Friday, October 21, 2011

Can the EU Solve Its Debt Crisis with More Debt?


The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

European and U.S. stocks were rallying on Friday in what appears to be a liquidity frenzy supplied by the central banks. The market is once again hopeful now that EU leaders are beginning six days of meetings on how to save Greece and the euro. Based on their previous track record, which has led to the current crisis, there is little reason for long-term optimism.

Stock prices have not been the only thing rising lately.  Interest rates have been too in the credit- challenged Eurozone countries. While yields of Greek one-year governments have fallen back to only 180%, they were as high as 189% on October 19th. Greek two-years are at a more manageable 77%. Rates keep increasing in Greece despite the bailouts and this indicates the bailouts aren't nearly large enough and will have to continue and get bigger to keep the country out of default.  The political will for ongoing and ever-larger amounts of bailout money doesn't exist in the EU or does it?

While the EU voting public doesn't approve of spending more rescue money, the EU has created the EFSF (European Financial Stability Facility) a 440 billion euro fund to help bail out its member countries that have debt problems and to bail out the banks that lent them the money that allowed them to have those debt problems. Much remains to be decided on how the EFSF will actually function. There is disagreement of how to use it to bail out failing banks for instance (this is currently being referred to as recapitalization since bank bailouts are also unpopular with voters). There is also a proposal to leverage EFSF funds up to five times, so there will be more than two trillion euros available. This idea is apparently a "helpful" suggestion made by the U.S. monetary authorities.

While the stock market is showing almost as much enthusiasm for the leveraged bailout proposal as it did for the great innovation of triple A rated subprime mortgages in the mid-2000s, such financial trickery ended badly the first time and is likely to fall apart even faster this time. Mainstream media coverage, at least in the U.S.,  rarely looks at where the money is coming from for the EFSF. Technically, the money is being borrowed. So in order to deal with a debt crisis that is wreaking havoc on the financial system because of too much risk, more money will be borrowed and then that money will be leveraged (a form of borrowing in and of itself) to magnify the risk of the new borrowing. If this appears not to make any sense at all, that's because it doesn't. When the default comes — and there is 100% chance that it will —  the end will be much, much worse.

A case can be made however that the EFSF money isn't really borrowed, but a form of money printing instead. If governments borrow without the ability to actually pay back the money without inflating their currency, they are printing money. EU countries are already highly indebted just like the United States (Japan is in even worse shape). The fact that there is a debt crisis in a number of Eurozone countries is confirmation that the level of debt is beyond the point of no return. So a more accurate portrayal of what is going on with the EFSF is that money will be printed, this counterfeit money will be leveraged by borrowing against it and this will solve the problem of too much debt. 

The world has already lived through a debt binge in the early 2000s. The current crisis centered in Europe is simply a continuation of the unraveling of that debt. Governments handled the first implosion with trillions of dollars of bailouts, by running trillions of dollars in budget deficits, and by printing trillions of dollars of money. Debt problems keep resurfacing however. Could it be that engaging in additional reckless and irresponsible financial behavior isn't a solution for reckless and irresponsible financial behavior? EU leaders may wish to ponder this before going forward. 

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

1 comment:


The answer to the question is no.