The Ice Is Cracking

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Ice skaters who go out onto lakes or large ponds are told from their early years not to skate on thin ice. The sound of cracking ice is a signal to skate toward the shore.

On Friday, August 5, 2011, the world heard the ice crack. Late in the day, Standard & Poor’s downgraded American government debt by one point: from AAA to AA+.

The decision of the U.S. Congress the previous Tuesday to raise the debt ceiling by over $2 trillion was a real crack in the ice. Standard & Poor’s only made it semi-official. “Yes, the loud noise you heard on Tuesday really was what it sounded like.”

That was not all. The European Central Bank on Friday announced that it would hold yet another a weekend meeting to deal with yet another crisis in the bond market for European national government debt. This time debts issued by the governments of Italy and Spain were coming under attack in the bond market. Lenders were demanding higher rates.


The European Central Bank on Sunday announced that it will begin buying bonds issued by the technically insolvent governments of Italy and Spain. In other words, it capitulated. It did the same thing with Greek government debt. By the terms of the Maastricht Treaty and the Lisbon Treaty, it is not allowed to do this. But, hey, you can’t make omelets without breaking a few eggs. Or laying them.

The key ingredient of these omelets is fiat money. The ECB will create the money required to buy these bonds. There are a whole lot of bonds to be bought. Italy has about 2 trillion euros worth. Spain has about a trillion.

Italy and Spain are huge debtors. They are not pipsqueak debtors the way Greece is. There is serious money invested in the IOUs of these two PIIGS. The bankers of Europe thought, “No Western nation will ever default.” They bought these IOUs with both hands. Now they face losses of 50% or more on these bad investments. The big banks have no intention of taking the famous haircut. Why should they? The ECB is there to bail them out. Bailing out large banks is the #1 task of all central banking. There is no reason for large banks to worry.

The ECB will not have to buy all of this debt. The fact that it stands ready to buy some of it will temporarily keep interest rates on these bonds lower than the 6% they were forced to pay a week ago. But this is merely another case of kicking the can down the famous road to insolvency.

The ECB makes perfunctory protesting noises about its decision. Its lips say “no, no,” but its eyes say “yes, yes.” The ECB issues statements about its responsibility to keep inflation low. Then it creates digits to buy the bonds of deadbeat nations.

Note: all nations are deadbeats. Some are more deadbeat than others.


In this sense, the ECB is like Germany’s Prime Minister Angela Merkel. She, too, makes statements about “no more bailouts.” But every time there is a major financial crisis because of a threatened default by a squaling PIIG, she and Sarkhozy and their supporting cast of small government nonentities get together over a weekend and come up with another round of bailouts. I like to think of her preliminary remarks as Merkel’s gurgles. Why the gurgling sound? Because she chokes on the words she will soon eat.

Merkel makes gurgling noises to placate German voters. German voters have some vague understanding that they will wind up paying for the mistakes of German bankers, French bankers, and all the other bankers. This is correct. They will.

What German voters do not perceive is that the bailouts were always assumed by bankers. The bankers wisely perceived that they would be bailed out. They lent money to PIIGS. It was such easy money. There was no risk. But, you say, there really was risk. Yes, yes – but not for large bankers. The ECB and the IMF and the other bailout agencies would accept the consequences for the decisions of the bankers.

It’s just like the Federal Reserve and the U.S. Treasury in September and October 2008. They bought the largest commercial banks’ toxic debt at face value.

What will voters do about all this? Nothing of any consequence. A few voters understand what is going on, but they have no way to protest effectively. Congress goes along with the bailout process. It has no intention of cutting spending. It has no intention of reducing the government’s debt. It never has.

German voters have no way to place restraints on the ECB. German central bankers make gurgling noises. They vote no in the ECB’s meetings, knowing that their votes are irrelevant to the outcome. They do not have enough votes in the ECB hierarchy to stop the ECB’s policy of buying PIIGS bonds. They go through the motions for the sake of the voters back home.

There is only one way out for Germany: to pull out of the European Monetary System. Germany can abandon the euro. The country is in a strong enough economic position to do this. The EMS allows the nations to have their own central banks, just not their own currencies. Germany can secede. But that will take a domestic political reversal of monumental proportions. This is not likely in the near future.

The planners of the New World Order have always planned to use Europe as the first step: the model of all the good things that treaty-based, centrally planned economic integration can achieve. Beginning with Jean Monnet and the American agent, Raymond Fosdick, at the Versailles peace conference in 1919, this has been the plan.

