Best of the Week
Most Popular
1. Stock Markets and the History Chart of the End of the World (With Presidential Cycles) - 28th Aug 20
2.Google, Apple, Amazon, Facebook... AI Tech Stocks Buying Levels and Valuations Q3 2020 - 31st Aug 20
3.The Inflation Mega-trend is Going Hyper! - 11th Sep 20
4.Is this the End of Capitalism? - 13th Sep 20
5.What's Driving Gold, Silver and What's Next? - 3rd Sep 20
6.QE4EVER! - 9th Sep 20
7.Gold Price Trend Forecast Analysis - Part1 - 7th Sep 20
8.The Fed May “Cause” The Next Stock Market Crash - 3rd Sep 20
9.Bitcoin Price Crash - You Will be Suprised What Happens Next - 7th Sep 20
10.NVIDIA Stock Price Soars on RTX 3000 Cornering the GPU Market for next 2 years! - 3rd Sep 20
Last 7 days
Stock Market Elliott Wave Analysis - 23rd Nov 20
Evolution of the Fed - 23rd Nov 20
Gold and Silver Now and Then - A Comparison - 23rd Nov 20
Nasdaq NQ Has Stalled Above a 1.382 Fibonacci Expansion Range Three Times - 23rd Nov 20
Learn How To Trade Forex Successfully - 23rd Nov 20
Market 2020 vs 2016 and 2012 - 22nd Nov 20
Gold & Silver - Adapting Dynamic Learning Shows Possible Upside Price Rally - 22nd Nov 20
Stock Market Short-term Correction - 22nd Nov 20
Stock Market SPY/SPX Island Setups Warn Of A Potential Reversal In This Uptrend - 21st Nov 20
Why Budgies Make Great Pets for Kids - 21st Nov 20
How To Find The Best Dry Dog Food For Your Furry Best Friend?  - 21st Nov 20
The Key to a Successful LGBT Relationship is Matching by Preferences - 21st Nov 20
Stock Market Dow Long-term Trend Analysis - 20th Nov 20
Margin: How Stock Market Investors Are "Reaching for the Stars" - 20th Nov 20
World’s Largest Free-Trade Pact Inspiration for Global Economic Recovery - 20th Nov 20
Dating Sites Break all the Stereotypes About Distance - 20th Nov 20
Reasons why Bitcoin is Treading at it's Highest Level Since 2017 and a Warning - 19th Nov 20
Media Celebrates after Trump’s Pro-Gold Fed Nominee Gets Blocked - 19th Nov 20
DJIA Short-term Stock Market Technical Trend Analysis - 19th Nov 20
Demoncracy Ushers in the Flu World Order How to Survive and Profit From What Is Coming - 19th Nov 20
US Bond Market: "When Investors Should Worry" - 18th Nov 20
Gold Remains the Best Pandemic Insurance - 18th Nov 20
GPU Fan Not Spinning FIX - How to Easily Extend the Life of Your Gaming PC System - 18th Nov 20
Dow Jones E-Mini Futures Tag 30k Twice – Setting Up Stock Market Double Top - 18th Nov 20
Edge Computing Is Leading the Next Great Tech Revolution - 18th Nov 20
This Chart Signals When Gold Stocks Will Explode - 17th Nov 20
Gold Price Momentous ally From 2000 Compared To SPY Stock Market and Nasdaq - 17th Nov 20
Creating Marketing Campaigns Using the Freedom of Information Act - 17th Nov 20
Stock Market Uptrend in Process - 17th Nov 20
How My Friend Made $128,000 Investing in Stocks Without Knowing It - 16th Nov 20
Free-spending Biden and/or continued Fed stimulus will hike Gold prices - 16th Nov 20
Top Cheap Budgie Toys - Every Budgie Owner Should Have These Safe Bird Toys! - 16th Nov 20
Line Up For Your Jab to get your Covaids Freedom Pass and a 5% Work From Home Tax - 16th Nov 20
You May Have Overlooked These “Sleeper” Precious Metals - 16th Nov 20
Demystifying interesting facts about online Casinos - 16th Nov 20
What's Ahead for the Gold Market? - 15th Nov 20
Gold’s Momentous Rally From 2000 Compared To Stock Market SPY & QQQ - 15th Nov 20
Overclockers UK Quality of Custom Gaming System Build - OEM Windows Sticker? - 15th Nov 20
UK GCSE Exams 2021 CANCELLED! Grades Based on Mock Exams and Teacher Assessments - 15th Nov 20
Global "Debt Mountain": Beware of This "New Peak" - 13th Nov 20
Overclocking Zen 3 Ryzen 5600x, 5800x, 5900x and 5950x to 4.7ghz All Cores Cinebench R20 Scores - 13th Nov 20
Is Silver Leading Bitcoin or is Bitcoin Leading Silver? - 13th Nov 20
How Elliott Waves Simplify Your Technical Analysis - 13th Nov 20
How to buy Bitcoins using debit/credit card? - 13th Nov 20
Will COVID Vaccine Kill Gold and Silver? - 12th Nov 20
Access to Critical Market Reports - 12th Nov 20
Stock Market Dow Futures Reach 30,000 on News of COVID-19 Vaccine Trials Success - 12th Nov 20
8 Terms & Conditions You Must Know Before Asking For Life Insurance Policy Quotes - 12th Nov 20
Gold Stocks Post 2020 US Election Outlook - 11th Nov 20
Champions’ League Group Stage Draw: All You Need To Know - 11th Nov 20
Stock Market Secular Trend - 11th Nov 20
Stock Market Correction Curtailed by US Election - 11th Nov 20
What Causes a Financial Bubble? - 11th Nov 20
Ryzen 9 5900X RTX 3080 - vs UK Custom PC System Builder Review - 10th Nov 20
Killing Driveway Weeds FAST with a Pressure Washer - Saving Block Paving from LOTS of WEEDs - 10th Nov 20
Trump Fired, Biden Hired, What Next?  - 10th Nov 20
Looking for a Personal Loan? Here Is What You Have To Know  - 10th Nov 20

