Europe’s three needs: a debt write-down, a real central bank, and a more efficient tax system

What can Europe learn from the United States?
First, the United States – like Canada, England and China – have central banks that do what central banks outside of Europe were created to do: finance the budget deficit directly.

I have found that it is hard to explain to continental Europe just how different the English-speaking countries are in this respect. There is a prejudice here that central bank financing of a domestic spending deficit by government is inflationary. This is nonsense, as demonstrated by recent U.S. experience: the largest money creation in American history has gone hand in hand with debt deflation.

It is the commercial banks that have created the Bubble Economy’s inflation, from North America to Europe. They have recklessly lent mortgage credit and other credit far beyond the ability of domestic economies to pay. A real central bank can create credit on its electronic keyboards just as easily as commercial banks can do. But central banks do not create credit for speculative purposes. They do not make junk mortgages based on “liars’ loans” (the liars are the banks, not the borrowers), based on fictitious evaluations by crooked appraisers, and sold fraudulently to investment banks to package and sell to gullible Europeans, pension funds and other customers.

In short, there is no need for the present austerity. If Europe acted like the United States, it could bail out the banks.

But would this be a good thing? My second point is that there are good reasons not to fund a dysfunctional debt overhead, financial and tax system. It is preferable to change these systems.

In the United States, Paul Krugman has urged the Federal Reserve to simply lend banks an amount equal to their bad loans and negative equity (debts in excess of the market price of assets). He urges a “Keynesian” program of spending to re-inflate the economy back to bubble levels. This is the liberal answer: to throw money at the problem, without seeking structural reform.

The Bank for International Settlements (BIS) disagreed last week in its annual report. It said – and I believe that it is right – that monetary policy alone cannot solve an insolvency problem. And that is what Europe has now: not merely illiquidity for government bonds and corporate debt, but insolvency when it comes to the ability to pay.

In such circumstances, the BIS explains, it is necessary to write down the debt to the amount that can be paid – and to undertake structural reforms to prevent the Bubble Economy from recurring.

The Canadian postal workers union has an informal slogan: “A job that’s not worth doing is not worth doing well.” I might apply this to Europe by saying that a badly structured economy is not worth subsidizing or saving. It should be made well.

This entails, for starters, writing down the debt overhead. That is what created the German Economic Miracle of 1948: the Allied Monetary Reform that wiped out debts over and above minimum working balances, and wages debts owed by employers to employees. It was easy to write down debts that were owed to Nazis. It is much harder to do so when the debts are owed to powerful and entrenched institutions – especially to banks.

Take the case of a Greek debt writedown. This would hurt the Greek banks first and foremost, and also more innocent German insurance companies and banks.I have a modest suggestion as to how to handle this. First, let the Greek banks go under. They helped stymie the Greek government’s attempt to stop tax evasion and money laundering. They have been described as co-conspirators and corrupt. Of course their depositors should be made whole by a standardized, public bank insurance scheme. But bank bondholders and stockholders, and even non-insured depositors, are another matter.

As for the German institutions, if a Greek Clean Slate pushes them into insolvency, the German Government should do what the U.S. Federal Deposit Insurance Corp. (FDIC) is empowered to do: take them over, make all the depositors and policy holders whole, and operate these institutions as a public option – either temporarily or permanently.

The alternative is austerity and debt deflation that will leave European markets shrinking, living standards falling, and turn Europe into what U.S. Defense Secretary Rumsfeld has said so often: “Old Europe,” as if it is too late to be saved. Any discussion of the U.S. economy necessarily involves the global context. So it is necessary to discuss not only domestic U.S. developments, but also relations with Europe and the BRICS countries.

The most important dynamic is financial. A continued decline in real estate prices, coupled with local government debts, has led to debt deflation. As personal and corporate income are diverted to pay debt service, spending on new consumption and investment goods is cut back. Sales and employment opportunities are falling off, especially for new entrants into the labor force. Major categories of debt cannot be repaid in Europe and the United States, except by foreclosures transferring property to creditors. Short-term financial aims overshadow the long-term adjustments that ultimately will be needed: debt writedowns in the public and private sectors. The alternative to this “business as usual” scenario is for the U.S. and European economies to look increasingly like the Baltics – austerity aggravating economic shrinkage.

The U.S. Government as well as European governments have taken bad bank debts onto the public balance sheet. This is not a problem for the United States, whose Federal Reserve can simply create the credit to roll over its debt. But for Europe, public debts simply cannot be paid under current central bank constraints. Instead of changing the central bank rules, the European Union is willing to plunge the continent into depression and economic shrinkage.

Source: http://michael-hudson.com/2012/07/the-weaponization-of-economic-theory/