Wednesday, February 11, 2009

Preaching to the choir... now, most of my readers realize that the Euro area is in far more trouble than the U.S. Combining monetary policy without fiscal policy is doomed to fail in floating currency regimes. Monetary creation is primarily fiscal and bank-created. Low interest rates do not "create money". In a floating foreign exchange regime, loans create deposits.

The nation that adapts more quickly than its competitors will gain first-mover advantage over a newly shaped world. The U.S. has fulfilled that function nicely, displaying a high level of activity and looking agile as compared to the China, Japan (and especially) the EU.

The U.S. Government will make mistakes, it will "misallocate" resources, create unintended consequences, "crowd out" some investment, etc.

But that is the function for the "liquidity provider of last resort", and it gives the U.S. enormous flexibility to achieve its policy goals.

But like all bubbles, the one in governmental power and authority will come to a close. Expect popular backlash against profligacy of all kinds and a return to more puritanical habits. This will include a more constrained role for government.

Other forms of government cannot do this.
European banks may need massive bail-out
European banks sitting on £16.3 trillion of toxic assets may suffer massive losses, according to a confidential Brussels document.

By Bruno Waterfield in Brussels
Last Updated: 1:51PM GMT 11 Feb 2009
A secret 17-page paper discussed by finance ministers, including the Chancellor Alistair Darling on Tuesday, also warned that government attempts to buy up or underwrite such assets could plunge the European Union into a deeper crisis.
National leaders and EU officials share fears that a second bank bail-out in Europe will raise government borrowing at a time when investors - particularly those who lend money to European governments - have growing doubts over the ability of countries such as Spain, Greece, Portugal, Ireland, Italy and Britain to pay it back.
“Estimates of total expected asset write-downs suggest that the budgetary costs – actual and contingent - of asset relief could be very large both in absolute terms and relative to GDP in member states,” the EC document, seen by The Daily Telegraph, cautioned. “

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