I've written about the crisis in Europe in the past.
But, let's take another crack at it.
May 2, 2010: Thoughts on Greece
February 19, 2010: The Problem
with the Euro
2010: The Problem with Greece
If you ask an "expert" today to explain the crisis in Europe
regarding sovereign debt, banks and the euro, what would they say? I know
what they would say. They would say: blah blah blah blah. This blah blah blah would continue until
you cut them off.
That's what they always say.
Remember my crisis management principle? I made it just a few words so that
you would remember.
Identify the Problem
Solve the Damn Problem
2008: Crisis Management
How could it be any other way?
So, what's the problem in Europe? I would break it down like this:
1) Governments' ability to pay back their debts is
coming into question. This is because a) they have a lot of debt,
compared to GDP or revenue; b) they keep running enormous deficits, despite
promises otherwise; c) their economies stink, which is leading to
disappointing tax revenue and also lots of demands for government assistance.
The result is that freely acting private investors no longer want to buy the
debt of these governments, or if so, only at an elevated yield that makes
governments' fiscal problems worse. Not only would a default cause investors
to take a loss, governments would no longer be able to run deficits, so they
would have to cut expenditures radically.
2) A sovereign default would lead to bank insolvency. Most major banks
are insolvent already, but the extend-and-pretend trick has been able to keep
the status quo running for now. A sovereign default or two would probably
start a new round of bank insolvency crisis.
3) The euro might have problems (i.e. fall like a rock) if the
combination of sovereign default and bank failure emerged, especially in an
We have a little twist on these trends recently, as Ireland's government,
with a manageable 65% debt/GDP ratio, has been flash-bankrupted by the rest
of the EU, which forced Ireland's government to bail out foreign bankers. The
Irish were sold into generations of debt slavery so that foreign bankers
don't have to take a loss. Actually, this has been the IMF playbook for
decades, so nothing new there.
2008: Privatize the Profits. Socialize the Losses.
Let's use capitalist principles here. What is supposed to happen,
according to capitalist principles?
1) If private investors are no longer willing to
purchase the debt of central governments, then the central government must
reduce its spending and possibly "restructure" existing debt.
This "restructuring" might take the form of an extension of maturity
at a low interest rate, or something of that sort. (This is fancy talk for
"I'll pay you back later, I promise.") As for reducing spending,
that might be a good thing. It would be a wonderful excuse to clear out the
bloat and scleroticism of entrenched, parasitic
interests, whether public employees, entitlement programs, corporate pork, a
military-industrial complex, or what have you. Nobody needs a
"bailout." This solution doesn't cost anything.
2) If banks are insolvent and unable to continue operations (typically
because the private market refuses to fund them, i.e. buy their debt), then
they go into government receivership. This is what is happening on a
weekly basis in the U.S., as the FDIC takes over smaller banks. For a large
bank, the best option would be a quick debt/equity conversion, followed by a
huge writedown of problem assets. The bank would
continue operations, and emerge from the process fully capitalized. Sort of
like what is happening with General Motors. General Motors never stopped making
cars, did they? This does not need to cost the government anything.
2008: Effective Bank Recapitalization 2: Three Examples
October 5, 2008:
Effective Bank Recapitalization
3) The euro can maintain its value, and not plunge, if the currency
managers know what they are doing. All they need to do, in the event of
euro selling, is to reduce euro base money by selling assets on the open
market. This also doesn't cost anything.
May 6, 2008: The Key to Managing
2008: How Banks Work 7: the Lender of Last Resort
March 16, 2008:
How Banks Work 6: Liquidy Crises and Bank Runs
March 9, 2008:
How Banks Work 5: Selling Loans
2008: How Banks Work 4: Banks and the Economy
2008: How Banks Work 3: More Elephant Poop
2008: How Banks Work 2: Shitting Like an Elephant
February 3, 2008:
How Banks Work
As you can see, all of these solutions have no cost.
Indeed, to the extent that government spending is reduced, the cost is
The next thing that people would say is that a sudden reduction in government
spending, not to mention a bank crisis, would be a big economic negative.
Let's think about this. If governments are unable to fund deficits, then they
must balance their budgets. So the economy is going to implode because a
government runs a balanced budget? Didn't this crisis come about because of
governments' large debts and huge deficits?
In all cases, waaaay more importance is attached to
government spending than it actually deserves. A reduction in government
spending is always portrayed as the "end of the world." This is
because, for a government bureaucrat or politician or public employee, it is
often the end of THEIR world. Mainstream economists pick up on this,
because at some level, they understand that their role is to make up
justifications for what politicians and bureaucrats were going to do anyway.
But for the economy as a whole, a little less government waste is not a big
deal, and probably a good thing overall. Did you notice some great economic
benefit from the last round of govenrment spending
and big deficits? I didn't. So what would be the result of not having
government spending and big deficits? Probably not that much, and it would
likely be a long-term benefit.
Yes, I know some economist is going to insist that government spending and
big deficits prevented some sort of disaster that would have happened without
it. Because the capitalist economy doesn't work unless the government wastes
a lot of money on useless nonsense, you know. The difference between me and
the other people discussing this stuff today is that I've been listening to
this crap for twenty years in the case of Japan, and the only result has
been immense waste, a government that has bankrupted itself, a stagnant
economy, and ever-higher taxes to pay off the debt incurred to waste money on
Some people make the example of the end of World War II, resulting in a huge
reduction in government spending (the U.S. budget deficit went from about 30%
of GDP to zero) and also mass layoffs of government employees (demobilization
of soldiers). Result? A period of adjustment, followed by an economic boom.
The end of a war is supposed to be a good thing, no?
