European Bailout: Deciphering the 'I' in IOU

Oh la la…that was fast! We’ve had headaches that lasted longer…

One day the world is convinced that the central bankers and financial meddlers of Europe have the secret to success. The next day, they change their minds. Turns out, the euro feds don’t seem to have the problem solved after all. The euro is going down again.

The problem is not the fickleness of the marketplace. It is not the cupidity of politicians, nor even the stupidity of the voters. Nor is the problem a lack of regulation or coordination or integration. It is none of those things discussed in the media. In a word, it is debt. Eventually, the euro feds – along with their American counterparts – will discover what everybody else already knows. You can’t really cure a debt problem with more debt.

At least investors seem to be able to put two and two together. After running up stocks and bonds on Monday, investors had a chance to think it over and on Tuesday they decided that maybe the euro bailout was not quite as good as they imagined it.

“European Bailout Optimism Cools,” announced a headline on Bloomberg.

For one thing, the plan is hard to figure out. Exactly who is paying for what? Already, the euro itself was enough of a mystery. In America, at least you know who is responsible for destroying the dollar. In Europe, you’re not sure. The dollar is, after all, an IOU issued by the world’s biggest debtor. What’s the euro? It’s an IOU too. But nobody is too sure who the ‘I’ is.

The bailout plan is a mystery on a mystery. The plan calls for a little of this and a little of that…and maybe it won’t happen at all if some nations vote against it…and who knows what they’re really going to do?

For another thing, no one really knows what the risk is or how much it should cost to protect against it. Yes, Greece, Portugal, Ireland, Spain and Italy all COULD go broke. But how? And when? So what?

No one knows. But, yesterday, investors felt that maybe they didn’t want to be holding quite so many pricey stocks or quite so many euros when they finally found out.

The Dow fell 36 points. The euro went down too…to close at $1.26 – even cheaper than before the rescue was announced.

What was really amazing was the price of gold. It went up $19 during trading hours. Later in the day, it was up to a new record, over $1,220. How do you like that?

Why would gold go up? After all, when stocks go down, it is signaling LESS faith in the growth, prosperity and inflation forecast. A falling stock market is a sign of growing pessimism…that haunting fear that people may actually get what they’ve got coming after all.

Meanwhile, in America, Governor Arnold Schwarzenegger is preparing the people of California. Hard times are a-comin’. They’re going to have to tighten their belts.

“Terrible cuts,” are on the way, said the governor.

How will Californians react? Will they close ranks, like the Koreans after the Asian debt crisis of the late ’90s? Will they take it with good humor and Guinness, like the Irish now? Or will they start to riot, like the Greeks of the debt crisis of 2010?

You remember what the Koreans did? They turned in their gold jewelry so that the state could pay its bills to foreign lenders.

The Greeks, on the other hand, seem to be looking for a rumble. They figure they’re entitled to the Good Life. They figure its part of what you get when you join the European Union. It must be in the constitution somewhere…that you have the right to life, liberty and a good time.

They’re used to being taken care of. And they don’t like giving it up.

They’d probably like it even less if they realized that it is all so that a group of French bondholders can be bailed out of their bad bets.

But what’s the alternative? You either pay your debts…or you go broke. If you go broke, no one will lend to you – so you’ll have to make do on what you actually earn. On the other hand, if you do pay your debts, you’ll have to take money out of earnings…leaving you with less money to spend.

Oh me, oh my…there’s no easy way out. Milton Friedman was right; there is no free lunch after all.

Bill Bonner
for The Daily Reckoning

The Daily Reckoning