26 Oct 2011

Two ways of solving the Euro crisis

We are continuously hearing that taxpayers will need to bail out the banks in the event of a Greek default. But is that really true?

Consider a bank that has lent 10 billion euros to the Greek government. The critical question is to know what percentage of that money was "real" money - money that was deposited in the bank by savers - and what percentage was produced out of thin air by the miracle of fractional reserve banking. It seems incredible, but when a bank receives a million euros in deposits by savers, it is allowed to lend up to 30 times that much to anyone who is prepared to sign an I.O.U.  For example, if  the Greek government signs a loan agreement for 10 billion euros with Bank X, it is perfectly possible that only 3% of that money is actually money that was deposited at the bank. The other 9.7 billion euros was quite possibly created out of thin air by a wave of a magic wand. See the positive money website if you don't believe it.

It seems to me that under these conditions, there are two perfectly acceptable ways of resolving the problem.

Solution 1 is for Greece to say that they will repay the 0.3 billion that was actually deposited in the bank (with interest) but refuse to pay the other 9.7 billion that the bank never had. Since the bank doesn't owe that money to anyone, this would have no impact on anyone except the bank. They would just have less money to hand out in bonuses and dividends. So what? For almost every normal person, that would be wonderful news. We wouldn't have to put up will the sight of all those bankers receiving their obscene bonuses at the end of the year.

Solution 2 is that that bank goes bust. This would indeed be very bad news to anyone who had deposited any money in that bank - including ordinary citizens who may have their life savings in there. In that case, I think it would be very important for governments to step in and reimburse the savers who lost their money. I am sure that every normal person would agree to have taxpayers money used for this noble purpose. 

The point is that neither solution should require the hundreds of billions that European leaders are trying to put together to bolster a bank bailout fund. When we are told that the EU will need to find at least 100 billion euros to protect european banks, then I would say that we can safely divide that number by at least 10 and quite possibly 30. Is 3-5 billion too much to find to save the euro? Not in my books it isn't.

The other very intersting feature of this approach is that it will require banks to distinguish between the money that was created out of thin air, and the real deposits that people assumed were safe when they put their savings in the bank. And if the banks can't tell the difference, then they deserve to go to the wall.

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