Enabling Europe’s Debt Habit

One magical day a long time ago (actually, it was yesterday) all the world’s major central banks got together and simultaneously eased credit. Some did it one way and some did it another, but they all made money easier to get. The markets loved it and everyone lived happily forever after.

It’s a great story, if you believe in fairy tales. I don’t, and neither does Ron Paul. Paul took a moment during his pesky libertarian campaign to rain on everyone’s parade. In essence, Paul said that the coordinated moves of central banks was an indication of just how worried governments are about the European financial crisis (quoted in the Wall Street Journal).

Hear, hear.

Learning how it all works is not for the faint of heart or for the clear-minded, who no doubt still find the wizardry of fiat money discomfiting. Let’s give it a try, though.

“The Federal Reserve, the European Central Bank, the Bank of England and the central banks of Canada, Japan and Switzerland said they’d make it easier for banks to get the dollars they need to lend.” The US can provide more liquidity (print more money credibly, in essence) than can the Europeans. The move was meant to make it easier for banks all over the world to obtain US dollars to lend. Dollars are used often in international loans. For the moment, our money is perceived as less of a fantasy than the Euro.

Even China, which did not coordinate formally with the other countries yesterday, eased its reserve requirements for Chinese banks. The purpose was the same: to make credit easier to get.

Ron Paul’s take on the unusual move is spot-on. If even one of the European Union’s member countries defaults, the whole Zone could collapse, causing a recession at best and a catastrophe at worst. Since Europe could not get its, ahem, act together to solve the root problem (too much debt), this coordinated central bank move will buy some time.

Think of it this way. A problem cocaine user is having trouble laying off the white stuff. Being casual users ourselves, we sympathize and give him time to sort things out by providing more cocaine. We let him sleep on the couch–just for a few weeks. The user becomes a genuine addict and we start using more ourselves, nearly going broke feeding both habits. One day we realize that he will never quit and we are no longer sure we can either. The addict breaks a bunch of our stuff. Devastated, we become hopeless addicts as well. Too late, we realize no clean and sober people are left to help either of us.

The entire premise of this latest attempt to save Europe is that banks need to lend more money to bolster the economy. Problem is, it was easy credit that got them into trouble in the first place. The Fed has made it easier for banks to lend in US dollars, but that does nothing to address the real underlying issue–too much debt.

Europe will be no better than we are at tackling the debt issue. Too many people have too much to lose by facing the truth that the system is unsustainable. They will continue to play global hot potato in the vain hope that they are not caught holding. Perhaps a better analogy is one of a bomb. No matter who is holding it when it goes off, everyone will get blown up.

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About Terry Noel

I am an Associate Professor of Management and Quantitative Methods at Illinois State University. My specialty is entrepreneurship.
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2 Responses to Enabling Europe’s Debt Habit

  1. Pat Quinn says:

    Terry,
    Can I come crash at your place a while?

    Like

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