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Tags: Question | European | Debt | Crisis

The Real Question in the European Debt Crisis

By    |   Wednesday, 30 November 2011 08:48 AM

Well here we are. I have said all along that the European debt crisis is not a Greek, Irish or Portuguese problem, but an Italian and Spanish problem.

That’s because if the Greek crisis spreads to Spain and Italy, the size of the Italian and Spanish debt is enough to bring down the German and French banking systems. Even the combination of the Greek, Irish and Portuguese debt problems wouldn’t do that. I have also said all along that the solution to the Italian and Spanish debt problem is printing money.

The only question is when and how much.

The European Central Bank (ECB) is clearly quite reluctant to print money.

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But, despite its reluctance, it is doing just that to purchase enough Spanish and Italian bonds to keep the markets for those bonds from completely melting down. So far, it has worked.

The question in my mind is "Will they make a Lehman-like mistake and push so hard against printing money to buy those bonds that the bond markets will truly begin to spiral out of control?"

U.S. Treasury Secretary Hank Paulson pushed hard against bailing out Lehman in the fall of 2008 — he had bailed out Bear Stearns in the spring of 2008 and he had made the historic $5 trillion bailout of Fannie Mae and Freddie Mac just a few weeks before the Lehman decision. He faced political pressure not to do more bailouts.

Also, Paulson didn’t want to create a “moral hazard” that encouraged companies to take risks and then not have to pay for them. Hence, his fear of bailing out Lehman was justifiable.

Likewise, the ECB’s fear of bailing out Spain and Italy with printed money is also justifiable. They want to keep pressure on those countries to solve their debt problems. There is political pressure, especially in Germany, against more bailouts.

The ECB also doesn’t want to create a “moral hazard” where it simply bails out indebted nations and encourages more such irresponsible debt management. In addition, the ECB fears that once a country goes on the printed money heroin, it will be hard to get it off. A reasonable fear as well.

Hence, the possibility for another Lehman-type situation certainly exists with the ECB. They could push so hard against printing money that the bond markets begin to melt down.

What happens then? My guess is that the ECB will react like Hank Paulson and in a massive panic will do everything it can to save the markets (remember the pictures of Hank on the cellphone looking like the world was coming to an end?). For the ECB that means printing massive amounts of money to buy bonds and stabilize the bond markets.

So, either way, whether they print money now or print money later because they are forced to, the end result is printing money. Of course, another wrinkle in the story is the role of the Fed.

The big difference between the Fed and the ECB is that the ECB thinks printing money will create inflation and the Fed doesn’t. That could become a very useful tool in fighting Europe’s debt crisis. If the ECB can get the Fed to lend printed money to Europe though some mechanism, such as their currency swaps window, which it is already doing, then that could help ease the ECB’s pain in a crisis.

Nothing better than having a friend like the Fed that steadfastly believes printing money won’t create inflation. Hence, the solution to the ECB’s debt problem is likely not just printing more euros, but also printing more dollars. As we know, U.S. banks and markets are also negatively affected by Europe’s debt problems.

Many people say the real savior for the Spanish and Italian debt crisis is to issue Eurobonds that would be backed by all European countries. I think that will be politically difficult.

It is opposed by over 80 percent of the German people and that’s the key country needed to back such an idea. I’m not saying it could never happen; just that it could take time and is highly uncertain. Printing money seems like a politically much easier way out than Eurobonds and politicians tend to gravitate towards easier outs rather than hard and painful decisions.

An alternative solution to the debt crisis than printing money is a long term multi-year bailout package for Greece that includes firewalls to prevent the Greek debt problems from spreading to Italy and Spain.

This solution, which was in vogue only a few weeks ago and led to some huge stock market rallies, seems to have fallen out of favor. I guess that’s because the grand all-encompassing multi-year bailout plan failed within a few weeks. The problems spread to Spain and Italy right after the plan was agreed to. Amazing, the difference a few weeks can make!

Yesterday’s historic breakthrough is now, well, yesterday’s news.

Another “solution” being talked about constantly these days is for the euro zone to simply break up and disband the euro. Unfortunately, this is no solution at all. Disbanding the European Union or getting rid of the euro in no way pays off Spanish and Italian debt and saves the French and German banking system.

It actually just makes things worse by adding an even greater degree of financial turmoil into the system. And, that’s the real problem here – saving the French and German banks, not saving the euro.

It’s really all about the banks and saving them from the bad loans they made to all the European countries in trouble. If the German and French banking systems melt down, that will melt down the German and French economies.

Keeping that from happening will be Job One for the ECB. And, unlike disbanding the European Union, printing enough money will keep the German and French banking systems alive. Hence, it is about the only politically feasible situation that actually works.

Now, is there a catch to all this? Of course, there is. UNLIKE what the Fed thinks and LIKE what the ECB thinks, printing money does create inflation. And, as I have said many times before, the effects of inflation in a BUBBLE ECONOMY are quite devastating. But, that’s another story for another time.

So, for now, all eyes on the ECB. Will they print enough money to avoid a crisis or will they wait until the crisis explodes before they, and their friend with the really big printing press (the Fed), are forced to print even more money to bail out a crisis? I’ll let readers decide, but either way, the path there is bound to be filled with excitement.

PS: This morning, as this is being posted, the Fed announced that it is expanding efforts with the ECB and other large nations to effectively print money to help ease the European debt crisis. Essentially the Fed enhanced an existing program in which foreign banks, on behalf of the ECB and other nations can borrow money from the Fed in exchange for collateral. Today’s change made borrowing, via this facility, much more inviting as the interest rate was lowered to half a percent, and the collateral requirement was eased significantly. As of today, a Greek bank for example, can borrow money from the Fed cheaper than a US bank can.

As we discuss in this alert, the Fed is printing money so others do not have to!

Markets around the world are shooting higher on the news.

About the Author: Robert Wiedemer
Robert Wiedemer is a managing director of Absolute Investment Management, an investment-advisory firm for individuals with more than $120 million under management. He is a regular contributor to Financial Intelligence Report, the flagship investment newsletter of Newsmax Media. Click Here to read more of his articles. Discover more about his latest book, "Aftershock," by Clicking Here Now.

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Well here we are.I have said all along that the European debt crisis is not a Greek, Irish or Portuguese problem, but an Italian and Spanish problem. That s because if the Greek crisis spreads to Spain and Italy, the size of the Italian and Spanish debt is enough to bring...
Wednesday, 30 November 2011 08:48 AM
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