Like a Fat Kid at a Christmas Cookie Walk

Folks, I have been that fat kid at a cookie walk, so I know whereof I speak.  The Federal Reserve has opted to bail out Europe in the form of liquidity swaps.  Although the money is not going directly to sovereign nations – although I might ask, under the EU government, how sovereign any of them truly are nowadays – that money will essentially allow the European governments to keep spending, which is partly what got them into this mess in the first place.  Isn’t giving more money to Europe a bit like inviting a fat kid to a cookie walk?  The kid is probably going to eat up everything in sight and certainly isn’t going to lose any weight.

The Fed has entered into liquidity swaps with the European Central Bank and several other foreign banks.  In a nutshell, the Fed is making more dollars available to the ECB and other foreign banks.  Translation: The Fed is flooding the market with dollars.  Again.  The Fed has also cut the interest rates for those loans and is insisting that there is no risk involved with these loans.

One might ask, at this point, why the ECB, the so-called “lender of last resort” for Europe, hasn’t bailed out Europe itself.  Well, nobody wants to do business with Europe right now.  Europe is not seeing an influx of money, and nobody wants to buy increasingly worthless government bonds.  The ECB is not actually mandated to print money; the ECB supposedly exists for price control of the Euro only.  That said, they have purchased something like $300 billion worth of government bonds, which does allow the individual nation to keep the printing presses turned on, so to speak.  The problem now is that the ECB has – correction: had – nothing with which to buy those bonds.  Enter the Fed.

The Fed has loosed more easy money into the world, and the ECB is likely going to use it to buy up government bonds and keep Europe from collapsing for another week or month or whatever.  Ultimately, the result is the same: the Fed is creating another bubble out of the ruins of the one from 2008, and I suspect that when this one deflates, it’s not going to take any prisoners.

There has been talk about nations giving over their printing presses to the ECB, and Germany has been against it.  Small wonder, given that some folks in that country still remember the fate of the Weimar Republic and its hyper-inflated currency.  Nevertheless, faced with a breakup of the Eurozone or turning on the presses, it seems that Germany is considering breaking one of its golden rules.

In any case, the Fed has just bailed out another group.  Only this time, instead of bailing out the big banks here at home, they’ve bailed out the banks and governments of Europe.  Interestingly, the Fed does not make these bailout records available to Congress.  They say that it would interfere with the Fed’s independence.  Of course, this bailout took place shortly after President Obama pledged to help Europe any way we can.  I guess he wasn’t kidding.

I would honestly laugh, if this whole thing weren’t so damn tragic.  Giving European nations more money is like giving that fat kid an open wallet to buy and eat as many delicious Christmas cookies as possible.  If those European nations are even half as gluttonous as I was as a child, we can kiss our butts goodbye.  Because I could seriously mess up some cookies – and I still can.

Check these out, if you want to read more about the Fed’s newest bailout.

Ron Paul’s Statement on the Bailout of Europe
“Should the Fed Bail Out Europe?” – Forbes
“Fed Says it Takes No Risk Lending Dollars to Europe” – LA Times
“The Easy Fix?  Can Europe Print its Way Out of Trouble?” – ETF Guide
“The Irish Subjugation” by Philipp Bagus via Mises Daily  (As always, I highly recommend Bagus and Mises for all your econ lit needs!)

Predictable: European Leaders Calling for Further Integration

I am generally unsurprised by the European meltdown.  I mean, the way that their banking system is set up doesn’t exactly induce member states to live by their means.  In the wake of this meltdown, European leaders are calling for closer integration which, in my mind, is just about the last thing these folks need.  I’ve found two articles today where in Angela Merkel, the chancellor of Germany, and Jose Barroso, EU Commission President, claimed that Europe needs to be more closely bound in order for the Euro to survive.  I have no idea what logic they’ve used to arrive at this faulty conclusion, but they’re wrong.

We need to look at why Europe is in this trouble in the first place.  The European Central Bank operates in much the same way that the Fed does, except that it is a “produce money and lend” (PML) approach, while the Federal Reserve used the “produce money and purchase” (PMP) approach.  Although the process is similar, says Philipp Bagus via the Mises Institute, the results are the same: the money supply is expanded, which allows governments to keep living beyond their means.

