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The Daily Reckoning

Debt is a bummer, on both sides of the ocean

The US has much to learn from Europe's debt crisis, but instead, we look the other way

(Page 2 of 2)



Athens made a show of it. But try as it might, it couldn’t turn Zorbas into Helmuts. Taxes went uncollected. Workers didn’t show up. And people rioted – attempting to burn down the finance ministry – when their government tried to force austerity measures on them.

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This left Greece in breach of the terms of its bailout. It also left the IMF and ECB with a bigger problem. Because now Greece needs more money. It cannot borrow from the free market. So it needs another bailout.

If the rest of Europe had their wits about them they would say to the Greeks what President Ford told New York City when it was in a similar situation in the 1970s: “Drop dead.” The city realized it could not continue borrowing and spending. It had exhausted all other options; it had to do the sensible thing. NYC flourished as a result.

But there is more to the story in Europe. If they tell the Greeks to drop dead, many large European banks – including the ECB itself – will have cardiac arrests too. Athens may have borrowed and spent recklessly and wantonly. But Paris, Berlin and Brussels were foolish to lend to them. And now it is difficult to separate the fool from the knave.

The ECB didn’t just cough up €90 billion for Greece. It also lent €106 billion to the Irish, €44 billion to the Spanish and €48 billion to the Portuguese. If these loans go bad, the ECB will face insolvency.

Fool? Knave? As you can see, the ECB is both. Perhaps it once lent to save the world. Now it lends to save itself.

What will happen when the credit runs out? That’s the trouble with the kick-the-can-down-the-road approach to debt. You end up down the road; and there’s the can! If the borrowers cannot make good on their debts to the ECB, the bank will run out of money and have to issue capital calls to its member national central banks.

The Germans, for example, will get a bill for 27% of the necessary funds. Other central banks will be asked to put in lesser amounts. But many of the member banks are the same as those that desperately need financing from the ECB. They won’t be able to meet the capital call; they’ll be making capital calls of their own. This will probably force Germany and France to shoulder larger percentages of the bank’s financing requirements and may force the weak banks (and the nations they serve) out of the system all together.

European officials have called this outcome “unthinkable.” But it is also an outcome that seems more and more likely. In the meantime, expect a combination of fraud and spin…as the authorities attempt to disguise and delay the inevitable default.

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