When bailouts don’t work

Jul 8, 2012·James Turk

Sometimes bailouts do not achieve what is intended, which is one reason they should be avoided. The people of Iceland apparently have some discerning insight into this basic financial reality.

When a financial collapse over three years ago sent their economy into a tailspin, Icelanders were given a chance to vote on whether they should impose more debt on themselves in order to bail out insolvent banks. The Icelanders decided to reject the proposed debt burden and the accompanying draconian austerity that would be required. As it turns out, they chose wisely. Happily, Iceland’s economy is back on its feet. As the BBC reported a few months ago: “Iceland is safe to invest in again, according to Fitch, which has upgraded its credit rating three years after its economy spectacularly collapsed.”

In contrast to what happened in Iceland, people in the eurozone were not given a chance to vote on the serial bailouts or the oppressive austerity measures that were intended to solve Europe’s long simmering bank and sovereign debt crises, but have failed to do so. Consequently, following the Spanish election that resulted in a leadership change, the recent election results in Greece and France that dealt incumbents with stunning losses should not be a surprise. They should be seen as an inevitable reaction by citizens in those countries rejecting the economic choices made by their governments.

As the Greek election shows in particular, impatience against incumbents, whether socialist or conservative, has reached an unprecedented level. Ideology no longer matters when an economy is in tatters and unemployment is at record levels.

Perhaps the various European election results also reflect rising disenchantment with European Union policies. Germans and Italians don’t want to bailout Greece or Spain anymore than New Yorkers and Texans would want to bailout California.

Demonstrators have taken to the streets in many cities across the EU protesting decisions concerning their country’s economic future. Worryingly, the growing social unrest is likely to be exacerbated as economies throughout the EU falter. Economic activity will not improve until unemployment starts falling, and the prospect for that is unlikely because the capital needed for investment is being better rewarded elsewhere in the world.

The implications are clear. Many voters and demonstrators have recognised that governments have taken for granted the hard-working citizenry, principally the masses of the middle class who have seen their lifestyle evaporate along with their savings.

Remedies that papered over problems in the past will no longer work. Today’s financial problems cannot be left for central planners to solve in the future. What worked in the past when debt loads were small, will not work today because debt loads are huge.

In short, there is just too much debt. The sovereign debt crisis – and the interrelated crisis of banks that own too much dubious quality paper of over-indebted governments – is a powder keg, and the fuse has already been lit.

The bailouts have not worked. Good money was thrown after bad. We are now seeing the unintended consequences. In this environment of financial uncertainty, each person needs physical gold now more than ever. It is the world’s safe-haven currency.

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