2011 August 04 Thursday
Italian And Spanish Borrowing Costs Hit Danger Level
The markets think it is now the turn of Italy and Spain to go thru sovereign debt crises.
Investors drove borrowing costs for Italy and Spain to 14-year highs, fueling sharp stock market drops in London, Frankfurt, Paris, Milan and Madrid. Though Italian and Spanish bonds later rebounded, borrowing rates for both nations remained dangerously high, at more than 6 percent — and closing in on the 7 percent threshold that eventually triggered bailout talks with Greece, Ireland and Portugal.
The weak economic recovery this year has made the markets doubt tax revenues will grow fast enough to pay the interest on the large debts of the southern European countries. The amount of debt outstanding today was issued based on rosier expectations for economic growth. Take away economic growth for an extended period of time and the result will be massive defaults.
Since the PIIGS (Portugal, Italy, Ireland, Greece, Spain) owe European banks and even some American banks big bucks sovereign defaults run the risk of triggering bank failures and a freeze-up in the willingness of banks to lend to each other. We could go thru a re-run of the late 2008 financial crisis.
Before we reach an acute crisis stage the European Central Bank might step in and buy up large amounts of Italian and Spanish debt at lower interest rates. But that's just kicking the can down the road if robust economic growth does not come back. Since I expect Peak Oil to weigh down Western economies I do not expect we will see a return to fast economic growth. Rather I expect the choice faced by central banks is between high inflation or many more sovereign defaults, bank failures, and future financial panics.
What is still not clear: do our financial problems indicate that we are nearing the end of empire?
The Treaty of Lisbon forbids the ECB from funding Government debt. The Peons will have to change their rules. The European Central Bank does have a keyboard for making new money. All central banks can make new money, much like our Federal Reserve does. But, in Europe, if a country like Greece spends more than it taxes, it has to go to the bond markets to get the extra money. The peon governments end up borrowing mostly from Commercial banks.
Governments like Greece will issue a bond, and it will be funded by a Commercial bank. The cross parties to the funding are often American financial interests. This is why Geithner told Europe to take it in the shorts, and not let their bondholders take the hit. The financial types always have the same argument, don't let us take the hit, shift it to the population.
Europe’s situation boils down to this: Will the Greeks will be as stupid as the Irish, and not as smart as the Icelanders?
Iceland’s Althing changed the rules of the game. They subordinated Iceland’s reimbursement of Britain and Holland to the ability of Iceland’s economy to pay.
Iceland’s General Assembly is called the Althing. It would be something like a parliament familiar to the Anglosphere. Here is one of their statements:
“In evaluating the preconditions for a review of the agreements, account shall also be taken to the position of the national economy and government finances at any given time and the prospects in this respect, with special attention being given to foreign exchange issues, exchange rate developments and the balance on current account, economic growth and changes in gross domestic product as well as developments with respect to the size of the population and job market participation.”
In plain English, Iceland decided to not harness their economy to austerity desires of their foreign creditors. Instead, they said, “these are the rules we shall play by, and we will pay you back according to the ability of our economy to do so.” Iceland’s sovereign government decided what the rules would be.
(My position is that money is law, and the Icelanders seem to understand that. Perhaps the rapid crash of their economy awakened them like no other people on the planet.)
The Althing’s proposal to settle its Icesave bankclaims caused Britain and the Netherlands to reject said proposal passionately as “unthinkable.” So Iceland told them, “No, take us to court.”
And that is where matters stand right now. I also understand that Britain threated to label Iceland as a terrorist country.
Yes, Iceland made the right decision and Ireland made the wrong one. The debt holders of Irish banks should have taken big haircuts for being so foolish to loan so much to those banks in the first place.
Borrowing costs. For what? To open a new business, those who do not have "stored value" need to get permission from those who have already "stored value", and to get this permission they must pay a tax to those who have this "stored value".
What if Google invents a new trading business software that makes transactions cash-free, by bartering work and good and services. After all, cash is just the transmission mechanism to exchange goods and services. This would make it possible for new companies to be formed without being at the mercy of banks who may or may not offer loans.
Wolf-Dog, Google is already competing with PayPal in the payments market. Unfortunately, interfacing with the conventional banking system is expensive. Bitcoin can do nearly costless transactions, but it has no inherent value at all: it's just a ledger which is managed by a P2P network and secured by cryptography.
Yes, liquidity constraints stop many people from starting new businesses. Self-financing is much cheaper than borrowing from a bank, but many people don't even have a savings cushion. And the government doesn't allow people to tap their 401k savings or SocSec earnings.