I will admit that the article, while excellent, can be a bit, well, scholarly (i.e. boring for most people and hard to read in parts).  Nonetheless, it has diagrams that go along with it to show the reader exactly how the money supply is being inflated.  Let’s start with the Fed.  In a nutshell, the government issues bonds or, as they are commonly referred to, T-Bills.  The government must pay interest on these T-bills.  The Fed buys them in an open-market scenario which, according to Bagus, “monetizes the debt in a way that does not hurt politicians.”  Basically, politicians make a promise to pay at a later date for money they spend today.  The government pays interest to the bond’s new owner, the Fed.  At the end of the year, the Fed pays a bulk of its interest profit back to the government.  When the bonds mature and the principal must be paid in full, the government simply issues new bonds to pay the principal on the old ones and continues the cycle of monetizing the debt.

At the same time as the Fed is buying government bonds, it will also allow credit extensions to private banks, which operate on the fractional reserve system.  Fractional reserve banks loan out money at a rate of about 6:1, meaning that, at any point, they are unable to pay back all of their depositors’ cash.  Essentially, the Fed uses the interest money to expand the supply of credit to the banks.

In the case of the ECB, it receives the government bonds from banks, rather than directly from the government itself.  The banks use those government bonds as collateral against ECB money, which it then loans out at interest.  At this point, you can see how fractional reserve banks are inherently bankrupt, for they are always increasing the money supply at a greater rate than they would be able to pay back, were those loans ever recalled and the money supply contracted.

In any case, since the bonds are merely collateral held by the ECB, the bonds still belong to the private banks, and the governments pay interest to the banks, rather than to the ECB directly.  The banks then pay interest on their loans from the ECB, and the ECB provides a portion of its profits to the governments.  In one sense, the Fed is actually more up-front about its dealings, because we can see the bonds on its balance sheets, whereas the ECB doesn’t directly declare this, since the bonds are still property of the banks.  The effect is essentially the same, with the major difference that the profits are often distributed unequally between participating governments, and this is where we run into problems with the likes of Greece, Italy, Spain, Ireland, and anyone else who needs a bailout this week.

Basically, what has happened is that banks have been buying up Greek bonds when they should have been rejecting them outright.  The whole fiat/fractional reserve system avoids meltdown by being held in check by the behavior of other banks.  In truth, there is very little to prop up the system, once it begins to spiral out of control, which is exactly what we’re seeing now.

The problem with Europe is what is commonly referred to in economics as a “tragedy of the commons.”  Because of the misdeeds and irresponsibility of a few, everyone is going to suffer.  In this case, Greek bonds were being purchased for rates similar to German bonds, but the Greek government was spending at a furious rate.  Now that banks aren’t buying Greek bonds, the interest rates have gone up, and the Greeks have been left out in the cold, unable to monetize the debt.  That’s why the news media keeps bleating on about Greece raising taxes on everything – heretofore, they were able to avoid raising taxes by monetizing the debt via the ECB.  Now everyone is going to end up paying for the misdeeds of individual as well as the EU government.

I hardly see how closer integration is going to solve anything, as the EU government has been a vehicle in creating this catastrophe.  It seems more likely that countries like Germany and France will force out the economically impoverished ones such as Greece, although none of Europe is in a glowing situation right now.  The only reason I can figure for Merkel and others calling for closer integration is so that there will be more regulation on the banking sector.  Still, I don’t know how that’s going to solve the essential problem that is inherent to all banking systems such as these.  It seems a far better idea to let go of this half-baked idea about the Euro and go back to currencies that are printed by the governments themselves.  It might not be such a bad idea back home, either!

Note: I owe Philipp Bagus a debt, as I used some of his ideas and source material to help me write this article.  While I have some different ideas about intellectual property, I wouldn’t want to begrudge a true scholar the recognition he deserves.  Please head over to the Mises Institute and check out his articles.  He makes the mess in Europe seem crystal clear.

“The Bailout of Greece and the End of the Euro”
“The Fed and the ECB: Two Paths, One Goal”
“The Commons and the Tragedy of Banking”