The E.U. Cracks Up

Political upheaval has hit Finland, and it’s merely a foreshadowing of bigger changes ahead. The core issue is whether Finland ought to be paying for bailouts for other EU states. In reaction to establishment support for the bailout, voters ousted the pro-bailout ruling party and gave an upset victory to the bailout-critical conservative party. Against every expectation, the eternal rule of the social democrats is at an end.

But most striking of all are the gains made by a previously invisible party called True Finns. This is the only party to take a hardcore position: no bailouts at all. It also so happens that this party is predictably nationalist on issues of trade and immigration. But that’s not the source of the appeal. The bailout is what is on everyone’s mind. And you know that the anger must be palpable if it fired up the usually sleepy world of Finnish politics. 

In the sweep of history, few issues are as politically volatile as tax-funded bailouts of foreign countries, especially during difficult economic times. It’s a policy that provokes dramatic political change. The 20th century’s most famous case was in interwar Germany, when nationwide resentment against payments to conquering allied nations ushered in National Socialist rule.

It should be no surprise that over-taxed Finns have no interest in sending their tax dollars to bail out the banking industry of Portugal, a country that is 2,500 miles and two days travel away. Even governments should have learned long ago that it is never a good idea to enact these sorts of policies. In this case, however, every EU nation is bound by a political contract to bail out any other; the bailouts are embedded in the very structure of how the political, financial, and monetary sector is currently structured. 

The entire EU system is afflicted with the paper money disease. It creates a boom that balloons the banking sector, allows politicians to spend wildly, and encourages private enterprise to expand operations in an unsustainable way. Then the bust comes and everything falls apart. Government revenue crashes, banks are threatened with insolvency, and mass bankruptcies are apparent everywhere. 

There is a fork in the road, one branch labeled liquidation and the other bailout. When the fiat money is available—and with their favorite interest group, the banking establishment, warning of the end of the world—guess which way the politicians choose? This is why member states are being told that they must cough up $129 billion (it will be more) to save Portugal from its own problems. 

It’s not that politicians all over Europe (and the US) love Portugal so much that they are glad to lavish it with more paper money. The real fear is contagion. If Portugal goes, Spain and Italy are next, and then the whole shaky system comes down, first in Europe, then in the UK, and finally in the US. This is the scenario that allows politicians once again to paper over the problem rather than confront it. 

Wasn’t the invention of the European Central Bank supposed to control credit expansion in Europe? Philipp Bagus, in his book The Tragedy of the Euro, identifies a fatal flaw. There is nothing that the ECB can do, even if it wanted to, about sovereign state finances or the fractional-reserve banking system that feeds on government-created debt. The ECB can control money injections, but it can’t stop debt creation or the banks that thrive on it. 

This debt creation generates its own unsustainable boom. A country’s finances then correct to reflect reality and the banking system comes under pressure. Then the bailouts begin. What ends up happening is that the (relatively) frugal states in the European Union subsidize the less frugal ones. There is moral hazard embedded in the very structure of the entire system. 

Nothing is going to fix it. Bailouts are only temporary aids until the next round of credit-fueled profligacy. And there is absolutely nothing that the ECB can do to stop it. Every profligate country knows that it is too big to fail, and that it enjoys presumed access to the financial resources of every other state in the EU. So the result is ongoing and worsening bailouts, leading to total bankruptcy. 

For this reason, everyone knows that there is far more at stake than just Portugal. The entire system of European finance and monetary arrangements is broken. It can’t be repaired with patchwork bailouts. At some point, the flaw in the system will have to be fixed (via a hard currency) or there will be a reversion to sovereign paper currencies and the Euro will be chalked up as yet another failed experiment in monetary and regional planning. 

Keep in mind that this is the third country to be bailed out recently. Ireland and Greece came first. And those bailouts barely worked. Once we plough through the smaller countries, we will move on to the larger countries. And there is not enough money, absent hyperinflation, to bail out Spain, much less Italy. 

The European Central Bank, which has been less irresponsible than the Fed in recent days, is the first world central bank to do what should have been done three years ago. It is raising rates with the intention of tightening money. The Fed should and must do the same thing. But there is a problem. If real interest rates reflected financial reality – with no presumed bailouts and no power to create new money – they would be sky high. 

The Portugal case and the Finnish reaction should serve as a wake-up call. All these bailouts and stimulus packages cannot hide the fact that the governments and banking systems of the US and Europe are fundamentally bankrupt, sustained only by the power to create money out of thin air. Each intervention is working to buy time but not to deal with the fundamental problem. And each time when the problems return, they are worse than before. 

It doesn’t take a True Finn to recognize the injustice of bailouts for foreign governments. Neither nationalism nor bailouts will fix the real problem. We will eventually find our way back to sound money. But it is going to be terrible slogging, and real convulsions, along the way.

http://www.marketoracle.co.uk/Article27638.html