3 Lessons You Must Learn

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Question: A Greek, an Italian and a Spaniard walk into a bar. Who picks up the tab?

Answer: The Americans.

All financial eyes are once again trained on the European debt crisis, with investors worldwide wondering how it will play out. Not well, I'm afraid. Not well for the Europeans to be sure. And it will be costly for Americans, too.

Some of the pain has already been felt by investors who had accounts with Jon Corzine's MF Global, now bankrupt from chasing higher-yielding bonds in the Eurozone. After a lifetime in high office and at Goldman Sachs, Corzine must have thought that if anything went wrong, everybody on Wall Street would just get bailed out again. He may have been right about that in the long run, but his timing was off.

(And to think that Corzine, who may now qualify to be a bunkmate of Bernie Madoff, could have easily ended up as U.S. Treasury Secretary. While that is a story for another day, it goes a long way to explain the financial mess the U.S. government is in.)

And then there is the decision by the Federal Reserve to ride to the rescue of European banks with more liquidity by cutting rates on dollar swaps. That follows hard on the heels of the news of $7.7 trillion in secret Fed bank bailouts during the mortgage meltdown. The chief beneficiaries of that Fed largesse — JPMorgan, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, and Morgan Stanley — have predictably been identified as those U.S. banks with the most exposure now to the European crisis, amounting to hundreds of billions of dollars. They, too, must have grown accustomed to the bailouts.

Must the rest of us be victimized by the collapse of European debt and its contagion? Is there anything for us to gain from it? The answer to both questions is yes.

Americans will be collectively victimized by the monetary authority, the Federal Reserve. The Fed will print as much money as necessary to protect the banking cartel which it serves. It has ever been so. And Americans will be victimized by the resulting destruction of the dollar and the further crippling of the economy.

But if you watch the unfolding European crisis while keeping the much larger U.S. debt in mind, there is something to be gained. You will have learned from the process so that as the U.S debt calamity unfolds, you will not be misled and can take steps to protect yourself.

3 Lessons You Must Learn From Europe

Here are three lessons you can learn from this mess that will benefit you when this sovereign debt crisis unfolds in America:

#1: The problem is bigger than the conventional wisdom acknowledges.

In one of the most boneheaded calls since Ben Bernanke claimed the subprime mortgage crisis was contained in 2007, Moody's Investor Services asserted two years ago that "investors' fears that the Greek government may be exposed to a liquidity crisis" were "misplaced." Frankly, it's no surprise when Moody's misses something, but the conventional wisdom has joined in on underestimating the sovereign debt crisis – which explains why so many banks are holding bad European debt.

Similarly, prolonged Washington debates about raising the ceiling on the visible portion of the U.S. national debt, now $15 trillion, only succeed in diverting attention from the enormity of the hidden debt, which includes a staggering $116 in unfunded liabilities.

#2: The solutions advanced by the governing classes are inadequate to the problem.

Just as the scope of the debt crisis is downplayed, the fixes offered are always inadequate for the true scope of the problem.

Having ineffectively tried to hold the line on the Greek crisis, the European Central Bank and the International Monetary Fund are up to their eyeballs in Greek debt.

Kyle Bass of Hayman Capital notes the ECB has been buying Greek debt since rates were 6.34%; 10-year Greek rates are now an astonishing 32 percent. "If the ECB can't hold back Greek rates, what makes anyone believe that they can do anything for Italian rates (where Italy's debts are $3 trillion while Greece was a paltry $500 billion)?"

The governing classes have responded to the compounding U.S. debt inadequately as well. The automatic provisions triggered by the failure of the congressional deficit reduction super committee target $1 trillion in budget cuts over nine years.

That represents cuts of just over $100 billion a year, while the federal debt grows by that amount each month. And as if to say, "Crisis? What crisis?," the politicians saw to it that those cuts don't begin until 2013, coincidentally after the presidential election. To add insult to injury, the plan counts on highly unlikely savings of $169 billion from lower interest costs going forward.

#3: With each new initiative the media breathlessly report that the problem has been solved. The equity markets take a ride on those reports.

On October 27, European leaders in Brussels announced "a blockbuster package" to stem the debt crisis. At the same time, there was euphoric talk that China would somehow ride to the rescue. The Dow jumped 340 points, almost 3%, only to give it all back in a couple of days.

A month later, action taken by the Fed and other central banks – once again aimed at providing liquidity instead of the addressing the underlying problem of debtor solvency – was good for 490 points.

It is little different than the giddy announcement three years earlier when 15 Eurozone nations agreed to provide their banks with more liquidity and fresh guarantees. As we have learned, the move did nothing to solve the debt issues that have only grown since then. But the news spiked the Dow 936 points that day – a gain that was also soon given up.

There are always some investors who are taken in by the latest in an unending string of breathless announcements that the debt crisis has been fixed. Wall Street gladly separates them from their money. Remember, the problem was years in the making. Its solution will demand a long process of costly adjustments and debt liquidation. Real solutions will not be greeted with euphoria.

A systemic global monetary breakdown can be delayed, but it cannot be avoided. That is because the debt is too big to be backstopped forever. Despite knowing that Greece lied about its deficits to gain admission to the Eurozone, naïve ratings analysts, state officials, regulators, bankers and investors all believed that Greece would be forever backstopped.

Maybe Germany could backstop Greece, but who is left to backstop Italy? China? But a third of China's reserves are already backstopping the U.S. Treasury, more backing Freddie and Fannie.

Can the Federal Reserve backstop everybody? It's been desperately trying to keep the American people from finding out just how much it has been backstopping the rest of the world. And what backstops the Federal Reserve?

Only the printing press.

Nation states and their institutions, the governing classes and the lapdog media are always surprised by crisis. But you don't have to be. If you understand that the European debt crisis is a dress rehearsal for what is to come here at home, you aren't likely to underestimate the problem or put much stock in patchwork plans that provide liquidity but leave the underlying debt unaddressed.

For astute investors the allure of gold, which is nobody's liability and doesn't need to be backstopped by anyone, grows with each new state crisis.

Charles Goyette [send him mail] is the author of the New York Times bestseller The Dollar Meltdown: Surviving the Impending Currency Crisis with Gold, Oil, and Other Unconventional Investments, now available in paperback. And coming in February 2012, Charles Goyette’s Freedom & Prosperity Letter.

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