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04.30.2010 0

The Fed’s European Bailout

  • On: 05/11/2010 06:34:52
  • In: Economy
  • By Bill Wilson

    On February 24th, 2010, when asked if the Federal Reserve was planning to bail out Greece, Fed Chairman Ben Bernanke testified to the House Financial Services Committee, “we have no plans whatsoever to be involved in any foreign bailouts or anything of that sort.” Now we know, he lied.

    As reported by the Wall Street Journal, “the U.S. Federal Reserve said Sunday that it would revive an emergency lending program used during the financial crisis. The Fed will ship billions of dollars overseas through foreign central banks, including the ECB, so they can, in turn, lend the money out to banks in their home countries in need of dollar funding.”

    No plans whatsoever? Clearly, the Fed had some contingency plans to bail out Europe on the shelf after all. The Fed’s credit line comes as the European Central Bank announced a program to purchase European government bonds, and the European Union and International Monetary Fund — which the U.S. funds — announced a wider €750 billion bailout for the entire continent in response to the swelling sovereign debt crisis.

    In the least, the Fed’s European bailout should be cause for the passage of a complete audit of the central bank, and for an immediate Congressional investigation to be launched into when, precisely, the central bank began planning to shore up the sovereign debt crisis faced in Greece, Portugal, Italy, Ireland, and Spain. When Bernanke testified under oath, he said that he had not talked with any international groups about participating in the bailout of Greece.

    Clearly, if Bernake had not been in touch with his colleagues over at the European Central Bank in February, he has since done so — and it will cost the U.S. down the road. It is up to Congress to rein in this unaccountable institution.

    Now, as the crisis is felt in the UK and other nations that have spent far beyond their means, the prospect looms of an ongoing role by the Fed to use its lending facilities to enable troubled states to keep up their sales of sovereign debt. The way nations pay off their debts is through the sale of bonds. The way they pay interest on those debts is through taxation upon the populace. When the principal comes due, nations simply sell more bonds.

    Such a kick-the-can system can “work”, for a while, until the accumulation of the debt rises to such a degree that markets become unsatisfied the nation could ever pay it back. Then, markets demand much-higher interest rates on the riskier loans to the indebted government. So, with the Greece crisis, for example, after it was disclosed the nation had grossly understated its debts, interest rates on that debt shot through the roof.

    Now, to cope with this, Europe and the Federal Reserve are basically printing money to subsidize the junk bond sales. The goal is to reduce, albeit temporarily, the yield on those bonds so that Greece and other nations do not default on their debt obligations.

    But the real question is not whether government intervention can briefly reduce interest rates, it is whether countries like Greece will ever ultimately be able to pay the bill. For, the Fed and European Central Bank’s actions are nothing more than a magician’s trick, a con to inflate the debt crisis away for an unspecified period of time.

    It buys nothing more than time at an obvious cost: that when the piper comes calling, the bill will be even greater.

    This is like a father guaranteeing to bail out his gambling son’s debts by lending him up to $1,000. Thanking his father, the son, instead of repaying the money he owed, returns to the casino to play cards. Predictably, the son loses, running up another $1,000 in debts, bringing his gross tab to $2,000.

    In real life, that’s a good way to get your thumbs broken, but for government, it’s called “monetizing the debt.” So, rather than breaking Europe’s thumbs, markets played right along and rallied, apparently happy at the prospect of another trillion-dollar debt bubble to invest in.

    But, even if rates are kept slightly down on Greek debt, for example, the implicit Fed and European Central Bank guarantees make particularly the short-term bonds more attractive because now they’re assured to pay out. This actually incentivizes lending money to debtor nations that cannot pay, because there will still be a payout — with a higher rate of return.

    However, the day of reckoning still looms. There is no guarantee that these nations will not ultimately default on their obligations, and now, the world’s greatest debtor, the U.S., is playing the role of the world’s lender of last resort. In essence, through financing the International Monetary Fund and the Fed’s European credit line, the U.S. is guaranteeing all future debts incurred by Europe that cannot be paid.

    The thought behind the credit lines is to keep bond yields low enough such that the next series of auctions will not fail. But, if they do, if Greece comes up short at a future debt auction, the Fed and European Central Bank will then have to make good on the credit line and intervene, essentially printing money to lend to the bankrupt nation.

    The result? The U.S. and Europe will sink together. This is insane.

    Fed Chairman Bernanke did well in February to distance himself from a European bailout. Even he, who ultimately pulled the trigger on it, knew how bad it could turn out. Too bad he was lying.

    Bill Wilson is the President of Americans for Limited Government.

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