Solving a debt problem with more debt - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 12 May 2010
Solving a debt problem with more debt A  A  A

Paris, France

Oh la la...that was fast! We've had headaches that lasted longer...

One day the world is convinced that the central bankers and financial meddlers of Europe have the secret to success. The next day, they change their minds. Turns out, the euro feds don't seem to have the problem solved after all. The euro is going down again.

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The problem is not the fickleness of the marketplace. It is not the cupidity of politicians nor even the stupidity of the voters. Nor is the problem a lack of regulation or coordination or integration. It is none of those things discussed in the media. In a word, it is debt. Eventually, the euro feds - along with their American counterparts - will discover what everybody else already knows. You can't really cure a debt problem with more debt.

At least investors seem to be able to put two and two together. After running up stocks and bonds on Monday, investors had a chance to think it over and on Tuesday they decided that maybe the euro bailout was not quite as good as they imagined it.

"European Bailout Optimism Cools," announced a headline on Bloomberg.

For one thing, the plan is hard to figure out. Exactly who is paying for what? Already, the euro itself was enough of a mystery. In America, at least you know who is responsible for destroying the dollar. In Europe, you're not sure. The dollar is, after all, an IOU issued by the world's biggest debtor. What's the euro? It's an IOU too. But nobody is too sure who the 'I' is.

The bailout plan is a mystery on a mystery. The plan calls for a little of this and a little of that...and maybe it won't happen at all if some nations vote against it...and who knows what they're really going to do?

For another thing, no one really knows what the risk is or how much it should cost to protect against it. Yes, Greece, Portugal, Ireland, Spain and Italy all COULD go broke. But how? And when? So what?

No one knows. But, yesterday, investors felt that maybe they didn't want to be holding quite so many pricey stocks or quite so many euros when they finally found out.

The Dow fell 36 points. The euro went down close at $1.26 - even cheaper than before the rescue was announced.

What was really amazing was the price of gold. It went up $19 during trading hours. Later in the day, it was up to a new record, over $1,220. How do you like that?

Why would gold go up? After all, when stocks go down, it is signaling LESS faith in the growth, prosperity and inflation forecast. A falling stock market is a sign of growing pessimism....that haunting fear that people may actually get what they've got coming after all.

Meanwhile, in America, Governor Arnold Schwarzenegger is preparing the people of California. Hard times are a-comin'. They're going to have to tighten their belts.

"Terrible cuts," are on the way, said the governor.

How will Californians react? Will they close ranks, like the Koreans after the Asian debt crisis of the late '90s? Will they take it with good humor and Guinness, like the Irish now? Or will they start to riot, like the Greeks of the debt crisis of 2010?

You remember what the Koreans did? They turned in their gold jewelry so that the state could pay its bills to foreign lenders.

The Greeks, on the other hand, seem to be looking for a rumble. They figure they're entitled to the Good Life. They figure its part of what you get when you join the European Union. It must be in the constitution somewhere...that you have the right to life, liberty and a good time.

They're used to being taken care of. And they don't like giving it up.

They'd probably like it even less if they realized that it is all so that a group of French bondholders can be bailed out of their bad bets.

But what's the alternative? You either pay your debts...or you go broke. If you go broke, no one will lend to you - so you'll have to make do on what you actually earn. On the other hand, if you do pay your debts, you'll have to take money out of earnings...leaving you with less money to spend.

Oh me, oh my...there's no easy way out. Milton Friedman was right; there is no free lunch after all.

*** People don't realize it, but these macro economic issues have real, personal consequences, said our French MoneyWeek editor. Simone calculated that keeping the debt under control, at 2009 levels, would cost the average Greek nearly $2,500 per year. That's just the cost, per capita, of keeping up with the interest, while holding other expenses even with government revenues.

Not many Greeks want to pay that amount. Not many will be able to. And more than a few will think they're being treated like chumps. They'll imagine that it's all a conspiracy of the elites...or some kind of fraud on the part of the governing classes.

And they'll be right!

The ruling classes want to keep everything under control. Like governing elites everywhere, they want to prevent change - at all costs. So, they prop up the old industries...reward the bad banks...and protect failed companies and bad speculators. Why? They're on the top of the heap...and they want to stay there.

They own the present. The future be damned!

So, what's their strategy? It's to squeeze the working classes and the middle classes...and everybody else. Anything and everything to preserve the old order.

Scrape the barnacles from the hull? Not a chance. They are the barnacles!

*** But the big news yesterday was the price of gold. It appears to us that gold may now be getting ready to prepare to commence the beginning of its final stage. You will notice that there is more fudging in that last sentence than in a birthday cake.

Why? Because even if we are right about the general flow of events, it is almost impossible to get the timing right.

Still, you gotta guess. And our guess is that gold is beginning to move up - on good news AND bad news. Inflationary? Deflation? It doesn't seem to matter. Gold is beginning to act more and more like real money, not just like a speculation.

When inflation increases what do you want? Well, real money...something that maintains your purchasing power even as the paper currency goes down. Traditionally, that's gold. Because they can't make more of it easily.

Gold is not perfect money. But it's the best thing we've got. And when consumer prices start to move up people look for ways to protect themselves. In the past, they could move to euros or to the dollar. Now, both the euro custodians and the dollar custodians have decided to sacrifice the integrity of their currencies in order to bailout bondholders. That leaves gold as the best choice for inflation protection.

What about deflation? In deflation, prices go down. But that means that the value of real money goes up. You can buy more with less money when you are in a deflationary cycle. Trouble is, in deflation, the backers of asset prices tend to go broke. You have a piece of paper. It says you own a share in a department store. Come a deflation and people stop buying - they'll wait to see how low prices go before spending their money. So, the poor department store goes bust and you lose all your money.

Or, take a bond from a sovereign country, such as Greece or the USA. In deflation tax revenues go down too. This leaves the country unable to pay the interest on its bonds. It misses payments. The value of the bonds collapses.

What can you buy that has no one on the other side who might go broke? Gold! The yellow metal went up in the last great depression. It will go up in the next one too..

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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1 Responses to "Solving a debt problem with more debt"


May 12, 2010

Dear Bill,
I was present when you were in India, your analysis for world economy was very pessimist and understandably right so but as an economist what is the solution or where solution lies ? Is world economy heading towards barter system ? Ideally what is wrong in it, at least discipline will return to all nations. One thing is sure all nations where democracy prevail politicians of those countries must stop to take financial decisions this financial cancer is spreading due to vote politics. We are 1.2 billion people and our politicians vision is very short and myopic and interested to stick to power at any cost by offering freebies.

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