Taxpayers are replacing bond holders as the biggest creditor of government...
ALL GREAT stories are family stories. The family of Europe is very unhappy right now with its wayward son, Greece. Will Greece be kicked out of Europe's monetary family? asks Dan Denning in his Daily Reckoning Australia.
It hasn't come to that, yet. And to be fair, it's hard to see who is conning who in Greece right now. Greek politicians want to avoid agreeing to any more austerity demands—although why anyone would actually want the job of a Greek politician now is a good question.
European bankers want to lend Greece money before it runs out, but don't want to deal with the more fundamental long-term issue: that Greece is insolvent.
Because if Greece is insolvent and the European banking system is suffused with Greek debt (and lots of other sovereign debt), then Europe's banking system is under-capitalized. It's hard to have sound money when your banking system is full of debt.
There are some home truths emerging from Europe and now being priced in to the markets. First, some countries are simply not going to be able to pay their debts. Second, you can call this a soft default or a hard default, but it's a default either way. Third, the bond market is being replaced as the biggest government creditor by the taxpayer. This point is worth exploring a bit more.
Since the Bank of England became the official creditor of the British Government in 1694, governments have always been able to count on financing from bond markets. Major banks and institutional investors have always been happy to finance the Warfare/Welfare State.
The main reason is that the State, as a borrower, has a nearly inexhaustible form of collateral: the taxpayer. It's the taxpayer that guarantees interest payments on government debt will always be met, and principal always repaid.
The arrangement between the Welfare/Warfare State and its financiers has been pretty cozy for the last three hundred years. You had a system of "perpetual debt" enabling a permanent war by the State against: other States, methods of conflict (like terrorism), drugs, alcohol, smoking, fat and lately, the colorless, odorless gas otherwise known as carbon dioxide.
By the way, at the domestic level, all of these wars are designed to generate more taxes. More taxes make it possible to borrow more, and fight more wars. It's the ceaseless expansion of the government into private and public life — a relatively new phenomenon that's been so long in escalating that we hardly notice how pervasive, intrusive, and insistent it has become.
The key element to all of this is that the private sector is the willing buyer of public debt. And that is exactly what is ceasing to be true in Greece right now. And if it's happening in Greece, it may soon happen in Spain, Ireland, Italy and Portugal. And if private creditors no longer willingly fund the debt of the State in Europe, Europe has a real systemic problem.
You have to give credit to the private sector in Europe (mostly the banks). All the risk of buying Greek bonds or loaning money to the Greek government that's taken by the European Central Bank and the IMF is really a risk for the taxpayer. Existing holders of Greek debt, the banks and private sector creditors (or the Money Power), are being given a back-door bailout via the ECB and IMF support of Greece's ongoing debts.
Private sector creditors to Greece are making the familiar argument that they should not be allowed to take losses on their investment because those losses will cause bank failures throughout Europe. If they're right — and we suspect they may be — it shows you how fragile Europe's financial facade really is.
And we don't mean to pick on Europe. We could easily be picking on China or America, both of which have their own profound credit-related problems. But for now, all the focus is on Europe. Our advice is to be aware of the short-term possibilities and prepare for them.
But in the longer term? The longer term is that every time the day of reckoning with bad debt is delayed, it makes the ultimate reckoning that much worse. The losses will be bigger. And the institutions that fail will be bigger too, including the State itself.
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