Wednesday, May 12, 2010

The Big, Fat, Greek Bailout

By now you've heard that Greece has had its pants pulled from the fire yet again.  Well, almost.  The bailout package hasn't been approved yet, but it probably will be. 

Some followers of this saga are probably confused by this whole bailout process.  After all, wasn't it just yesterday that the governments were bailing out the banks, and today the governments themselves in need of bailouts?  From whom, exactly?  The banks?  Yes, actually.

How in the world can that work?

First of all, not all governments are the same, nor are all banks.  Some are in better shape than others.  But in reality, the approximation is correct.  It shouldn't make any sense to someone with two functioning brain cells that two entities in dire financial straits can bail one another out and actually have the books balance.  But that is how it works.  Oh thank heaven for fractional reserve accounting!  What ever would we do without it?

Extra credit for those out there who figured out that if it can work, somebody out there is getting the shaft.  These gifted folks must have at least three functioning brain cells.  But let's go on to the tougher question:  who are the winners, and who are the losers in this fiasco?  Let's take a look.

The government of Greece ran up high debts for the benefit of its populace/voters/supposed taxpayers, in return for getting to rule over said subjects.  Banks lent the Greek government the money, and kept lending, and kept lending.  After all, who can resist loans guaranteed by a government?  But now that it looks like the Greek government can't make its interest payments, there is much crying and wailing.   So much for government guarantees.  Usually, when a debtor fails to make payments in a timely fashion, he's in trouble.  But we're talking about a government here.  With an army and everything.  And it owes a spectacular quantity of money.

What followed, naturally, was a game of financial brinkmanship.  If Greece defaults, it is in big trouble.  But so are the banks which hold Greek debt.  The banks would like for Greece to continue making timely payments, and Greece would obviously like to continue it's lavish spending habits, but clearly nobody wants to lend more money to Greece to keep the gravy train rolling.  Everyone would like for somebody else to step up to the plate, and nobody dares to blink.

The ECB (European Central Bank), representative of European banking interests as the FED is representative of American banking interests, would like for its client banks to be paid back, but balked at lending any more money and asked the other European governments to step in.  Said governments, Germany in particular, balked at the suggestion of the ECB.  Wasn't this the banks' problem, after all?  Finally, May 6 happened, and lit a fire under everyone's behind.  Greece held it's ground, certain of its voters and their Molotov cocktails showing that it was perfectly capable and willing to take down the global financial system if it didn't get its way, and everybody else caved.  Now Greece is to be the beneficiary of a spectacular bailout at the hands of multiple governments and multiple banks.  For its part, Greece has promised, cross-its-heart-and-hope-to-die, to get its financial house in order in return for this line of credit. 

Of course, everyone knows that Greece won't, and everyone knows that another bailout will come next time around, because at the end of the day everyone now knows that any sufficiently large debtor is perfectly capable of taking down the global financial system.  If the banks wish to survive to see tomorrow, they will bail out their debtors today, and that's just the way it is.  Likewise, governments that wish to keep their citizens from burning the place down and their politicians away from the gallows had better bail out the banks and keep the goodies flowing, on time and with a smile.  Everyone's a crook, and among crooks, the truth is usually the first victim.  The currency is debased.  Inflation is.

All of this is interesting, especially from an American's perspective because the standoff arose out of the fact that Greece has no central bank of its own.  Authority over its banking system lies with the ECB, over which it has very little political power.  This is similar to the American situation, where the FED is run by the banks mostly independent of government.  However, our government could easily nationalize the FED, while Greece has no recourse against the ECB except default, and we have just seen what the trump suit is.  Having just watched this drama play out, it should be very clear what is in America's future:  bailout of the US government by the FED, with or without nationalization.

Without a bailout, there really would have been deflation.  That is the possibility that scared the pants off everyone.  Remember that bank deposit insurance is through the government, not the central bank.  Had Greece really defaulted and its banks failed (because they owned so much government debt), there would have been no entity to pay deposit insurance claims.  The deposits would have been destroyed, and a sort of financial black-hole created a la the early years of the Great Depression. 

This is why you can be fairly certain that there is to be no catastrophic deflation in our futures.  Any debtor/government with sufficient cojones has a gun to the head of the banking system.  Printing money by extending such spectacular loans will create inflation, discredit the banks and the money system they are in charge of, and devalue their debt holdings as interest rates rise.  Banks do want to inflate, but not on those terms.  On the other hand, not inflating at the mercy of governments will destroy them instantly.  Their choice is clear.

Any bank of sufficient size likewise also has a gun to the head of governments.  The failure of the bank would create a tremendous claim against the government, which has guaranteed bank deposits, especially as the failure took down other banks.  Failure to pay such claims would result in the deflationary financial black-hole scenario, and probably certain death for politicians at the hands of voters.  Governments really have no choice but to bail out the banks.

It is settled.  The governments and banking systems of the world are locked in a death embrace of debt.  They cannot let go of one another.

So the winners this round:  debtors, and especially Greek welfare recipients.  The Euro survived to see another day, but will ultimately be devalued by this action.  The losers:  creditors, European banks.  For now.

In the long run, we'll all be losers.  But the really important thing was settled:  the powerful of today got to remain so.  The empire crumbles, but the same select few remain at the top of the slag heap.  The old order and its hangers-on hold sway for a while longer. 

We've approached the brink twice now, and we've seen the outcome in both cases:  bailouts and inflation.

Expect the trend to continue.

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