Krugman's Chickens Come Home to Roost: Imminent Euro Meltdown Begs the Question--When Will Debt Contagion Infect the U.S.?

The laboratory experiment known as Keynesian economics is set to complete in the Eurozone over the next few months. The European Central Bank's infinite borrow-and-spend policies, backstopped by heaven knows what, appears to be the same game-plan advocated by the likes of Paul Krugman here in the states.

And it is all set to topple like a house of cards during an earthquake.

This weekend offered no respite for the European central bankers, who have moved from country to country trying to reassure investors that banks are healthy even though they own billions in badly wounded bonds. The EU and the IMF shored up Greece in the spring with €10 billion and have arranged a set of bailouts for Ireland that will total around €85 billion more. But dominoes Portugal and Spain are now tilting over concerns that they, too, will be unable to service the massive debts they've incurred over the last two decades.

The three-year tab for all of the Eurozone rescues was earlier set at €440 billion; there are now plans to double it before the European banks that own the toxic debt are themselves crushed.

Even Germany Threatened: 'You cannot find a bank safe deposit box'

Even the most financially secure EU state -- Germany -- is trembling. The ongoing crisis "on the eurozone periphery is starting to contaminate the creditworthiness of Germany and the core states of monetary union."

Credit default swaps (CDS) measuring risk on German, French and Dutch bonds have surged over recent days, rising significantly above the levels of non-EMU states in Scandinavia.

"Germany cannot keep paying for bail-outs without going bankrupt itself," said Professor Wilhelm Hankel, of Frankfurt University. "This is frightening people. You cannot find a bank safe deposit box in Germany because every single one has already been taken and stuffed with gold and silver. It is like an underground Switzerland within our borders. People have terrible memories of 1948 and 1923 when they lost their savings."

The critical question remains unanswered. At what point does Germany refuse to bail out the more irresponsible members of the EU. That question is going to the German Constitutional Court early next year as many citizens have objected to the legality of the Greek bailout and other backstopping efforts.

No Certain Thing: 'time the Irish became more militant'

While Eurozone officials would like to portray Ireland's bailout as a fait accompli, the 100,000 protesters in the streets of Dublin yesterday tell another story. The turnout was gargantuan given the snow and freezing temperatures the marchers had to endure. Most protesters are unionists and socialists objecting to the four-year austerity plan announced by the government.

Among the marchers there is deep anger that most of the more than €80bn (£67bn) from the EU and the International Monetary Fund will be given to shore up Ireland's ailing banks.

Marching in the rally was Irish builder Mick Wallace who has had to lay off 100 workers due to the crash in the construction industry. Wallace said it was time the Irish became more militant.

If there's a pattern of civil unrest to be detected throughout Europe, it hinges on the malevolent collaboration between public sector unions and socialists. Their mission, it would appear, is to overthrow any vestige of capitalism in Europe.

'Day of Reckoning' Nears With Talk of Restructuring

The borrowing costs for the most exposed European states are at record highs. The average yield for 10-year bonds issued by Portugal, Ireland, Italy, Greece and Spain hit a Euro-era record of 7.57 percent on Friday.

The spread of PIIGS debt compared to German issues also hit a new high of 492 basis points (or nearly 5%). And the cost to insure the five countries' bonds also hit a record of 517 basis points.

“It’s no longer taboo to speak about a restructuring,” said Johannes Jooste, a portfolio strategist at Bank of America Corp.’s Merrill Lynch Global Wealth Management in London, which oversees about $1.4 trillion for clients. “The fact that bond yields continue to rise and put pressure on countries that have to fund from the market makes investors less and less confident, and it’s bringing forward the day of reckoning.”

Bondholders of European banks are being urged to accept "huge haircuts" because the nature and amount of the debt owned by those institutions is simply so huge it can never be repaid.

Downgrades

Irish banks were hit with another downgrade by rating agencies on Friday and many bank bondholders have already taken horrible losses of 80 to 90 percent.

[Prime Minister] Cowen is unveiling an emergency budget Dec. 7 that seeks to cut euro6 billion ($8 billion) from Ireland's 2011 deficit. He and European officials say that budget must be passed to clear the way for the EU-IMF bailout loan for Ireland.

Ireland's 2010 deficit is running at 32 percent of GDP, the highest in Europe since World War II. The country's severe financial problems are rooted in its enormous bailout of Irish banks who gorged themselves on overpriced real estate.

Meanwhile Portugal, reportedly next weakest of the peripheral Eurozone countries, has denied that it needs a bailout. Economists, however, point to increased risk premiums for Portuguese debt and a survey of experts found most agreeing that a bailout is imminent due to "spiraling debt costs".

Spain, which appears to be next on the endangered list, has a two-fold plan to build a "firewall" against further contagion. It has announced massive budget cuts and is simultaneously trying to find local buyers for its debt.

“The big elephant in the room is Spain, which is too big to fail and too big to be bailed out,” Nouriel Roubini, the New York University professor who predicted the global financial crisis, said in an interview Nov. 23. “In some sense though, Spain is in a better place.”

Asked whether its size would deter an EU bailout, Bank of Spain chief economist Jose Luis Malo de Molina said late yesterday that “the systemic importance” of a country like Spain “reinforces the incentives and stimuli for the rest of the countries to be ready to help in the case that it were necessary.” He said market tensions can become a “self- fulfilling prophecy.”

In other words, remain calm. Don't panic.

'Urgent Action' Needed in the U.S.

With debt contagion washing over Europe, there is little doubt what the impact will be for the U.S.

The US needs to take urgent action to cut its debt in order to prevent the next financial crisis, which may start in Washington, Sheila Bair, chair of the Federal Deposits Insurance Corp. (FDIC) wrote in an editorial in the Washington Post...

The federal debt has doubled over the past seven years, to almost $14 trillion, and the growth is a result of both the financial crisis and the government's "unwillingness over many years to make the hard choices necessary to rein in our long-term structural deficit," Bair wrote...

The tidal wave of baby boomers headed into retirement represents a double whammy for the federal deficit. Bair noted that this year's spending on the big three entitlements (Social Security, Medicare and Medicaid) represents 45 percent of federal spending -- but that it was 27 percent in 1975.

"Eventually, this relentless federal borrowing will directly threaten our financial stability by undermining the confidence that investors have in U.S. government obligations," Bair said.

"With more than 70 percent of US Treasury obligations held by private investors scheduled to mature in the next five years, an erosion of investor confidence would lead to sharp increases in government and private borrowing costs," she added.

The policy prescription of Krugman and the Eurozone is simple:

"Borrow more money to pay off borrowed money."
The problem is, someday the ability to borrow money runs out.

And that's the day that the Ponzi scheme collapses, like Bernie Madoff -- times a million.


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