Jim Jubak
So how does this end?
I don't mean the current Spanish debt crisis or even the euro debt crisis. I think we know what the "solution" will be to that.
And I don't even mean the U.S. debt crisis or the Chinese debt crisis. I think we know what the "solutions" for those will be as well.
But what about the meta crisis? The one that's been created by the current round of "solutions." How does that end?
I'd suggest that we all brush up on Gresham's Law, the 16th-century description of what happens to strong currencies when they meet up with bad money. In a nutshell, Gresham's Law says that the bad currencies win. Figuring out what to do about that is important as investors head into era of bad money as far as the eye can see.
Creating new money
I think it's clear by this point in the aftermath of the global financial crisis that all the various local crises have been "solved" to date by the creation of vast sums of money essentially out of thin air on the official balance sheets of central banks such as the Federal Reserve and the European Central Bank and on the unofficial balance sheets of, say, China's banking system. I think it's equally clear that, for all the talk about economic reforms creating growth, or austerity creating growth, or financial market confidence creating growth, the most likely "solution" going forward is the continued creation of vast sums of money essentially out of thin air.
It's still an open question if the "solution" will work. In the case of Spain, for example, the European Central Bank fixed the crisis for a while by giving banks access to 1 trillion euros in three-year loans in December and February. But by late March the crisis was back, and the yields on Spanish and Italian government bonds had started to rise again. Now we're looking at another program of bond buying by the central bank to lower yields or another program of three-year loans to banks to give them the money to buy more bonds in order to lower yields.
To condense what I wrote in my Friday, April 13, column, "Why Spain scares the market," on the current state of the art in the Spanish crisis, Spain and the eurozone are likely to fall back on a series of increasingly desperate work-arounds by the European Central Bank, other global central banks and, finally, the International Monetary Fund. Each of those fixes would require that somebody print money -- either the European Central Bank, the International Monetary Fund or some combination of the Federal Reserve, the Bank of Japan and the People's Bank of China. Print enough and the immediate Spanish crisis goes away again as bond yields sink and governments get more breathing space to propose economic reforms and budget cuts.
At some point, though, the bill for these solutions comes due. I hope that point comes after some semblance of economic order has returned to the eurozone and when growth has recovered in the United States and China. But even if Spain -- and Italy, Portugal and Ireland -- win back enough confidence to be able to sell bonds in the financial markets again, the world will still be looking at the bill for this crisis. And we'll still be looking at unsolved budget and balance-sheet problems in the United States and China.
How big is the bill?
The grand total depends on how many central banks we want to include in our reckoning.
At the least we should count the balance sheets of national central banks. For example, the Banco de España, Spain's central bank, showed an increase in its balance sheet for net lending to 228 billion euros in March from 152 billion in February. The March 2012 lending total was up from just 42 billion euros in March 2011.
Go up another level to the balance sheet of the European Central Bank. At the beginning of March, that bank's balance sheet hit a record 3.02 trillion euros (roughly $4 trillion). That was nearly one-third bigger than the German economy.
The only thing good about the rapid expansion of the European Central Bank's balance sheet is that it makes the Federal Reserve's balance sheet, at $2.9 trillion, look positively conservative.
Deleveraging those balance sheets will be extremely dangerous. Central banks will have to sell bonds and other assets back into the financial markets to reduce the size of their balance sheets. That will reduce the money supply and cut into growth. At the same time, governments that haven't yet dealt with their outsize budget deficits and their own debt will have to raise taxes, cut spending or both. The two-track effort, even if successful, will be a huge drag on national economies and on the total global economy.
I think we can assume, however, from the behavior of national governments and central banks during the crisis so far that they will do all they can to put off any significant deleveraging.
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