusted for inflation) of above $1,920 an ounce last September. That was shortly after the credit rating of the United States was cut by Standard & Poor's following the debt ceiling mess on Capitol Hill.

At that time, demand for U.S. bonds was extremely high as well. The 10-year Treasury yield was also near an all-time low. (Bond prices and rates move in opposite directions.) So it seemed last fall that gold was being viewed as a classic safe haven.

But that may have created some froth in the market for gold. Even some gold investors conceded that prices got way ahead of themselves. So this recent pullback may be the continuation of a needed correction.

"I am a bull on gold long-term. But a lot of interest in gold over the past year has been speculative. It had been due to concerns about political paralysis on both sides of the Atlantic," said Brian Gendreau, market strategist with Cetera Financial Group in Los Angeles.

Investors may be dumping gold as they begin to realize that it may not be as safe as they thought. And you can't really blame some long-term gold investors for cashing in now.

The SPDR Gold Shares Trust  (GLD), an exchange-traded fund that invests in the commodity, is still up more than 65% since the stock market bottomed in March 2009.

Cameron Brandt, director of research with EPFR Global, a Boston-based firm that tracks mutual fund flows, noted that there has been a steady level of redemptions from gold funds over the past few weeks.

"People are looking to get back into cash and move to the sidelines. Given Europe's troubles, there is a segment of investors that may want to be liquid either to sidestep more trouble or pounce on other opportunities," Brandt said. . . .

. . . . . Ritholtz, who said his firm does have a position in gold, said that having some gold investments makes sense. Gold should rise when the U.S. dollar is weakening and inflation is a worry.

But he added that the biggest problem with the metal is that it's not as easy to objectively value it like a stock or bond. Still, he said some investors treat gold like a "cult" and refuse to believe that the prices can ever go down.

"Gold doesn't have any earnings. It doesn't pay you interest. It's a shiny yellow metal. Its value only comes from its relative rarity. It should trade on supply and demand," he said.

Gold is a commodity first and foremost, not a currency. Commodity prices, even for something like gold that doesn't have as much commercial use as other metals, tend to closely track consumer demand. So it should be no surprise that gold prices are now tumbling.

After all, copper prices are sliding. So are the prices of silver and platinum -- and just about every other commodity. Oil is at a five-month low. Wheat, corn and cotton prices are all much closer to their 52-week lows than highs.

"This should not be a surprise. There are good economic reasons for gold prices to be falling," said Gendreau. "A slowdown in Europe and China and lower retail demand for jewelry in India and other emerging markets should lead to a soft market for gold for awhile."