Market Oracle FREE Newsletter

How to Get Rich Investing in Stocks by Riding the Electron Wave

Europe's PIGS Gorging on Free Euros as ECB Bankrolls the Incontinent Subcontinent

Politics / Euro Feb 17, 2010 - 09:12 AM GMT

By: Gary_North


Diamond Rated - Best Financial Markets Analysis ArticleThe wicked borroweth, and payeth not again: but the righteous sheweth mercy, and giveth (Psalm 37:21).

The question arises: How wise is it to lend to wicked people? Not very. What about lending to national governments, whose representatives were elected in order to show mercy to certain voting blocs with taxpayers' money? Not very. Yet this is what has been done on a massive scale.

The European Central Bank now faces its moment of truth: how to finance the European Union's rumored bailout of Greece.

Why was the bailout agreed to – assuming that the details can be worked out? Because of the threat to the commercial banks of Northern Europe. A default would have busted some big banks all over Europe.

The issue did not turn on the issue of whether to help the national treasuries of the profligate PIIGS: Portugal, Italy, Ireland, Greece, and Spain. The European Central Bank does not answer to, or have any concern for, the elected governments of the PIIG nations. It answers to, and has a great deal of concern for, the large commercial banks of Northern Europe. That is to say, it is a central bank. It feathers the nests of large commercial banks under its jurisdiction.

Whenever we hear "bailout," we should follow the money. Where does the money wind up? Who is the final beneficiary?

The Federal Reserve System and the Treasury bailed out AIG in 2008. Who were the beneficiaries? AIG was helped; this kept it from a well-deserved bankruptcy. But AIG did not keep most of the money. Who got the money? The banks that were owed billions of dollars by AIG because of AIG's issuing of derivatives. The bailout money was pure profit for the recipient banks, which were paid off at face value for their preposterously high-risk leveraged investments. The losers are the rest of us.

The EU and ECB have decided to fund the spendthrift nations that ran up debts to European banks. The threat of default still hangs over the banks that made the stupid, supposedly low-risk loans to the PIIGs.

The money on the line is huge: trillions of euros in a wave of defaults in a worst-case scenario. The euro is the common currency unit in Europe, although not for the United Kingdom and Switzerland.

Speaking of the UK and Switzerland, their banks are holding lots of IOUs from the PIIGs. According to one estimate, the money owed to British banks is the equivalent of 16% of the UK's entire gross domestic product. British financial columnist Edmund Conway has estimated Great Britain's exposure as close to $350 billion in euros. Not to be outdone, Swiss banks are holding the bag for 21% of Switzerland's GDP.

These are big numbers. They are not limited to just two nations. Loans to PIIGs are in the range of 30% of France's GDP. Germany's banks: 19%. Netherlands: 29%. Then there are the PIIG nations themselves. Their banks are also holding bags. Portugal's banks: 24%. Ireland's banks: 34%. For a table on which nation's banks are holding the bag for what percentage of its nation's entire GDP, click here.


The carry trade is a variation of "buy low and sell high." It is "borrow low and lend high." This is possible because of a specific central bank policy: to stimulate the economy with low short-term rates. Borrowers can then lend long: buy high-rate bonds. They borrow short and lend long.

How did these banks get themselves into such trouble? Simple: the ECB funded it.

The spendthrift nations ran up large debts. They borrowed more money than lenders – banks – thought was reasonable at low interest rates. So, the lenders demanded higher rates. In the case of Greece, rates were as much as three percentage points above German bonds of the same maturity.

