Debt Crises in Ireland, Greece, Portugal and now Spain may Prove too much for the Euro to Survive

Posted by PITHOCRATES - June 3rd, 2012

Week in Review

The woods are lovely, dark and deep.  But I have promises to keep.  And miles to go before I sleep.  And miles to go before I sleep.  Lines from a poem by Robert Frost.  For some reason this came to me as I read about the never-ending crisis that is the sovereign debt crisis in Europe.  And the Eurozone.  For the Euro is lost in those dark and lovely woods.  Woods that are so deep that it will never find its way out.  And the only kind of sleep the Euro is going to get is the kind you don’t wake up from (see Britons face £5bn bill to help out Spanish as fears grow that Madrid will have to ask IMF for €300billion bailout by Hugo Duncan And James Salmon posted 6/1/2012 on the Daily Mail).

British taxpayers could be forced to stump up another £5billion to rescue Spain as the crisis in the eurozone spirals out of control.

Fears are mounting that Madrid will have to ask for an emergency bailout of up to £300billion as it struggles to prop up its basket-case banks.

A third of that money could come from the International Monetary Fund – including around £5billion from the UK, even though Britain is not in the eurozone.

UK taxpayers have already coughed up £12.5billion to rescue debt-ridden Greece, Ireland and Portugal…

But growing doubts over how the Spanish government will finance the £15billion needed to rescue Bankia, one of its biggest lenders, have raised fears that it will follow Ireland, Greece and Portugal in requiring a bailout from Europe and the IMF.

This week US investment bank JP Morgan warned a joint rescue of Spain could cost around £300billion.

The Spanish banking system has been crippled by nearly £150billion in toxic property loans.

At the heart of the sovereign debt crisis in Europe is debt.  They have way too much of it.  So much that the odds are not good that they will ever be able to repay it.  Which makes people very reluctant to loan them any more money.  It’s like loaning a friend money who already owes you a lot of money.  Do you loan him more money?  It just may help him turn his life around.  Start anew with a new job.  Earning enough money to support himself and pay you back.  That’s one possibility.  Then there’s the possibility he may just blow the money on booze, drugs and women.  You know he’s just going to spend whatever else you loan him.  And not pay any of it back.  So it would be rather foolish to loan him more money.

This is the decision facing the people who could attempt to bail out those in the Eurozone.  They’ve already loaned them a lot of money.  So these in-trouble countries can sustain the government spending their current tax revenue can’t support.  But the deal was to cut back that spending so they can live on what their tax revenue CAN support.  But there’s only one problem.  The people of these countries reject calls for them to live within their means.  And have had enough of austerity.  And that’s a big problem.  Because if they don’t live within their means they will perpetuate the sovereign debt crisis.  As they will always need to borrow more money to pay for the things that their tax revenue can’t afford.  Until the day this house of cards collapses.  And the longer it goes on the more money people will lose in bad loans to these in-trouble countries.

The central problem in this crisis are bad loans.  Caused by the easy credit policies of central banks to loan money to anyone so they can buy a house.  All this easy credit caused housing booms in countries all around the world.  And housing bubbles.  Then the bubbles burst.  Leaving countries with debt crises as toxic mortgages weakened banking systems everywhere.  And still Keynesian economists are urging central banks to repeat this reckless lending behavior again to stimulate economies.  And to bail out the Eurozone.  The problem is that the central banks have so destroyed their economies no one is borrowing money.  Or spending money.  Because no one thinks the worst has passed.  And businesses and private citizens have learned the lesson from the great debt crisis we’re going through everywhere.  Too much debt is a bad thing.  And are refusing to take on new debt.  And using what income they have to pay down existing debt.  Contrary to all Keynesian doctrine.  For they want reckless and irresponsible spending.  Because they believe only spending is good.

Politicians and central bankers said the situation in the eurozone was unsustainable and drastic action was needed to prevent the ‘disintegration’ of the single currency.

They spoke out as European leaders scrambled to stop the financial crisis in Spain spiralling out of control and infecting other countries such as Italy…

Mario Draghi, president of the European Central Bank, said the eurozone was unsustainable in its current form.

In his sharpest criticism yet of eurozone leaders’ handling of the crisis, he said the European Central Bank could not ‘fill the vacuum’ left by governments in terms of economic growth or structural reforms.

So, no, more easy credit isn’t the solution.  Countries must live within their means.  Which means adopting austerity measures.  And find ways to achieve real economic growth.  Not the kind that leads to bubbles.  Or sovereign debt crises.  And the best way to generate real economic growth is with tax cuts.  Cutting spending as needed so they spend only what their tax revenue can afford.  They must stop running deficits.  And stop borrowing money.  (Good advice for the United States as well).  As the private sector economy picks up because of a more business-friendly tax structure they will create jobs.  So all of those government workers who lost their jobs in the public sector can get new jobs in the private sector.  Whose salaries and benefits will not have to be paid for by more government borrowing.  If they adopt pro-growth policies like this the international community may still be able to help them.  And save the Euro.  But will they?  With all of that public opinion against any more austerity?  Don’t know.  Probably not. 

It’s unlikely that the Euro will ever find its way out of the woods.  For these woods are scary, dark and deep. 

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World War I, Gold Standard, German Reparations, Hyperinflation, Credit-Anstalt, Keynesian Policies and the Great Depression

Posted by PITHOCRATES - March 13th, 2012

History 101

Nations abandoned the Gold Standard to Borrow and Print Money freely to pay for World War I 

Banks loan to each other.  They participate in a banking system that moves capital from those who have it to those who need it.  It’s a good system.  And a system that works.  Providing businesses and entrepreneurs with the capital to expand their businesses.  And create jobs.  As long as all the banks in the system go about their business responsibly.  And their governments go about their business responsibly.  Sadly, neither always does.

World War I changed the world in so many ways for the worse.  It killed a generation of Europeans.  Bankrupted nations.  Redrew the borders in Europe as the victors divvied up the spoils of war.  Setting the stage for future political unrest.  Gave us Keynesian economics.  Saw the beginning of the decline of the gold standard.  A deterioration of international trade.  A rise of protectionism and nationalism.  Punishing German reparations.  To pay for a war that they didn’t necessarily start.  Nor did they necessarily lose.  Which created a lot of anger in Germany.  And provided the seed for the Great Depression.

A set of entangling treaties brought nations eagerly into World War I.  There was great patriotic fervor.  And a belief that this war would be Napoleonic.  Some glorious battles.  With the victors negotiating a favorable peace.  Sadly, no one learned the lessons of the Crimean War (1853-1856).  Which killed approximately 600,000 (about 35% of those in uniform).  Or the American Civil War (1861-1865).  Which killed approximately 600,000 (about 20% of those in uniform).  The first modern wars.  Where the technology was ahead of the Napoleonic tactics of the day.  Modern rifled weapons made accurate killing weapons.  And the telegraph and the railroads allowed the combatants to rush ever more men into the fire of those accurate killing weapons.  These are the lessons they didn’t learn.  Which was a pity.  Because the weapons were much more lethal in World War I (1914-1918).  And far more advanced than the tactics of the day.  Which were still largely Napoleonic.  Mass men on the field of battle.  Fire and advance.  And close with the bayonet.  Which they did in World War I.  And these soldiers advanced into the withering fire of the new machine gun.  While artillery rounds fell around them.  Making big holes and throwing shredded shrapnel through flesh and bone.  WWI killed approximately 10,000,000 (about 15% of those in uniform).  And wounded another 20 million.  To do that kind of damage costs a lot of money.  Big money.  For bullets, shells, rifles, artillery, machine guns, warships, planes, etc., don’t grow on trees.  Which is why all nations (except the U.S.) went off of the gold standard to pay for this war.  To shake off any constraints to their ability to raise the money to wage war.  To let them borrow and print as much as they wanted.  Despite the effect that would have on their currency.  Or on foreign exchange rates.

As Countries abandoned the Gold Standard they depreciated their Currencies and wiped out People’s Life Savings

Well, the war had all but bankrupted the combatants.  They had huge debts and inflated currencies.  Large trade deficits.  And surpluses.  A great imbalance of trade.  And it was in this environment that they restored some measure of a gold standard.  Which wasn’t quite standard.  As the different nations adopted different exchange rates.  But they moved to get their financial houses back in order.  And the first order of business was to address those large debts.  And the ‘victors’ decided to squeeze Germany to pay some of that debt off.  Hence those punishing reparations.  Which the victors wanted in gold.  Or foreign currency.  Which made it difficult for Germany to return to the gold standard.  As the victors had taken most of her gold.  And so began the hyperinflation.  As the Germans printed Marks to trade for foreign currency.  Of course we know what happened next.  They devalued the Mark so much that it took wheelbarrows full of them to buy their groceries.  And to exchange for foreign currency.

Elsewhere, in the new Europe that emerged from WWI, there was a growth in regional banking.  Savvy bankers who were pretty good at risk evaluation.  Who were close to the borrowers.  And informed.  Allowing them to write good loans.  Meanwhile, the old institutions were carrying on as if it was still 1914.  Not quite as savvy.  And making bad loans.  The ones the more savvy bankers refused to write.  Weak banking regulation helped facilitate these bad lending practices.  Leaving a lot of banks with weak balance sheets.  Add in the hyperinflation.  Heavy debts.  Higher taxes (to reduce those debts).  Trade imbalances.  And you get a bad economy.  Where businesses were struggling to service their debt.  With many defaulting.  As a smaller bank failed a bigger bank would absorb it.  Bad loans and all.  Including an Austrian bank.  A pretty big one at that.  The largest in Austria.  Credit-Anstalt.  Which was ‘too big to fail’.  But failed anyway.  And when it did the collapse was heard around the world. 

As banks failed the money supply contracted.  Causing a liquidity crisis.  And deflation (less money chasing the same amount of goods).  Currency appreciation (further hurting a country’s balance of trade).  And low prices.  Which made it harder for borrowers to service their debt with the lower revenue they earned on those lower prices.  So there were more loan defaults.  Bank runs.  And bank failures.  Spreading the contagion to Amsterdam.  To Warsaw.  Germany.  Latvia.  Turkey.  Egypt.  Britain.  Even the U.S.  Soon countries abandoned the gold standard.  So they could print money to save the banks.  Lower interest rates.  Depreciate their currencies.  And wipe out large swathes of wealth denominated in that now depreciated currency.  What we call Keynesian policies.  People’s life savings became a fraction of what they were.  Making for a longer working life.  And a more Spartan retirement. 

Abandoning the Gold Standard didn’t fix the U.S. Economy in 1971

Meanwhile in the U.S. the government was destroying the U.S. economy.  Trying to protect domestic prices they passed the Smoot-Hawley Tariff.  Raising the price for businesses and consumers alike.  And kicking off a trade war.  Both of which greatly reduced U.S. exports.  New labor legislation keeping wages above market prices while all other prices were falling.  And higher taxes to pay for New Deal social programs.  Wiping out business profits and causing massive unemployment.  Then came the fall in farm prices due to increased farm productivity.  Thanks to farmers mechanizing their farms and greatly increasing their harvests.  Thus lowering prices.  Making it hard to service the bank loans they got to pay for that mechanization.  Thus leading to bank failures in the farming regions.  That spread to the cities.  Causing a liquidity crisis.  And deflation.

Then came Credit-Anstalt.  And all the woe that followed.  Which caused a speculative run in Britain.  Which made the British decide to leave the gold standard.  To stem the flow of gold out of their country.  Which destroyed whatever confidence was still remaining in their banking system.  People thought that the U.S. would be next.  But the Americans defended the dollar.  And instead raised interest rates (by reducing the money supply).  To keep the dollar valuable.  And to protect the exchange rate.  Making it less attractive to exchange cash for gold.  And to restore confidence in the banking system.  Of course, this didn’t help the liquidity crisis.  Which Keynesians blame for the length and the severity of the Great Depression.

Of course, it wasn’t the gold standard that caused the fall of Credit-Anstalt.  It was poor lending practices.  A weak banking regulation that allowed those poor lending practices.  And a lot of bad government policy throughout Europe.  Especially those punishing German reparations.  And the gold standard didn’t cause the economic collapse in the United States.  For it worked well the previous decade.  Providing all the capital required to produce the Roaring Twenties that modernized the world.  It was government and their intrusive policies into the free market that caused the economic collapse.  And abandoning the gold standard wouldn’t have changed that.  Or made the economy better.  And we know this because leaving the gold standard didn’t solve all of the countries woes in 1971.  Because the government was still implementing bad Keynesian policies.

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