One reason that reducing government spending is perceived as a big negative
is that this is so often paired with big tax hikes. It is the big tax
hikes that cause the problems, not the reduction in spending! So, don't raise
taxes. (Usually spending isn't really reduced very much anyway. They just
talk about reducing spending, and do nothing, but they really do raise taxes.
Have you noticed that?)
On the fiscal level, the plan should be:
reductions in government spending
No tax hikes (and maybe some tax cuts!)
This is the Reagan/Thatcher strategy, which worked well in both instances.
Both Reagan and Thatcher delivered big tax cuts, which, oddly enough, didn't
reduce tax revenue as a percentage of GDP. Since GDP generally increased as a
result of the pro-growth tax cuts, if you multiply (bigger GDP)*(stable
revenue/GDP ratio) then you obviously end up with MORE REVENUE in
absolute terms. Reagan was never able to get much meaningful reduction in
spending from the Democrat-controlled Congress -- plus, he had his own
military spending ambitions. In fact spending did trend gently lower (as a
percent of GDP) during the 1980s and 1990s as a result of the generally
healthy economy, resulting in fewer demands on govenment
for assistance. The big reductions in spending/GDP in the U.S. took place in
the 1990s, with the Republican-controlled Congress beginning in 1994.
2010: The Futility of Raising Taxes
March 9, 2010: Ancient Economic
Wisdom Still Applies Today
May 9, 2010:
The Two Santa Claus Theory
June 24, 2010: Stimulus,
Austerity, and the Spiral of Decline
2010: The Deadly Cycle of "Stimulus" and "Austerity"
2010: U.S. Tax Hikes of the 1930s
November 2, 2008:
2009: "Austerity" and "Stimulus" 2.0
So, to summarize:
that can't raise funds in the private market default. No sovereign bailouts!
"Default" means that they probably extend the maturities of
existing debt. Unable to issue new debt, they must reduce their spending
dramatically. The standard bureaucratic respone
will be to cut the most important spending first. the actual,
important services provided to the taxpaying citizens. Bureaucrats will cut
the most egregious waste last, because that is, basically, their bloated
pension, their headcount, and the various pork/handouts for which they are
getting bribed. Ideally there will be some national leader to counter this
natural bureaucratic tendency. As the government cuts the most important
government services first, and probably tries to raise taxes, naturally
there is civil unrest. This civil unrest is always spun by the media as a
backlash against any reduction in government spending. If a government
cuts useless waste, bloat, and theft, the only complainers are the
bureaucrats and public employees themselves. The general citizen is quite
happy. Wouldn't you be happy?
2) Bank that are unable to stand on their own go into receivership,
debt/equity conversion, and take a big writedown of
assets. Since there are so many banks in this condition today, it would
probably be best to do it all at once, a "bank holidy"
of a week or so, in which major banks would all go through a capital
3) The central bank must maintain a stable currency by adjusting the
supply of base money as appropriate. This would mean reducing base money by
selling government bonds in the event that the currency threatened to decline
4) Ideally, all of this would be paired with some sort of pro-growth policy,
which in practice means big tax cuts. A Russian-style flat tax -- which was
implemented while Russia was in a crisis and the government was in default on
its debt -- would be wonderful.
May 30, 2010: The Flat Tax in
If we look at this list, we see that it follows all the principles of
capitalism and justice, it can be done quickly and efficiently, and doesn't
cost the taxpayer a penny. Indeed, if significant tax cuts were part of the
package, the taxpayer and businessperson would be much better off.
Afterwards, we would have healthy government finances, healthy banks, a
stable currency, and a much improved tax system. Business would conclude,
correctly, that the situation looked pretty good going forward, and they would
begin to make new investments.
December 10, 2006: The Magic
Alas, if we look at this list, we can also recognize that it would be nearly
impossible for this generation of leaders to pull it off. This is quite an
agenda for even those who have mastered the basic principles involved -- a
group which includes basically none of today's leaders. To pull it off in the
real world, with all the real world complications, is a little more tricky
than just talking about it. To pull it all off simultaneously --
government default, spending reduction, bank reorganization, currency support
-- would take a wizard. Even then, the wizard would need the consensus and
cooperation of central banks, parliaments, bureaucrats and so forth, which we
know are basically corrupt today, and basically incapable of acting in the
public's interest even if, for a second or two, they wanted to.
So what will happen? Probably, after a few more rounds of self-cannibalization
as we're seeing in Ireland, they will just print the money. They are already
printing the money! So, they will print more, and more.
2010: Learning from Germany
It will all be a lot easier once everything has burned down to cold ashes.
Then there won't be anything to "save" because all will be lost.
This is not a bad situation, because then we have nothing more to lose, and
everything to gain. Ideally, we will then be able to implement a recovery
based on first principles, finally unopposed because the opposers
have either gone extinct, or have realized that general prosperity is in
their best interests. Eventually even the oligarchs figure out that you don't
get richer by making poorer those you either a) sell things to for a profit,
or b) steal from. The United States has much wealthier oligarchs than Haiti.
Today's Chinese leadership is not composed of saints, but they understand
that you make the pyramid taller by making the base wider. Their
self-interest is much more sophisticated.
Nathan Lewis was formerly the chief international
economist of a leading economic forecasting firm. He now works in asset
management. Lewis has written for the Financial Times, the Wall Street
Journal Asia, the Japan Times, Pravda, and other publications. He has
appeared on financial television in the United States, Japan, and the Middle
East. About the Book: Gold: The Once and Future Money (Wiley, 2007, ISBN:
978-0-470-04766-8, $27.95) is available at bookstores nationwide, from all
major online booksellers, and direct from the publisher at
www.wileyfinance.com or 800-225-5945. In Canada, call 800-567-4797.