We could use a little economic disaster
The recovery is stalling because the government intervened too soon. A little disaster goes a long way to wipe out bad business.
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And while Americans’ earnings slip, so do their balance sheets. The Fed’s latest dose of QE medicine revived the stock market, but not the housing market, which is where most people have most of their money. The latest figures show house prices off by 40% in real terms, and still falling.Skip to next paragraph
Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind The Daily Reckoning (dailyreckoning.com).
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In Britain, according to one estimate published in The Financial Times this week, the typical middle-class working household will be 720 pounds worse off in real terms in 2012 than in 2009.
Japan, meanwhile, is in such a funk it looks like it may never get out. And Europe is still bailing out the bankers whose loans hurt everyone but themselves.
In all four economies, the rescue strategy is basically the same. Look at the European situation, for example. Greece has just been downgraded; default (as predicted here at The Daily Reckoning) now appears unavoidable. But here’s the good news: default also could be catastrophic.
Who’s the Greeks’ major creditor? The European Central Bank. As of the end of the first quarter, Greece had borrowed 90 billion euros from the ECB. Against this, the ECB has all of 5.3 billion euros in capital. In other words, if the Greek debt loses just 6% of its value, Europe’s central bank is underwater.
But wait, it gets worse. The Europeans have used the ECB as a small town uses a landfill. Everything gets dumped there. In addition to the Greek debt, the ECB holds dubious paper from 17 member central banks, totaling some $1.9 trillion of assets. Against these assets, the ECB lends to Ireland, Portugal, Spain and other needy states, taking their paper in return. If the debtors don’t make their payments, the ECB’s ‘assets’ lose their value and the ECB will go broke. The next critical challenge comes in July, when Greece will need more money. Commentators, economists, and meddlers have already warned that if the Greeks aren’t taken care of, there will be a disaster.
Great! Avoiding disaster didn’t work. Let’s try another approach.
“The contagious impact on the rest of South Europe and Ireland would, as [Mr. Trichet] has said, be all too similar to the aftermath of the Lehman collapse,” writes John Plender.
So, the ECB will lend in order to keep Greece, and itself, in business. But by lending more, it doesn’t improve the quality of its credits; au contraire, it makes them even worse.
The Japanese are in the same general predicament. There, the government must borrow to meet its expenses. At 210% of GDP, it no longer has a hope of ‘growing its way out of debt.’ Instead, the best it can hope for is to grow its way deeper into debt for as long as possible.
Likewise, in America the critical moment comes in August. That is when the statutory debt limit will be breached. Ben Bernanke has already issued another warning. If members of Congress don’t get their act together and allow the federal government to borrow more, all hell could break loose.
Based on these facts, we have a modest insight: perhaps its time to let the calamity happen. There are several brick walls approaching. Let’s aim for one of them and see what happens.
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