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Europe does “cash for trash” to prop up its failing system – straight from the US Fed’s playbook

by Aaron McCormack on January 30, 2012

 

 

 

 

 

 

 

 

 

 

It’s the debt, stupid.

That is Europe’s problem.  Many of its countries are insolvent and it is only a matter of time before they have to go bankrupt.  Those that cannot go bankrupt (for example, because they continue to play by the rules set down by the EU/ECB) will slowly kill themselves by saddling their peoples with the twin burdens of austerity and rising debt payments.

There is no economic growth on the horizon to magic our way out of this.

The ONLY thing that can rescue the economies of Ireland and Greece, Italy and Spain is a significant haircut on debt (a default) and a sharp “external devaluation” (a new and weaker currency).

Pacts on fiscal stability don’t cure the debt problem (in fact as the IMF keep warning us, too much is becoming a problem as it is stunting growth and recovery).

A new superstate in Europe, in and of itself, won’t cure the problem unless it comes hand in hand with a significant debt and interest rate change for the debtor countries.  Even then, without a sharp devaluation of the Euro, those countries will still struggle.

Think about what is happening, folks.  The ECB has now followed the US Federal Reserve and started a “cash for trash” scheme.  It is lending money to banks at 1% interest rates in return for what is euphemistically called “a wider definition of collateral”.  That means any old junk can be used to back the loan.  I don’t know if any of you have tried borrowing money for yourself or your business recently, but banks won’t lend you money unless there are significant cast-iron guarantees from you on your ability to pay it back.  However, the ECB has decided to significantly broaden what it calls collateral.

The banks are taking that money and lending it in large part to European governments in the form of bonds – usually at a rate of more like 5% of 6%.

They borrow money at 1%, lend it out at 6%.  Not a bad day’s work you might say.  But it gets better….

Normally a bank risks its own money (effectively that of those of its depositors, bondholders and shareholders).  If it makes bad decisions, the people who made those investments will suffer.  The government usually steps in to save the depositors.

But this money from the ECB is being sourced directly from the citizenry of Europe – you and me.  Our governments, even the ones that are broke, are contributing to the funds that back this “cash for trash” scheme.

And who is paying the 6% interest?  That’s right, it is we the citizenry again.

We raise the money for the banks – we lend it to them at rock-bottom rates.  They lend it back to us at high rates and pocket the difference.  We are both the source of capital AND the source of profit.

How is this paid for?  Right now the austerity measures that are being implemented in countries across Europe are helping to fill the gap. In addition, any inflationary effects will also penalize savers – so you pay for it threefold.

But, this semi-Ponzi scheme cannot go on for ever and the powers-that-be in Europe must be hoping and praying for some economic growth to help inflate away these debts.  That is not going to happen in any reasonable timescale.

In the USA you may know that there is no such austerity really taking place at the Federal level.  In fact the US Federal government, despite the fact that all spending bills must come from the Republican-controlled Congress, added about $1 trillion in new debt in 2011.  And the Federal Reserve is playing the same “cash for trash” game as the ECB has now started to play.  The difference in the USA is that the Fed is printing the money – in the ECB the money is raised from the people of the Eurozone.

This is the next phase in what will be a long and difficult correction to the world that we thought was normal – reasonable levels of growth with manageable and only occasional recessions.

Again, the need to “protect the system” will trump all other options – including letting capitalism do its job.

With the politicians and bureaucrats so heavily and personally invested in this course of action, only disorderly default within the system can drive the correction to a faster conclusion.

That, or the political courage to do something different and unilateral – but we in Ireland blew our “Eminem moment” in March 2011.

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