The banks bought these bonds and then used them as collateral to get ECB loans. They paid the ECB 1% per annum. That rate point spread is worth billions of euros in profits.

Now economic reality is breaking through. Greece may default. The risk factor is high. The commercial bankers assumed that there would never be a default. They assumed that the spread between Greek bond rates and German bond rates was there for no good reason other than to make them richer. They assumed that the ECB would never allow the Greek government to default. After all, if the ECB really was convinced that Greek debt was too risky, the ECB would not have accepted the Greek bonds as collateral for its 1% loans.

This is the carry trade in action. It always comes to this: a day of reckoning, when the debt-ridden borrower cannot pay its debts. No one ever expects any government to pay off all of its debts. They do expect it to meet its interest payments in full and on time.

The risk of default is real. While governments never pay off their debts, they can walk away from them at any time. No one can prosecute them. This is what economists call an asymmetric relationship: in this case, between sovereign national borrowers and fractionally reserved lenders. Lots of leverage means that a single national default can take down a lot of banks.

The ECB, having funded this inverted pyramid of debt, now must take action to see that a default does not take down any large banks. It will have to intervene to save the big banks. It wants to avoid this.

The fractionally reserved dominoes could easily have toppled. The ECB knows this. It subsidized these high-risk loans at low rates in order to save the European economy from the recession, but now the policy has backfired. The banks gorged themselves with IOU's from PIIG governments. Now what?

In an economic sense, the ECB has been bailing out the PIIG governments all along. It allowed their bonds to be used as collateral. Now the inverted debt pyramid is larger than when the bailout process began. If it topples, the devastation will be must worse.


In 1802, a free market economic theorist and successful banker, Henry Thornton, described what the ECB is facing today. A central bank will be called upon to provide emergency loans to bail out insolvent banks, in order to avoid a wave of defaults and busted banks. Two generations later, Walter Bagehot named this phenomenon: moral hazard.

It is a shame that Thornton did not come up with this phrase, for it was Thornton, more than any banker in history, who was most closely associated with morals. He was William Wilberforce's cousin and a founder of the Clapham Sect of evangelical Protestants, which promoted moral reform and the abolition of slavery. He was a gold standard advocate.

Until this year, the moral hazard argument had been confined to a discussion of government and central bank bailouts of profit-seeking banks and brokerage firms. Now, however, there has been a quantum leap. The moral hazard argument has been extended to nations – indeed, to a subcontinent: southern Europe. It has been called Club Med, because of its club-like spending habits and the nations' location on the Mediterranean or close to it (Portugal). Ireland is included, leading some wag to call it Club O'Med.

The amount of money at stake is astronomical. Europe's entire experiment in the European Union and the common currency is now facing destruction. Salaried bureaucrats must now make decisions that could saddle taxpayers with new debts for a generation. The central bankers must decide how much fiat money will be required to paper over (digit-over) the crisis.

This crisis goes far beyond domestic politics and monetary policy. Beginning with Jean Monnet before World War I, there has been a messianic push for a United Europe. This goal has been a big part of the modern push toward centralization and micro-management by governments. The proponents of European union were relentless in their efforts to move from a free trade zone (the matador's red cape) to the creation of a new nation state (the sword under the cape). As of December 1, 2009, they had fulfilled their goal through the Lisbon Treaty. This had to be substituted for a Constitution, which did not get ratified by the voters of all the nations. There is now a new Europe.

Then, without warning, the financial crisis has hit this year. It is now apparent to everyone that the recession has undermined the supposed guidelines for bank capital and fiscal policy. No agency is enforcing high bank capital requirements set by the Basel Accord I (1992). No one is enforcing the less restrictive Basel II guidelines (2004). No one is enforcing the low percentage requirements set for national deficits in relation to GDP.

The only common agency of the New Europe that has the authority to impose sanctions on the treasury departments of the independent nations is the ECB. The central bank is officially in control over monetary policy. It can legally decide which banks and governments receive or do not receive assistance in the form of newly created digital money. It must back up any decisions made by the EU. It holds the purse strings.

The ECB still faces the threat of governments defaulting on their debt. This was considered inconceivable as recently as three months ago. The risk factor has risen, as reflected in rising insurance rates against default.

Any default could create a crisis for the commercial banks in each nation. The major European nations are under the ECB. Only Great Britain and Switzerland are outside the euro zone, meaning outside the authority of the ECB. So, a threat to any nation's commercial banks becomes a threat to the euro zone as a whole. This means that the ECB will have to take action, country by country to deal with any domino effect of one or more national defaults. The ECB must act on behalf of Europe as a whole, yet it has no civil authority over the domestic policies of individual member nations. It has only the power over the monetary base that affects all of them. It holds the money bag. Meanwhile, large commercial banks are holding bags full of IOU's from struggling national governments.

