No Wonder the Eurozone is Imploding

You might assume that the reason for the implosion in the Eurozone is a mystery.

But it's not.

There Wouldn't Be a Crisis Among Nations If Banks' Toxic Gambling Debts Hadn't Been Assumed by the World's Central Banks

There wouldn't be a crisis among nations if banks' toxic gambling debts hadn't been assumed by the world's central banks.

As I pointed out in December 2008:

The Bank for International Settlements (BIS) is often called the "central banks' central bank", as it coordinates transactions between central banks.

BIS points out in a new report that the bank rescue packages have transferred significant risks onto government balance sheets, which is reflected in the corresponding widening of sovereign credit default swaps:

The scope and magnitude of the bank rescue packages also meant that significant risks had been transferred onto government balance sheets. This was particularly apparent in the market for CDS referencing sovereigns involved either in large individual bank rescues or in broad-based support packages for the financial sector, including the United States. While such CDS were thinly traded prior to the announced rescue packages, spreads widened suddenly on increased demand for credit protection, while corresponding financial sector spreads tightened.

In other words, by assuming huge portions of the risk from banks trading in toxic derivatives, and by spending trillions that they don't have, central banks have put their countries at risk from default.

No wonder Greece, Portugal, Spain and many other European countries - as well as the U.S. and Japan - are facing serious debt crises.

But They Had No Choice ... Did They?

But nations had no choice but to bail out their banks, did they?

Well, actually, they did.

The leading monetary economist told the Wall Street Journal that this was not a liquidity crisis, but an insolvency crisis. She said that Bernanke is fighting the last war, and is taking the wrong approach (as are other central bankers).

Nobel economist Paul Krugman and leading economist James Galbraith agree. They say that the government's attempts to prop up the price of toxic assets no one wants is not helpful.

BIS slammed the easy credit policy of the Fed and other central banks, the failure to regulate the shadow banking system, "the use of gimmicks and palliatives", and said that anything other than (1) letting asset prices fall to their true market value, (2) increasing savings rates, and (3) forcing companies to write off bad debts "will only make things worse".

Remember, America wasn't the only country with a housing bubble. The world's central bankers let a global housing bubble development. As I noted in December 2008:

The price of Southern California homes is already down 41%, Southern California hasn't fallen as fast as some other areas, and we're nowhere near the bottom of the market.

Moreover, the bubble was not confined to the U.S. There was a worldwide bubble in real estate.

Indeed, the Economist magazine wrote in 2005 that the worldwide boom in residential real estate prices in this decade was "the biggest bubble in history". The Economist noted that - at that time - the total value of residential property in developed countries rose by more than $30 trillion, to $70 trillion, over the past five years – an increase equal to the combined GDPs of those nations.

Housing bubbles are now bursting in China, France, Spain, Ireland, the United Kingdom, Eastern Europe, and many other regions.

And the bubble in commercial real estate is also bursting world-wide. See this.

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Moreover, the real estate bubble formed the base upon which a series of bubbles in derivatives were built. Specifically, mortgages were packaged in "collateralized debt obligations" (CDOs), which were sold in enormous volumes all over the world. Credit default swaps were then bet against the companies which bought and sold the CDOs.

Now, with housing prices crashing, the CDO bubble is crashing, as is the CDS bubble.

A series of other derivatives bubbles are also crashing. For example, the "collateralized fund obligations" - sort of like CDOs, but where the assets of a hedge fund are the asset being bet on - are getting creamed as hedge funds are forced to sell off many hundreds of billions in assets to cover margin calls.

As everyone knows, the size of the global derivatives bubble was almost 10 times the size of the world economy. And many areas of derivatives are still hidden and murky.

So the bust of the derivatives bubble could even be bigger than the bust of the housing bubble.

BIS also cautioned that bailouts could harm the economy (as did the former head of the Fed's open market operations). Indeed, the bailouts create a climate of moral hazard which encourages more risky behavior. Nobel prize winning economist George Akerlof predicted in 1993 that credit default swaps would lead to a major crash, and that future crashes were guaranteed unless the government stopped letting big financial players loot by placing bets they could never pay off when things started to go wrong, and by continuing to bail out the gamblers.

These truths are as applicable in Europe as in America. The central bankers have done the wrong things. They haven't fixed anything, but simply transferred the cancerous toxic derivatives and other financial bombs from the giant banks to the nations themselves.

Are Debt-Based Economies Sustainable?

Of course, Eurozone countries like Greece and Italy have been living beyond their means and masking their real debt levels for years (with a little help from Goldman Sachs, JP Morgan and the boys) - just like the U.S.

And of course, Eurozone central banks - like America's Federal Reserve - create fiat money out of thin air. As I argued in March, one or the primary problems is that Europe and America have debt-based economies, and the debt-based ponzi scheme has reached it's maximum limit:

Private banks don't make loans because they have extra deposits lying around. The process is the exact opposite:

(1) Each private bank "creates" loans out of thin air by entering into binding loan commitments with borrowers (of course, corresponding liabilities are created on their books at the same time. But see below); then

(2) If the bank doesn't have the required level of reserves, it simply borrows them after the fact from the central bank (or from another bank);

(3) The central bank, in turn, creates the money which it lends to the private banks out of thin air.

It's not just Bernanke ... the central banks and their owners - the private commercial banks - have been running the printing presses for hundreds of years.

Of course, as I pointed out Tuesday, Bernanke is pushing to eliminate all reserve requirements in the U.S. If Bernanke has his way, American banks won't even have to borrow from the Fed or other banks after the fact to have reserves. Instead, they can just enter into as many loans as they want and create endless money out of thin air (within Basel I and Basel II's capital requirements - but since governments are backstopping their giant banks by overtly and covertly throwing bailout money, guarantees and various insider opportunities at them, capital requirements are somewhat meaningless).

The system is no longer based on assets (and remember that the giant banks have repeatedly become insolvent) It is based on creating new debts, and then backfilling from there.

It is - in fact - a monopoly system. Specifically, only private banks and their wholly-owned central banks can run printing presses. Governments and people do not have access to the printing presses (with some limited exceptions, like North Dakota), and thus have to pay the monopolists to run them (in the form of interest on the loans).

See this and this.

At the very least, the system must be changed so that it is not - by definition - perched atop a mountain of debt, and the monetary base must be maintained by an authority that is accountable to the people.