Honestly, if this Eurozone debt crisis weren’t so hysterically funny, I might take it more seriously. The comedic plot goes something like this. Thousands of commercial banks lend money to Eurozone sovereign governments internationally known as financial deadbeats.
It’s not like these bankers missed that memo either. Everyone knows these governments repeatedly default on their IOUs, and have no hope of repaying their debts. (At least that’s been the case for the last 2,000 years. . .but we can always hope for change.)
Suddenly the worst deadbeat governments get so deeply in hock that they can’t even make interest payments. The bankers who loaned the cash panic. They run to their mother, the central bank, and beg her to take the deadbeat government IOUs off their hands, begging her to replace those bad loans with cash (i.e., IOSs from the central bank. In the U.S we call them Federal Reserve Notes.)
The mother central bank happily buys the worthless bonds. After all, politicians have given central bankers power to issue as many IOUs as they want at zero cost in exchange for the central bank’s promise to buy government bonds whenever necessary.
It’s a Wonderful Scheme, Isn’t It?
Politicians get to pass out goodies and get re-elected. Bankers make lots of profits on the loans. Central bankers fly around the world, wine and dine at the best resorts, and everyone listens to every word they say.
The only problem is those pesky little deadbeat governments like Greece. Suppose they can’t keep up with interest payments? Not to worry! The politicians and bankers have a solution for that. “Stronger” governments will simply step in, sell bonds and loan the money to the deadbeats. But wait. Those governments are also running deficits. No matter. The central banks will cover the whole mess by printing their own IOUs.
Or am I missing something?
This tragic-comedy moved toward a denouement last month when Greece teetered on the brink of default. The Greeks owed foreign banks 338 billion pounds for both government and private bonds. Across the continent, commercials banks scrambled to figure out which of their banking partners were at risk.
It was clear that French and German banks are the most exposed to the deadbeats. They lent nearly $1 trillion to their ne’er-do-well European neighbors. The German bank Depfa said it held 80 billion pounds in public-sector debt from Portugal, Ireland, Italy, Greece and Spain (affectionately called the five “PIIGS”.) But other than the Depfa admission, no one seemed to know which bankers held the shaky Greek debt. As a consequence, these naturally suspicious bankers simply refused to lend to one another.
Eurozone politicians, the European Central Bank and the IMF hatched a plan. They would all contribute to a new pile of IOUs totaling 110 billion pounds to handle the immediate Greek problem.
The markets were not impressed with such a paltry offer. In a matter of days, they shined the light on Portuguese, Spanish, Italian and Irish government bonds.
Now all the larger players were running deficits themselves – including France and Germany. But still, the gang of Eurozone politicians agreed to up the ante.
If 110 billion of promises isn’t enough, they would raise it to 750 billion (nearly $1 trillion) in new IOUs. That should cover all five little pigs, all the way home.
Another Dozen Unwanted Piglets
But within a couple of weeks the yields began edging up again. Investors realized that the five PIIGS were only part of a much larger litter of piglets.
In addition to their loans to the five PIIGs, EU banks also had lent nearly $2 trillion to the entire Central and Easter European bloc. That includes countries like Albania, Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia. . .to name a few. Sooey!
Clearly, the contagion is spreading, and central bankers are finding it harder to jawbone the markets into believing that the paper game is working.
This river of government and central bank IOUs is about to turn into a flash flood and overrun its banks (pun intended).
Lars Christensen, chief analyst at Denmark’s Danske Bank, has been anxiously watching the EU debacle unfold for years. “The day they decide not to save one of these countries will be the trigger for a massive crisis with contagion spreading into the EU.”
How can European authorities control the crisis? They only have one tool: the printing press.
In his latest testimony before the House of Representatives budget committee, Ben Bernanke assured us that printing money to prevent bad debts from defaulting works quite well, pointing to the imaginary economic recovery that we’re supposedly experiencing. While sheepishly admitting that the U.S. recovery isn’t fully roaring yet, Bernanke warned the committee that the debt problems in Europe will spill across the Atlantic.
To keep the imaginary recovery on track, he says, the Federal Reserve must join forces with the European Central Bank and make sure the bonds of the deadbeat Eurozone government don’t default. How? By standing ready to guarantee debts of the deadbeat Eurozone governments with Federal Reserve IOUs.
As politicians and bankers worldwide load their monetary cannons with fresh IOUs, they claim that creating money out of thin air is a necessary evil. They tell us that this is the only way to prevent global financial meltdown.
They also tell us that default of government bonds (or those of any large debtors) would create a cascade that would topple the world’s banking systems.
Sounds familiar, doesn’t it? Two years ago, they told us the Fed must prevent the default of derivatives by buying them itself with printing-press money. Otherwise, a new dark age would descend, the entire financial system would collapse, and anarchy would follow.
As ABC News’ John Stossel says: “Give me a break!”
Bernanke to ECB:
“Let Them Eat Paper”
Yes, if Helicopter Ben had not stopped up a trillion dollars in worthless IOUs a long chain of bankruptcies would have followed.
But preventing those bad debts to default was the wrong thing to do.
When banks are given an endless source of funds, it’s inevitable that $15-an-hour manual laborers will have access to no-money-down loans to buy $700,000 houses. It gives politicians unlimited funds to build roads to nowhere.
Bankers and politicians benefit, but who ultimately pays the bill? The poor and the middle class. First they overspend and under-save, then suffer through recession, unemployment, and bankruptcies, only to finally be hit with price inflation.
Lending money to deadbeats misallocates resources, and the only way to rebuild an economy that has been thus distorted is to purge those IOUs from the system. They must be written off, and the losses taken by those who borrowed the money.
Allowing the PIIGS and Piglets to default would surely trigger the collapse of over-leveraged banks, financial institutions, and businesses worldwide.
Yes, it would plunge the world into a deeper depression – but cleansing the world of these toxic “assets” (what a joke to call a worthless IOU an “asset”) is the best thing that could happen. The ensuing depression would be short-lived, far shorter than the lingering Great Recession that will now be with us.
The new economy would emerge on a foundation of real savings. Real capital would replace paper IOUs, and this capital would be re-allocated to uses that more clearly reflected the demands of consumers. Unemployment would soar temporarily, but sounder businesses would soon create better, more permanent jobs.
Price inflation would be replaced by falling prices and soaring output. The standard of living of the world would rise, not just for advanced nations, but for all nations following their lead.
Will it happen? Sadly, not within the foreseeable future.
Voters can and do vote their own self-interest. The strikes and violent mobs that rail against cutting government services in Athens, Paris, Madrid and a hundred other cities tell us it will be a long bloody road to sound money and a free society.
John Pugsley founded the Bio-Rational Institute
www.biorationalinstitute.com
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