The Crack in the Ice
by Gary North
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.