Neither a borrower nor a lender be
18 March 2011
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry
Hamlet, Act I, scene 2, 75-77
Europe’s leaders should have heeded Lord Polonius’ wise words to his son Laertes. The countries now struggling under a mountain of debt should have realized earlier that excessive reliance on borrowing invites excessive consumption and wasteful investment. But the leaders of Germany and the other creditor countries should also be aware that a lender can lose both its capital and its friends...
...However, this widespread impression that the ‘bailout’ of Ireland constituted an onerous interest rate ‘diktat’ by the EFSF is misleading. A much larger ‘bail-out’ on very generous terms has taken place silently via the balance sheet of the ECB. Here again public attention has focused on a side show, namely the direct purchases of distressed government bonds by the ECB. However, the portfolio of government bonds held by the ECB under its ‘securities markets programme’ has so far amounted only to about €70 billion, of which only part will have been in Greek and Irish bonds. But more importantly, the ECB has not provided any fresh money to the countries concerned by buying their bonds in the secondary market. It has only increased the price at which some investors were able to sell their holdings of Greek and other bonds. The ECB is, however, providing direct support to the countries in difficulties via its normal monetary policy operations, which allow the banking systems of these countries to refinance themselves at the official rate of 1%. This has resulted in an infusion of liquidity of an unprecedented magnitude given the small size of these economies...
...Insolvency can certainly be avoided as long as liquidity is (almost) free and available in unlimited amounts. However, unlimited cheap financing (‘liquefaction’) has its disadvantages. First of all, it is obviously not a solution for insolvent debtors; it just postpones the day of reckoning – and makes it more painful when it does arrive because the debt burden will be even larger. Secondly, it is addictive. The European Central Bank will remain by far the cheapest source of funds for banks in the euro periphery. Those countries will thus try to maintain and increase their recourse to ECB funding for as long as possible, with the result that the risk on the balance sheet of the ECB will also increase. This is why the ECB recently had to tighten its eligibility criteria for the collateral it accepts.
[Mrt: Gold a wealth asset par excellence here we go!]
Source: Neither a borrower nor a lender be