The Crack in the Ice
by Gary North: How
Karl Marx Foresaw Bernanke and Krugman
who go out onto lakes or large ponds are told from their early years
not to skate on thin ice. The sound of cracking ice is a signal
to skate toward the shore.
August 5, 2011, the world heard the ice crack. Late in the day,
Standard & Poor's downgraded American government debt by one point:
from AAA to AA+.
of the U.S. Congress the previous Tuesday to raise the debt ceiling
by over $2 trillion was a real crack in the ice. Standard & Poor's
only made it semi-official. "Yes, the loud noise you heard on Tuesday
really was what it sounded like."
That was not
all. The European Central Bank on Friday announced that it would
hold yet another a weekend meeting to deal with yet another crisis
in the bond market for European national government debt. This time
debts issued by the governments of Italy and Spain were coming under
attack in the bond market. Lenders were demanding higher rates.
Central Bank on Sunday announced that it will begin buying bonds
issued by the technically insolvent governments of Italy and Spain.
In other words, it capitulated. It did the same thing with Greek
government debt. By the terms of the Maastricht Treaty and the Lisbon
Treaty, it is not allowed to do this. But, hey, you can't make omelets
without breaking a few eggs. Or laying them.
The key ingredient
of these omelets is fiat money. The ECB will create the money required
to buy these bonds. There are a whole lot of bonds to be bought.
Italy has about 2 trillion euros worth. Spain has about a trillion.
Italy and Spain
are huge debtors. They are not pipsqueak debtors the way Greece
is. There is serious money invested in the IOUs of these two PIIGS.
The bankers of Europe thought, "No Western nation will ever default."
They bought these IOUs with both hands. Now they face losses of
50% or more on these bad investments. The big banks have no intention
of taking the famous haircut. Why should they? The ECB is there
to bail them out. Bailing out large banks is the #1 task of all
central banking. There is no reason for large banks to worry.
The ECB will
not have to buy all of this debt. The fact that it stands ready
to buy some of it will temporarily keep interest rates on these
bonds lower than the 6% they were forced to pay a week ago. But
this is merely another case of kicking the can down the famous road
The ECB makes
perfunctory protesting noises about its decision. Its lips say "no,
no," but its eyes say "yes, yes." The ECB issues statements about
its responsibility to keep inflation low. Then it creates digits
to buy the bonds of deadbeat nations.
Note: all nations
are deadbeats. Some are more deadbeat than others.
In this sense,
the ECB is like Germany's Prime Minister Angela Merkel. She, too,
makes statements about "no more bailouts." But every time there
is a major financial crisis because of a threatened default by a
squaling PIIG, she and Sarkhozy and their supporting cast of small
government nonentities get together over a weekend and come up with
another round of bailouts. I like to think of her preliminary remarks
as Merkel's gurgles. Why the gurgling sound? Because she chokes
on the words she will soon eat.
gurgling noises to placate German voters. German voters have some
vague understanding that they will wind up paying for the mistakes
of German bankers, French bankers, and all the other bankers. This
is correct. They will.
voters do not perceive is that the bailouts were always assumed
by bankers. The bankers wisely perceived that they would be bailed
out. They lent money to PIIGS. It was such easy money. There was
no risk. But, you say, there really was risk. Yes, yes but
not for large bankers. The ECB and the IMF and the other bailout
agencies would accept the consequences for the decisions of the
It's just like
the Federal Reserve and the U.S. Treasury in September and October
2008. They bought the largest commercial banks' toxic debt at face
What will voters
do about all this? Nothing of any consequence. A few voters understand
what is going on, but they have no way to protest effectively. Congress
goes along with the bailout process. It has no intention of cutting
spending. It has no intention of reducing the government's debt.
It never has.
have no way to place restraints on the ECB. German central bankers
make gurgling noises. They vote no in the ECB's meetings, knowing
that their votes are irrelevant to the outcome. They do not have
enough votes in the ECB hierarchy to stop the ECB's policy of buying
PIIGS bonds. They go through the motions for the sake of the voters
There is only
one way out for Germany: to pull out of the European Monetary System.
Germany can abandon the euro. The country is in a strong enough
economic position to do this. The EMS allows the nations to have
their own central banks, just not their own currencies. Germany
can secede. But that will take a domestic political reversal of
monumental proportions. This is not likely in the near future.
of the New World Order have always planned to use Europe as the
first step: the model of all the good things that treaty-based,
centrally planned economic integration can achieve. Beginning with
Jean Monnet and the American agent, Raymond Fosdick, at the Versailles
peace conference in 1919, this has been the plan.
up in 1920 after the Senate refused to ratify the Versailles Treaty.