The ECB must now use money as the only sanction available within the euro zone that is a serious threat to member national governments. There is no way that NATO will be used to take over bankrupt member states. There is no agency with police power that can enforce a decision by any court to require member states to honor their IOU's.

An agency without any guns has become the agency with the only available sanction: butter. It can intervene and work out an arrangement by which technically bankrupt O'Med national governments can preserve the legal façade that they are solvent. The game of deceiving investors can continue.

The investors are the best and the brightest bankers in Europe. They decided that there can be no default by a member nation. What were they thinking of?

Maybe they thought that nations cannot default. That was the standard textbook account in the good old days. But, way back in the good old days (pre-2000), each European nation had its own central bank. Not today.

Maybe they thought that the ECB would intervene in order to prevent any default. A default could topple very large banks all over Europe. That would force the ECB to put the pieces back together. The ECB now has to face this threat. Commercial bankers concluded that, in a showdown between the ECB and a national treasury department, the ECB would blink first and provide the government with newly created funds.


Let us review: "The wicked borroweth, and payeth not again."

Professor Philipp Bagus has written an enlightening article on the threat to the euro. He identified the origins of the euro carry-trade. He also identified the political incentive to sin.

The incentives for irresponsible behavior for these and other countries are clear. Why pay for your expenditures by raising unpopular taxes? Why not issue bonds that will be purchased by the creation of new money, even if it finally increases prices in the whole eurozone? Why not externalize the costs of the government expenditures that are so vital to securing political power?

When the New Europe's new central bank subsidized this behavior, thereby providing huge profits to commercial banks, sin increased. Economics teaches this: "When the price falls, more is demanded." The price of fiscal profligacy fell because of the policies of the ECB.

Greece got away with this. It will now get bailed out by the ECB. This will send a message to voters and politicians across Europe: "Gravy train!"

For the member states in the eurozone, the costs of reckless fiscal behavior can also, to some extent, be externalized. Any government whose bonds are accepted as collateral by the ECB can use this printing press to finance its expenditures. The costs of this strategy are partly externalized to other countries when the newly created money bids up prices throughout the monetary union.

Each government has an incentive to accumulate higher deficits than the rest of the eurozone, because its costs can be externalized. Consequently, in the Eurosystem there is a built-in tendency toward continual losses in purchasing power. This overexploitation may finally result in the collapse of the euro.

To prevent such behavior, there must be negative sanctions. There have been none. There have been guidelines. But without negative sanctions, the guidelines are enforced by a plea to act responsibly. This has been about as effective as sex education in the tax-funded schools.

Such a regulation was installed for the European Monetary Union. It is called the Stability and Growth Pact, and it requires that each country's annual budget deficit is below 3% and its gross public debt not higher than 60% of its GDP. Sanctions were defined to enforce these rules.

Yet the sanctions have never been enacted and the pact is generally ignored. For 2010, all but one member state is expected to have a budget deficit higher than 3%; the general European debt ratio is 88%. Germany, the main country that urged these requirements, was among the first to refuse to fulfill them.


The ECB did not decide to let the Greek government go without aid of any kind. That would have sent a message: "No more Mr. Nice Guy." But the Greek government might have defaulted. Greek voters would not have risen up to demand that the government raise taxes and cut spending to be able to pay foreign bankers.

If any other debt-laden government defaults, some large commercial banks all over Europe will suffer huge losses. Then the ECB will have to bail them out. So will their own national governments.

For the first time in my lifetime, politicians in Europe are having to consider the costs and benefits of national default. The theology of the messianic welfare state is being reconsidered. "A government need not default" has always meant, "a government can stiff lenders with fiat money." Today, that traditional avenue of concealed default has been cut off in Western Europe. The threat of real default has reappeared.

If the euro dies, the New Europe also dies.

That will be a funeral I hope to attend.

    Gary North [send him mail ] is the author of Mises on Money . Visit . He is also the author of a free 20-volume series, An Economic Commentary on the Bible .

    © 2010 Copyright Gary North / - All Rights Reserved
    Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


18 Feb 10, 01:23
Same Greek story 4 months running. Enough already!

Enough already!

Do you get the feeling that the media is playing a broken record? That's because they are. Haven't they got any original news to tell us?

It's been Greece Greece Greece for the last four months now!

As though a country that is responsible for a meagre 2.5 per cent of European GDP is big enough to break Europe when its debt levels GDP-wise are no different from the United Kingdom's!

Iceland fell in less than a week when it was subjected to the same treatment. Looks like Greece has some staying power. Greece has had more persistent media coverage than it had during the 2004 Athens Olympic Games (most of that was negative too up till the actual event happened).

Why not pick on California instead which is responsible for 12.5 per cent of American GDP. California's debt problem is super-sized like many Californians who have been gorging on debt for far longer than the skinny PIIGS.

But it doesn't end in California. There are numerous States in the United States in no less worse a position.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules