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The Dangers of European Contagion

You never forget a near-death experience, and over my years I've had quite a few.

As investors, I believe we are wise never to lose sight of just how close we came during 2008 to some seriously horrific scenarios that could have proven quite fatal to our entire financial system.

In a moment, I will ask you to invest four minutes and 22 seconds of your life, in order that you may give serious and timely consideration to the possibility that right here -- right now -- the world may be far closer than most people imagine to seeing the European debt crisis spiral completely out of control.

But first, let's take a moment to recall just how close the United States and the U.K. came to suffering similar fates such a short time ago.

A pair of near-death experiences
As former Rep. Paul Kanjorski asserted in this astonishing appearance on C-SPAN in 2009, had the U.S. Treasury not taken bold action to stem an "electronic run on the banks" that gripped U.S. money markets on the morning of Sept. 18, 2008, then we could have seen "the end of our economic system and our political system as we know it." Kanjorski added: "If [the Treasury] had not done that, their estimation was that by 2 o'clock that afternoon, $5.5 trillion would have been drawn out of the money market system of the United States, would have collapsed the entire economy of the United States, and within 24 hours the world economy would have collapsed."

I remember my jaw dropping to the floor when I first encountered that watershed admission, and I know I was not alone.

The United Kingdom faced its moment of truth a few weeks later, on Oct. 10, 2008. According to then-Financial Services Secretary to the Treasury Lord Myners, the U.K. banking system came within three hours of complete collapse, as the nation experienced its own major bank run. Talk about a trial by fire; Lord Myners had only been appointed to the post the week before!

So both the United States and Britain reportedly came within a few hours of experiencing complete meltdowns of their respective financial systems that would have triggered dire economic scenarios for the world at large. I find it humbling to recognize the underlying frailty of it all, and three years later I find little reassurance that a repeat performance has been taken off the table.

The eurozone as a giant powder keg
Lord Myners appeared on British television last week, and lamented: "I wish I could give a more cheerful complexion, but we're on the verge of a perfect storm."

That's a sobering appraisal, to be sure, but I really wish to draw your attention to statements made on that same BBC program by economist Dr. Robert Shapiro. Shapiro served as undersecretary of commerce for economic affairs under President Bill Clinton (from 1997 to 2001), and has been an economic advisor to multiple presidential campaigns ... including that of Barack Obama. He presently serves as an advisor to the International Monetary Fund.

In the interest of keeping our eyes wide open as we observe the European crisis unfolding, please take a few moments to hear what Shapiro had to say in the following video clip:

For every Fool's sake, I hope we will one day look back and criticize that assessment as an overly alarming outlook. But from everything I have seen, I believe Shapiro's concern is well warranted. I agree with him that the greatest danger of all may lie in the persistent dark shadows of our financial system ... among the opaque exposures to derivative instruments like credit default swaps that continue to hide out on the balance sheets of our institutions under the temporary disguise of "mark-to-model" accounting.

In a blog post written shortly after the annual meetings of the World Bank and the IMF in Washington, D.C., last month, Shapiro wrote:

U.S. officials worry privately that U.S. banks are holding unknown billions of dollars of credit-default swaps against both those [European government] bonds and the European banks that hold them. That puts them in a position that recalls AIG in late August 2008, as insurance providers for a catastrophe that now lies somewhere between the possible and the likely. Finally, a meltdown of European finance would mean horrendous recessions across Europe and an end to our own recovery.

What's a Fool to do?
In an effort to prepare for the worst while hoping for the best, I recommend that investors keep some cash on the sidelines as insurance against such a worst-case scenario. The indiscriminate selling pressure that would likely blast equities and commodities alike as contagion gives way to panic-driven liquidation would almost certainly yield some historic buying opportunities for the long-term investor. As creatures of habit flock to U.S. Treasuries amid the carnage, even gold and silver are likely to take a hit in the early going. But that's precisely where I would encourage Fools to seek an ultimate safe haven as the already-underpriced mining equities conceivably grow cheaper still!

What it boils down to is that -- no matter whether they are ultimately successful or not -- nations know only one knee-jerk response to an acute credit crisis: They throw paper money at it like it's going out of style. The last thing to expect is that central bankers and politicians will stand idle and watch the entire system come apart at the seams. Rather, I believe the scale of the European crisis is likely to spawn a round of global quantitative easing and associated currency debasement that will cement the role of gold and silver as the immutable hard-money alternatives. That is the unfortunate catalyst that will likely send the metals soaring well beyond the more conservative price targets presently circulating. For that reason, I believe you cannot afford not to own gold.

Getting hold of a few pieces of gold or silver bullion might be one place to start ( is a well-respected source), but equity investors may find Central Fund of Canada (AMEX: CEF  ) similarly alluring with its roughly equal parts of unencumbered gold and silver bullion. Beneath $47, Goldcorp (NYSE: GG  ) is already the premier bargain among the major producers, and any further decline would render the long-term opportunity just that much sweeter. Among the mid-tier marvels, AuRico Gold (NYSE: AUQ  ) continues to glisten following a huge score with the acquisition of Northgate Minerals (AMEX: NXG  ) . Among the juniors, Primero Mining (NYSE: PPP  ) is my pick of the litter, but stay tuned to my article feed here for a pending discussion of another golden pick. Likewise, powerful bargains abound for silver amid the latest correction, with fast-growing superstar Great Panther Silver (AMEX: GPL  ) and the underrated Coeur d'Alene Mines (NYSE: CDE  ) shining brightly.

I urge a methodical approach to gold (and silver) that turns major pullbacks within the broader trend into timely opportunities to gain some measure of strategic exposure. Please join me in preserving some modicum of hope that Shapiro's frightful contagion scenario never comes to pass. Still, I encourage you to join me in taking some appropriate steps to prepare for the possibility. It's better to be safe, after all, than sorry.

Fool contributor Christopher Barker can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He tweets. He owns shares of AuRico Gold, Central Fund of Canada, Coeur d'Alene Mines, Goldcorp, Great Panther Silver, and Primero Mining. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (6) | Recommend This Article (26)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 13, 2011, at 6:02 PM, Charbroil121 wrote:

    Wasn't Kanjorski's statement later implied to be a major exaggeration?

  • Report this Comment On October 13, 2011, at 8:57 PM, XMFSinchiruna wrote:

    Charbroil, not to my satisfaction. It is clear in the clip that he is very deliberate and purposeful with the numbers he gave, and I find no reason to question his account of the events. I think the situtation as it was already publicly understood prior to his C-SPAN apppearance was sufficiently dire to provide ample political cover for members of Congress for the unprecedented steps they took, thereby precluding any reasonable motive he might have for grossly exaggerating the events as he experienced them.

    Remember, we're talking about the former Chairman of the Financial Services Subcommittee on Capital Markets, Insurance, and GSEs. He certaintly would have been well in the loop at the time. Take note of the preface in the beginning of his comments relating to those events. He states: "Here's the facts; and we don't even talk about these things ...". Not quite the sort of language one uses when they're preparing to offer an exaggerated account of events.

    I, for one, am far more inclined to consider Congressman Kanjorski's seemingly candid version of events than I am a report by the particular portion of the financial industry in question.

  • Report this Comment On October 13, 2011, at 9:37 PM, skypilot2005 wrote:

    JP Morgan: Gold Is Going To $2150, And The Miners Are Way Undervalued


    Chinese Investors Prefer Gold To Stocks And Real Estate


    Sky Pilot

    Official Web Link assistant to Sinch

  • Report this Comment On October 18, 2011, at 2:29 AM, DarthMaul09 wrote:

    Jim Rickards has a series of interviews on KWN explaining how the derivative market has created a much bigger problem than just Greece and the other failing European economies. In the above interview a month ago he expands on the problems that will be faced by European and US central banks as they try to hold the system together. Eventually, not by their intent but by necessity they will arrive at a hard money (gold) solution.

    Martin Armstrong also gave some interesting interviews on KWN, discussing the banking system and the unintended consequences of government intervention.

  • Report this Comment On October 18, 2011, at 10:56 AM, rfaramir wrote:

    From the video clip: What is necessary is a "very significant agreement… to recapitalize the banks, … it requires the political will of Europe's leaders to agree on a program as soon as possible."

    This amounts to asking to be raped. "Recapitalize the banks" means taking money by force from the public and giving it to bankers who otherwise would go bankrupt. Bankers have mismanaged capital (by lending it to sovereigns who will not pay it back), so they deserve to have their business sold to others who will manage it better. That's what bankruptcy does, reallocate capital to those who satisfy consumers better than the current holders. And what about the taxpayers? What did they do to deserve to have their wealth confiscated by government to give to the zombie banks? And not just net taxpayers (the 53%), but all holders of fiat currency (dollars here, but euros and pounds there) will be surreptitiously stolen from (their purchasing power diminished) when the central banks electronically print the money necessary to accomplish this travesty.

    "sufficiently dire to provide ample political cover for members of Congress for the unprecedented steps"

    In other words, they acted unconstitutionally, but because they scared us enough, we didn't make them pay for this power grab.

    Chris, your resulting financial advice is very good. But your gullibility in believing the statist party line is disheartening.

  • Report this Comment On November 04, 2011, at 6:26 PM, wrightdda wrote:

    Agree with the reference to CEF, but if we have a meltdown of the magnitude, I think I have a lot bigger problem than how to cash out my gold winnings - does my bank exist? How about my brokerage account? If you believe this, you should have cash buried in the basement of your house....

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