Trend: Financially strong governments are buying the bonds of debt-stricken governments to try to maintain stability. The threat of financial instability ripples through equity markets, increasing volatility and uncertainty.
John Mauldin discusses why Europe's leaders suddenly decided to buy Greek bonds
Basically, the leaders of Europe marched to the edge of the abyss, looked over, decided it was a long way down, and did an about-face. It was no small move, as they shoved almost $1 trillion onto the table in an “all-in” bet.
Above all, this is a move to buy time. There is enough in this fund to purchase all the expected debt of Greece, Portugal, and Spain for three years. The money could actually last a lot longer, as Spain might not need to tap the fund for some time.
What this Euro-TARP does is take money from mostly good credit and give it to weak credit. It will crowd out private savings that go into private enterprise (which is where jobs come from) and put it to unproductive uses in the government debt of weak countries.
There are only two ways to grow an economy: you can grow your population or you can increase productivity. That’s it. The Club Med countries are not growing their populations appreciably, as their birth rates are low. And you increase productivity by investing private capital into businesses, the way the Germans have done, which is why their labor unit costs are so low compared to their competition.
Euro-TARP almost mandates that capital be misallocated into non-productivity-enhancing government programs and debt.
Europe is run by Keynesians (as is the US). They see everything as a liquidity problem. And sometimes it is. But the PIIGS have a debt problem. And you don’t cure a debt problem with more debt unless you have a clear path to grow your way out of the debt. But as I have demonstrated, there is no clear path to growth with the current policies. They will produce deflationary recessions, lower government tax receipts from reduced GDP, and higher unemployment.
At the end of the day, Greece will just have more debt. Perhaps Spain and Portugal can work through their problems, but that will be very difficult and will involve considerable economic pain. Italy can succeed if it decides to.
This new program simply buys time to try and figure things out. It is Germany saying, “Ok, I give you 3-4 years. But don’t come back asking for more.”
All this does is bridge to the middle of the decade, when the truly massive health and pension promises made all over Europe must be dealt with. The US has the option of raising taxes, reducing benefits, and means testing, should we so choose to do so to meet the demands of entitlement problems. Europe already has tax rates that are high and growth-inhibiting. The entitlement problems in many countries are more onerous, and their working populations are not growing.
This is just the beginning of their woes. They have a long way to go and a short time to get there. Can it be done? Yes, of course. But it is going to require a great deal of change. I hope they pull it off, I really do. I have been to most of Europe and love every bit I have seen. The world is better off with a united Europe.
That being said, I have my doubts that the European Union in its current form will exist in 5-7 years. I hope I am wrong.
One implication. The euro is on its way to parity with the dollar. So is the pound. That is going to help their exports vis-a-vis the US. Watch the yen fall rather sharply over the next few years. Senators Schumer and Graham gripe about China. What are they going to say about Europe, Britain, and Japan, all of which are on course to premeditated devaluation? This is going to be just one more challenge for businesses in countries with the world’s stronger currencies.
Another side bet? The ECB says it will sterilize those government bonds it buys (meaning, it will make sure it does not add to the money supply). My bet is that when deflation starts to run throughout Europe, the ECB will decide that maybe not so much sterilization is required after all.
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