Flash Point: Bailing Out the Rats

We have been reading about and participating in the “bailout” of European economies for years now. To understand what this means and has achieved, we begin with an examination of the term. A few definitions are (our added emphasis):

  1. Merriam-Webster Dictionary: a rescue from financial distress.
  2. Google: An act of giving financial assistance to a failing business or economy to save it from collapse.
  3. Wikipedia has a more interesting definition: A bailout is a colloquial pejorative term for giving a loan to a company or country which faces serious financial difficulty or bankruptcy. It may also be used to allow a failing entity to fail gracefully without spreading contagion. The term is maritime in origin being the act of removing water from a sinking vessel using a smaller bucket.

As can be seen from the above, the popular understanding of “bailout” is supported, that of saving or rescuing a country that is at the point of an economic collapse. The idea is that with the bailout, the country avoids the collapse and recovers its economic health. The Wikipedia definition however offers an alternate interpretation, that of allowing a “graceful” failure or collapse that minimizes damage to other parties.

Before we explain why the bailouts of the eurozone economies is destined to fail in the popular sense, we consider past IMF bailouts. There is a long tradition of the IMF’s bailing out collapsing economies due to excessive debt. The solution is two-pronged, fiscal and monetary.

Fiscal solutions involve government fiscal policies and programs that reduce spending and possibly increase revenue through taxation – austerity measures. Monetary solutions require the devaluation of the country’s currency, making exports more competitive and boosting economic growth leading to recovery. The result in past instances has been that affected countries returned to economic health in at most a few short years.

There areĀ  however, a couple of requirements that facilitate such a turnaround. One is that the global economy be robust and expanding. This allows the effects of monetary policy to quickly gain traction through increased exports. The other is that the country’s economy be closer to the top of a business cycle than the bottom so that the economic contraction created by austerity measures does not damage the economy to the extent of creating a destructive positive feedback loop. In other words, the economy must have room to contract relative to its normal past recessions.

The problem with the current economic environment for the southern eurozone economies is that none of these conditions are met. First of all, no country has its own currency so currency devaluation is not possible and monetary policy solutions are ineffective. Second, the global economy is contracting and much of Europe is in recession or at the bottom of their business cycles, including the economies of the southern periphery. The result is austerity measures are compounding the problem of these counties and their debt rather than leading to economic growth.

But let’s examine what the bailouts to-date have achieved. The major effects have been to provide loans to countries that have been used to recapitalize their failing commercial banks and to provide money to roll over existing sovereign debt as it comes due. Little of the money has actually descended to the level of the average citizens to help alleviate their suffering. Indeed, the austerity imposed as part of the conditions for the loans has increased their suffering immeasurably.

In short, the bailout measures have done nothing to save or rescue these economies. What they have done is to facilitate the transfer of private debt onto the sovereign, allowing the debt holders – the mammoth Northern European banks, to exit their positions in the failing economies at the cost of the citizens of said economies.

To return to the Wikipedia example, the ships of state of the southern periphery are sinking. The bailouts are doing nothing to save or rescue them. The bailouts are only allowing time for commercial banks and private investors to gracefully escape their risk obligations – for the rats to leave the sinking ships.

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