Fosdick gave up in 1920 after the Senate refused to ratify the Versailles Treaty. He returned to the USA, where he became John D. Rockefeller’s main lawyer and financial bagman for the next 40 years. But Monnet never stopped lobbying to create the European Union. He achieved his main goal before he died in 1979: treaty-based economic integration. This was a preliminary step to political unification.

The grand experiment is unraveling before our eyes. The New World Order’s designers could not create the European New World Order in one step. They knew that. They did it piecemeal, one treaty at a time, for 50 years, beginning with the Treaty of Paris in 1951. This was Monnet’s brainchild. Then came a series of treaties signed in Rome.

The problem is this: they could not get the votes to merge the central banks into one. The others still exist as figureheads. But they do exist. The Eurocrats could not get the voters to accept a common fiscal agency that would control the deficits of each nation. So, the system has a soft underbelly: national parliaments that can run up debts, combined with a common central bank whose primary purpose is unofficial, namely, to bail out large banks.


This system is now visibly falling apart. Northern European political leaders call for economic “austerity” – reduced government deficits – for the PIIGS. Ireland has buckled. It has promised to cut its deficit. But it did this only because the political party in power late in 2010 agreed to terms for IMF loans – loans that the party’s leaders had denied were necessary a week earlier. The voters had no say. They threw out the majority party a few months later, but by then it was too late.

In response, the Irish Times ran the most accurate obscene mainstream media political cartoon I have ever seen. But that was what the protest was limited to: symbolic protests.

Why did Ireland’s government buckle? Because it was already on the hook. It had nationalized its banks. It stood behind their debts. Now the banks faced bankruptcy. The Irish Times described the dilemma.

Finance Minister Brian Lenihan said the bailout was necessary because Ireland’s banks have become wholly dependent on loans from the European Central Bank and, just like the government, are likely to be frozen out of normal credit markets for at least a year.

He said Ireland’s six banks, five of which are already nationalized or part-owned by the state, would be pruned, merged and possibly sold off.

“Because of the huge risks they (Irish banks) took earlier this decade, they became a huge risk not only to this state but to the eurozone as a whole,” he said.

Irish banks invested aggressively in runaway property markets at home and abroad. After the 2008 credit crunch sent property prices into freefall, the government tried to save the banks from bankruptcy by insuring all of their borrowings against default. That unprecedented promise – made to retain investor confidence in the country – cannot be kept without a bailout, the government has finally been forced to concede.

Does any of this sound familiar? All over the West, bankers have extended loans to bad risks. It was the fiat-money-fueled property markets, 2001-2007. But now we learn that certain national governments’ IOUs are only marginally better than the bad property loans, which have yet to be written down by the banks.


This new risk is far worse for bankers. Why? Because national governments can conceal the bad property loans. They cannot conceal their own looming insolvency. The credit markets keep increasing the interest rate that lenders are willing to accept. The governments must pay these rates, which are eating into their budgets.

The PIIGS’ voters can take to the streets to protest budget cuts. But that does not change the fact that private lenders are not going to lend more money at low rates. The protests in fact persuade lenders that a particular PIIGS nation is an even lower credit risk. So, the lenders raise the rate again.

The only ways out are these: (1) balance the budgets, (2) find non-private lenders.

The PIIGS’ governments need an excuse to cut welfare spending. When the ECB or the IMF lend money and impose conditions, the politicians can blame these hard-nosed lenders. This strategy did not save the Irish government earlier this year. It fell. But its replacement has meekly abided by the terms of the loans.

The PIIGS can of course take the borrowed money and then renege on the terms. If one majority government refuses, it can be voted out of office. But, as the Irish voters discovered, that did not change anything. The new government is abiding by the terms set by the IMF.

At some point, some PIIGS electorate will toss out the existing government and replace it with a government that will stiff the IMF and ECB. The new government will not cut spending. But then the government’s interest rates will rise. The government will then have to decide: (1) pay the rates by cutting welfare spending or (2) default.

There is a third option: pull out of the EMS. Abandon the euro. Put its domestic central bank in charge. Tell it to buy the country’s bonds. In other words, the government can inflate. It will default through inflation.


The Eurocrats keep telling us that this will never happen. Of course it will happen. Politicians will heed the desire of domestic voters, who want goodies from the government. The voters will not get goodies; they will get depreciating money. But that has been acceptable to most Western voters ever since the end of World War II.

