Friday, 7 May 2010

The Fiat Money End Game

The rescue team, which consists of the stronger countries and the IMF, are damned if they do and damned if they don't. Instead of banks being insolvent with runs occurring on them as in the 1930s and 2008, we have whole countries being bankrupt, but their paper is held by banks in France and elsewhere, so there is a contagion thing to worry about. If the EU lets default happen, there is a run against all the bonds of all the weaker countries. Their yields rise, and they have to default too, and then that weakens a host of banks and others who hold the paper, and then they demand to be bailed out. If instead they rescue Greece and others, then the rescuing governments have to issue more debt, or else the IMF does too, or else the ECB gets into the act too, and this weakens the stronger countries and drives down the euro. So, either way, there are problems. It appears that the rescue option has been invoked, although tardily and reluctantly. This means that the governments are rescuing the bondholding banks and whoever else holds the Greek paper. That's the bailout here. This is preferable to the rescuers as compared with an outright default which then starts a contagion via the bond yields rising sharply which induces country bankruptcies and defaults.


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