Saturday, 29 October 2011

Why on earth does the EFSF want to borrow from China?

The Eurozone (EZ) is contemplating bailing out Greece and possibly other indebted periphery countries. Banks holding those countries’ bonds may also be bailed out.

But the EFSF is contemplating getting some of the money for this exercise from China. The EFSF evidently does not understand monetary sovereignty.

That is the European Central Bank can print any number of Euros for bail out purposes any time it wants. As to how inflationary that would be, that is moot. If the indebted countries acted responsibly and continued with their deflationary policies (which are intended to make them more competitive) they would not go on a spending spree.

Likewise the banks which were relieved of their toxic sovereign debts would arguably not go on a spending spree either. Banks on both sides of the Atlantic have had their fingers burned recently as a result of the irresponsible borrowing they indulged in in the run up to the credit crunch. Give a chance they will certainly make the same mistakes again, but not in the next two or three years. Walter Bagehot a hundred and fifty years ago pointed to the never ending cycle of irrational exuberance followed by busts, followed by a few years of recovering from the hangover, followed by the next round of irrational exuberance.

And in the US and UK, bank bail outs have not led to excessive bank lending: quite the reverse.

But even if indebted countries and banks DO GO ON A SPENDING SPREE, Europe (if it gets its act together) ought to be able to take deflationary countermeasures. And this of course is where the real “core countries subsidising PIGs” effect arises. That is, core countries have to rein in demand so as to enable PIGs to spend.

And finally (and to add insult to injury) borrowing from China does not solve the above “spending spree” problem. That is, if indebted countries and banks are going to go on a spending spree with freshly printed Euros supplied by the European Central Bank, they’ll almost certainly do the same with freshly supplied money coming from China.


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