He returned to the USA, where he became John D. Rockefeller's main
lawyer and financial bagman for the next 40 years. But Monnet never
stopped lobbying to create the European Union. He achieved his main
goal before he died in 1979: treaty-based economic integration.
This was a preliminary step to political unification.
The grand experiment
is unraveling before our eyes. The New World Order's designers could
not create the European New World Order in one step. They knew that.
They did it piecemeal, one treaty at a time, for 50 years, beginning
with the Treaty of Paris in 1951. This was Monnet's brainchild.
a series of treaties signed in Rome.
is this: they could not get the votes to merge the central banks
into one. The others still exist as figureheads. But they do exist.
The Eurocrats could not get the voters to accept a common fiscal
agency that would control the deficits of each nation. So, the system
has a soft underbelly: national parliaments that can run up debts,
combined with a common central bank whose primary purpose is unofficial,
namely, to bail out large banks.
is now visibly falling apart. Northern European political leaders
call for economic "austerity" reduced government deficits
for the PIIGS. Ireland has buckled. It has promised to cut
its deficit. But it did this only because the political party in
power late in 2010 agreed to terms for IMF loans loans that
the party's leaders had denied were necessary a week earlier. The
voters had no say. They threw out the majority party a few months
later, but by then it was too late.
the Irish Times ran the most accurate obscene mainstream
political cartoon I have ever seen. But that was what the protest
was limited to: symbolic protests.
Why did Ireland's
government buckle? Because it was already on the hook. It had nationalized
its banks. It stood behind their debts. Now the banks faced bankruptcy.
The Irish Times described the dilemma.
Brian Lenihan said the bailout was necessary because Ireland's
banks have become wholly dependent on loans from the European
Central Bank and, just like the government, are likely to be frozen
out of normal credit markets for at least a year.
He said Ireland's
six banks, five of which are already nationalized or part-owned
by the state, would be pruned, merged and possibly sold off.
of the huge risks they (Irish banks) took earlier this decade,
they became a huge risk not only to this state but to the eurozone
as a whole," he said.
invested aggressively in runaway property markets at home and
abroad. After the 2008 credit crunch sent property prices into
freefall, the government tried to save the banks from bankruptcy
by insuring all of their borrowings against default. That unprecedented
promise made to retain investor confidence in the country
cannot be kept without a bailout, the government has finally
been forced to concede.
Does any of
this sound familiar? All over the West, bankers have extended loans
to bad risks. It was the fiat-money-fueled property markets, 2001-2007.
But now we learn that certain national governments' IOUs are only
marginally better than the bad property loans, which have yet to
be written down by the banks.
RATES STICK PIIGS' CREDITORS
This new risk
is far worse for bankers. Why? Because national governments can
conceal the bad property loans. They cannot conceal their own looming
insolvency. The credit markets keep increasing the interest rate
that lenders are willing to accept. The governments must pay these
rates, which are eating into their budgets.
voters can take to the streets to protest budget cuts. But that
does not change the fact that private lenders are not going to lend
more money at low rates. The protests in fact persuade lenders that
a particular PIIGS nation is an even lower credit risk. So, the
lenders raise the rate again.
The only ways
out are these: (1) balance the budgets, (2) find non-private lenders.
governments need an excuse to cut welfare spending. When the ECB
or the IMF lend money and impose conditions, the politicians can
blame these hard-nosed lenders. This strategy did not save the Irish
government earlier this year. It fell. But its replacement has meekly
abided by the terms of the loans.
The PIIGS can
of course take the borrowed money and then renege on the terms.
If one majority government refuses, it can be voted out of office.
But, as the Irish voters discovered, that did not change anything.
The new government is abiding by the terms set by the IMF.
At some point,
some PIIGS electorate will toss out the existing government and
replace it with a government that will stiff the IMF and ECB. The
new government will not cut spending. But then the government's
interest rates will rise. The government will then have to decide:
(1) pay the rates by cutting welfare spending or (2) default.
There is a
third option: pull out of the EMS. Abandon the euro. Put its domestic
central bank in charge. Tell it to buy the country's bonds. In other
words, the government can inflate. It will default through inflation.
keep telling us that this will never happen. Of course it will happen.
