Saturday, May 8, 2010

Monetization for Europe – Take two aspirins and your head should clear up soon.

The front page headline of the Financial Times on Saturday May 8, 2010 is “European banks in bonds plea.” What’s the story here? Basically the commercial banks of Europe are worried that spillovers from the Greek sovereign debt crisis are going to result in much higher risk premiums and tightened credit across Europe. So instead of the banks going to the individual governments of Europe and asking them to do something about national creditworthiness, they are instead pleading to the European Central Bank to become the “lender of last resort for Europe.” Clearly, if the problem is caused by large government deficits and debt, it can only be truly solved by rebalancing these equations.
Now maybe there is some fine print somewhere that would let the ECB become the lender of last resort for Europe, but the last time I looked the ECB was an independent central bank and could not monetize debt of European countries. The ECB can conduct a looser monetary policy and it can buy more government bonds to do so – but it can do this only if inflation is not near or above 2%. With inflation in the 16 countries of the Eurozone at about 1.5% in April, this clearly gives them some wriggle room – but probably not enough to accommodate the begging bankers.
It goes without saying that there is a financial crisis in Greece that is spreading through Europe and beyond. It is true that the Fed vigorously acted as a buyer of last resort in the last years. But one wonders where this will all end. Yes, inflation is low in most countries today. Yes, there is plenty of slack on world labor and goods markets to prevent inflation from suddenly rising in the very near future. But it is also true that the most past virulent hyperinflations got started somewhere -- and mostly from central banks monetizing large government deficits. At what point do which governments begin leading the parade of fiscal responsibility? At what point do banks and private citizens begin to worry about the devastating impacts of runaway inflation associated with excessive national and world liquidity?
Let me end by cutting to the chase. The deficits, debts, and ensuing financial problems we are experiencing today are the result of governments who fail to pass the fiduciary test. They have been warned for years and in some cases for decades about getting their fiscal houses in order. Well – the day of reckoning has finally arrived and few are talking seriously about real fiscal solutions. Mostly we get smoke and mirrors. Instead we put pressure on central banks to bail us out. But the truth is that there is no end to these problems without fiscal solutions. Monetary remedies will do no more than a couple of aspirins when it comes to solving the drunk’s problem.


  1. Two words I did not notice in your post are "bond vigalante". They function sorta like the cop that pulls over the drunk driver, and it does not matter if the drunk ate a couple of aspirins or not. Almost two weeks ago the WSJ discussed this

    I wonder how the vigalanties will react vis a vis Greece, and the other EU weak sisters.

  2. NYT headline today about obama pushing the EU to bail out Greece.

    My guess is that sooner rather than later the house of cards will fall.

  3. Just saw some more bad news in the credit default swap movement yesterday, the prices had a significant jump yesterday. For those of you who cut class the day they taught credit default swap here is the short course. Credit default swaps are sorta like insurance for loans. So if a bank loans money to Greece the next thing they do is get insurance on the loan so if Greece does not pay them back they are not stuck with the loss. If the price of the credit default swap goes up this means investors are betting Greece will default on the loan.

    The really bad news is that the company writing the credit default swaps for the (mostly) German banks loaning the money to Greece is AIG. Since AIG is a wholly owned subsidiary of the US govt bail out program, already to the tune of hundreds of billions of dollars what this means in simple terms is that in addition to every thing else the US tax payer is stuck with the bill if Greece defaults.

  4. Dear LSD. Last evening I watched one of your favs – Glen Beck – who talked about the Greece bailout and had David Asman of Fox News/Fox Business News on the show. Asman explained the credit default swaps issued by AIG to cover in the event of a Greece default on the bailout – which most likely will occur. AIG will again be caught with its pants down and U.S. taxpayers will again be forced to bail it out.

    The U.S. portion of the IMF is 17%, amounting to $54B to bail out Greece.

    The current U.S. financial reg legislation does not include Fannie/Freddie, the latter of which just asked for $10.6B following its 1st quarter loss of $8B. Both Freddie/Fannie have lost $145B.

    Mikey32304 is correct – the house of U.S./global cards will fall. Owning all the gold in the world will not protect any of us from the impending financial meltdown. Better we start our own home farming and wine-making to get us the through . . . .