The German parliament has a historic opportunity to say no to the bankers: On Wednesday, the Bundestag gets to vote on the expansion of the European bailout fund, the EFSF. The new limit: €1 trillion ($1.37 trillion), though it had just been expanded to €440 billion. Since no one has any money, the expansion will be in form of leverage—the very mechanism that has wreaked so much havoc already.
While the details are still uncertain, we know one thing for sure: you can’t enlarge something by leveraging it without multiplying risks and ultimate costs. And the idea that these operations will prevent contagion and buy time to solve the underlying fiscal problems is self-contradictory: if the EFSF were actually able to eliminate market pressures on over-indebted governments, it would also eliminate the incentives to make the needed hard choices.
That’s what happened in the U.S. The Fed’s strategy of printing trillions of dollars and forcing interest rates to near zero has eliminated any and all market pressures on Congress to solve the budget fiasco. As a consequence, Congress is sitting contentedly on a situation where the U.S. borrows 38% of every dollar it spends. In about two years, gross national debt will approach 120% of GDP, the unenviable spot where Italy is today.
And Italy is in deep trouble. To bail it out, experts are already examining how the leveraged EFSF could buy massive amounts of Italian debt on the secondary market (Spiegel). This, despite provisions in the European Union treaty that specifically prohibit such bailouts. But these experts are now looking for a way around the law. The same has already occurred at the ECB, which has been buying the debt of countries like Italy, though by law, it cannot do so.
No country has ever paid off its sovereign debt without resorting to inflation and devaluation. It can’t be done because the money from debt sales goes into salaries, paperclips, wars, politicians, pensions, offshore bank accounts, subsidies, infrastructure, bailouts, healthcare, etc., which do not produce enough revenues to pay off the debt when it matures. Investors understand that. But they have some sort of fuzzy guarantee that the piece of paper (or number on a screen) they hold will be redeemed at face value with funds obtained from the sale of new debt.
The idea is to create 2-3% inflation and 2-5% growth. Then a deficit of 3% of GDP, or more when the economy dips, is no problem. New debt can be issued, and maturing debt can be rolled over. The debt level remains “sustainable.” Until the percentages go out of whack.
Now they have gone out of whack. Italy, Greece, the US, and some other countries have deficits that are 8-10% of GDP, far beyond the rate at which a developed country can grow. At these levels of deficit spending, even during a period of growth of 5%—the sound barrier for developed countries—the debt problem only gets worse. Inflation, at least in the U.S. economy, is no solution either because real wages have declined significantly since their peak in 1999. Reduced purchasing power has been a drag on growth, and more inflation will only make it worse.
So, rather than getting budget deficits in line, fancy schemes are devised to borrow more, print more, and add leverage to the mix. Losses, risks, and mountains of debt are shifted from one country to another, from banks to the taxpayer, and from one generation to the next.
Now the Bundestag has an opportunity to say no to this madness—and to stand up to the bankers. German taxpayers are shouldering 48% of the EFSF that is ballooning with every squiggle in the market. Their voices should be heard. While the Bundestag apparently cannot, or does not want to, prevent the subversion of the laws that govern the ECB and the EFSF, it can turn off one of the spigots. Through its vote, the Bundestag can allow market pressures to impose some discipline on budgets around the Eurozone. In the U.S., the Fed has eliminated that discipline, and with it, the checks and balances of capitalism. And we’re paying the price. In the Eurozone, that is about to happen, too. So just say no.