Politicians will heed the desire of domestic voters, who want goodies
from the government. The voters will not get goodies; they will
get depreciating money. But that has been acceptable to most Western
voters ever since the end of World War II.
voters are willing to protest against inflation. Germany remains
an exporting nation. It is doing well inside the EU. But it has
a problem. To keep the system going, it is required to bail out
PIIGS through direct government subsidies. It is also required to
go along with the ECB when the ECB buys PIIGS bonds by creating
new money. Germans may not like the arrangement, but the only way
out is to stop the government-to-government bailouts and then pull
out of the EMS.
them have two huge problems. First, its currency would rise in relation
to the euro. This would reduce German exports. The export sector's
economists (read: shills) would cry for a weaker currency. Export-based
special interests are almost always successful politically in trade
surplus nations. Mercantilism is still a major political force in
nations that are running balance of payments surpluses. "Don't kill
the goose that lays the golden eggs!"
problem is the squeeze on German banks. These banks have loaned
hundreds of billions of euros to PIIGS. They will be repaid, if
at all, in euros. But euros in relation to a newly resurrected deutsche
mark will be falling in value. Even if the interest payments on
the loans still arrive, they will arrive in a depreciating currency.
The banks will take their haircuts. They will lend less. Rates will
rise. The economy will go into a recession.
voters have voted for the welfare state. A majority of them are
addicted to these wealth-transfers. They really do believe that
government austerity putting the state on a fiscal diet
will cause a recession. They are determined to keep the welfare
state alive. But it is steadily going bust. Why? Because the welfare
state has always relied on the flow of low-rate loans to the government.
have always rested their entire position on one assumption: "Loans
to the national government are safe." This was Keynes' view, stated
obscurely in The
General Theory of Employment, Interest, and Money (1936).
Here is the
Keynesian logic. Lenders are afraid to lend. This cuts consumer
spending. The economy stays in recession. This is the lipstick on
the Keynesian pig.
You want more?
Here's more. Lenders want safety. They are afraid to lend to private
borrowers, who may default. They will lend to a national government.
The government will then pay for various projects that the free
market judged were wasteful and loss-producing. This gets the economy
This is conceptually
stupid. I assume that you see why. Lenders have to put their investment
money somewhere, unless they spend it for consumer goods, which
Keynesian economists say is a Very Good Thing. Lenders who have
enough money to affect the economy do not have their money in currency
under mattresses. They have it in banks or mutual funds. If this
money does not go to a government to be spent either on centrally
planned projects or to buy votes, it will go to some other investment.
This should be obvious to anyone who has the faintest inkling of
how to follow the money.
This is why
Keynesianism is conceptually stupid. But most Ph.D.-holding economists
are self-blinded to such an extent that they cannot understand this.
They have not read W. H. Hutt's book, The
Theory of Idle Resources (1939).
assumption "Government debt is close to risk-free"
is at long last being called into question. It is being called into
question by the acts of politicians. They are incapable of getting
their national governments' budgets under control.
This is why
Keynesian economists are apoplectic over the S&P downgrade. They
are also upset that anyone should question the ECB's wisdom in extending
a helping hand to Spain and Italy. The Keynesian assumption has
always been that lenders should invest money in government bonds.
Government bond markets are the foundation of all Keynesian theories
of counter-cyclical spending by governments.
We never hear
a unified cry from Keynesians in boom times that it is time to cut
government spending and start paying off the government's debt.
We are told that Keynes called for counter-cyclical policy in boom
times, not just bust times. That meant running surpluses to reduce
the debt. But we never see quotations from Keynes to this effect.
We never see signed statements from Keynesian economists calling
for debt reduction.
There is a
reason for this. Keynesian economics is welfare state economics.
It has always been a cover for wealth-redistribution. Officially,
this wealth redistribution has been justified in the name of helping
the poor. Operationally, it has always been wealth transfers to
very large banks.
there is a financial crisis, the government and the central bank
bail out large banks. Every time, Keynesian economists hail this
policy during the crisis period. Then, after the dust settles, and
the surviving banks are larger than ever before, they bewail the
fact that Wall Street was bailed out again.
are not slow learners. They are non-learners.
We are witnessing
the break-up of the ice pond. The public is skating on the pond.
They hear the cracking sounds. A few wise skaters have started heading
for the shore. Gold hit $1,750 on Monday in response to Friday's
Tens of millions
of Americans and an equal number of Europeans are going to be trapped
when the Great Default comes. Yes, Alan Greenspan has denied that
this will ever happen.
United States can pay any debt it has because we can always print
money to do that. So there is zero probability of default" said
Greenspan on NBC's Meet the Press.
Does this reassure
North [send him mail]
is the author of Mises
on Money. Visit http://www.garynorth.com.
He is also the author of a free 20-volume series, An
Economic Commentary on the Bible.
2011 Gary North
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