Yes, German voters are willing to protest against inflation. Germany remains an exporting nation. It is doing well inside the EU. But it has a problem. To keep the system going, it is required to bail out PIIGS through direct government subsidies. It is also required to go along with the ECB when the ECB buys PIIGS bonds by creating new money. Germans may not like the arrangement, but the only way out is to stop the government-to-government bailouts and then pull out of the EMS.

Germany would them have two huge problems. First, its currency would rise in relation to the euro. This would reduce German exports. The export sector’s economists (read: shills) would cry for a weaker currency. Export-based special interests are almost always successful politically in trade surplus nations. Mercantilism is still a major political force in nations that are running balance of payments surpluses. “Don’t kill the goose that lays the golden eggs!”

The second problem is the squeeze on German banks. These banks have loaned hundreds of billions of euros to PIIGS. They will be repaid, if at all, in euros. But euros in relation to a newly resurrected deutsche mark will be falling in value. Even if the interest payments on the loans still arrive, they will arrive in a depreciating currency. The banks will take their haircuts. They will lend less. Rates will rise. The economy will go into a recession.

The West’s voters have voted for the welfare state. A majority of them are addicted to these wealth-transfers. They really do believe that government austerity – putting the state on a fiscal diet – will cause a recession. They are determined to keep the welfare state alive. But it is steadily going bust. Why? Because the welfare state has always relied on the flow of low-rate loans to the government.


Keynesian economists have always rested their entire position on one assumption: “Loans to the national government are safe.” This was Keynes’ view, stated obscurely in The General Theory of Employment, Interest, and Money (1936).

Here is the Keynesian logic. Lenders are afraid to lend. This cuts consumer spending. The economy stays in recession. This is the lipstick on the Keynesian pig.

You want more? Here’s more. Lenders want safety. They are afraid to lend to private borrowers, who may default. They will lend to a national government. The government will then pay for various projects that the free market judged were wasteful and loss-producing. This gets the economy rolling again.

This is conceptually stupid. I assume that you see why. Lenders have to put their investment money somewhere, unless they spend it for consumer goods, which Keynesian economists say is a Very Good Thing. Lenders who have enough money to affect the economy do not have their money in currency under mattresses. They have it in banks or mutual funds. If this money does not go to a government to be spent either on centrally planned projects or to buy votes, it will go to some other investment. This should be obvious to anyone who has the faintest inkling of how to follow the money.

This is why Keynesianism is conceptually stupid. But most Ph.D.-holding economists are self-blinded to such an extent that they cannot understand this. They have not read W. H. Hutt’s book, The Theory of Idle Resources (1939).

This crucial assumption – “Government debt is close to risk-free” – is at long last being called into question. It is being called into question by the acts of politicians. They are incapable of getting their national governments’ budgets under control.

This is why Keynesian economists are apoplectic over the S&P downgrade. They are also upset that anyone should question the ECB’s wisdom in extending a helping hand to Spain and Italy. The Keynesian assumption has always been that lenders should invest money in government bonds. Government bond markets are the foundation of all Keynesian theories of counter-cyclical spending by governments.

We never hear a unified cry from Keynesians in boom times that it is time to cut government spending and start paying off the government’s debt. We are told that Keynes called for counter-cyclical policy in boom times, not just bust times. That meant running surpluses to reduce the debt. But we never see quotations from Keynes to this effect. We never see signed statements from Keynesian economists calling for debt reduction.

There is a reason for this. Keynesian economics is welfare state economics. It has always been a cover for wealth-redistribution. Officially, this wealth redistribution has been justified in the name of helping the poor. Operationally, it has always been wealth transfers to very large banks.

Every time there is a financial crisis, the government and the central bank bail out large banks. Every time, Keynesian economists hail this policy during the crisis period. Then, after the dust settles, and the surviving banks are larger than ever before, they bewail the fact that Wall Street was bailed out again.

These people are not slow learners. They are non-learners.


We are witnessing the break-up of the ice pond. The public is skating on the pond. They hear the cracking sounds. A few wise skaters have started heading for the shore. Gold hit $1,750 on Monday in response to Friday’s cracking.

Tens of millions of Americans and an equal number of Europeans are going to be trapped when the Great Default comes. Yes, Alan Greenspan has denied that this will ever happen.

“The United States can pay any debt it has because we can always print money to do that. So there is zero probability of default” said Greenspan on NBC’s Meet the Press.

Does this reassure you?

August 10, 2011

Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

Copyright © 2011 Gary North