A Pecuniary Obituary

There is a great sadistic pleasure to be had watching the EU swines squirm over their precious failing currency.  The icing on the cake came from my man of the hour, Herman Van Rompuy, when he claimed that if the euro failed, the EU would too.  Splendid!

As much as I wish this to be true I expect that the kleptomaniacal euro-crats will attempt to artificially prop up their beloved project, even in the face of complete bankruptcy.

Regardless of what happens to the EU there are (at least) two important economic lessons to be learnt from the euro.  Many half intelligent people will have probably figured these out for themselves, but let me just reiterate for our academically challenged EU contemporaries.

1 - Do not attempt to artificially grow your economy through the use of government controlled interest rates, or allow your country to become locked into a foreign, uncontrollable interest rate.

This is probably the most important lesson to heed and the leading contributor to the current EU mess.  Across the Eurozone nations (even within specific nations) there are differing levels of growth and wealth.  These are essential factors in determining how risky an investment is in that area, in other words how much of a return can I expect on my investment and how much collateral do they have to pay me back with if something goes wrong.  The interest rates on any loan will be determined by these factors (along with past payment considerations, etc), therefore these rates will vary largely across the EU.

Exerting control over these rates may allow for a better flow of credit, by artificially adjusting the rates down debtors who may not have been able to initially afford a loan now can.  However the creditors are not being adequately compensated for the risk they are taking, therefore if the debt cannot be repaid then not only will the debtor go bust, but potentially the creditor too.  This has knock-on effects to other debtors who may see interest repayments rise to cover the cost of the defaulted debt.

Tying your country into a foreign interest rate is an even worse idea, as the rate are being set by a non related economy, which do not reflect your level of growth or wealth.  Take Greece for example, who could borrow at low EU (German) rates, so they borrowed huge sums of money and then could not pay back the debt.  So to prevent the creditors (German banks) from losing out and refusing to loan to anyone else the EU bailed out Greece.  However if Greece had more realistic interest rates (reflecting their own economy) to begin with then their creditors would not have allowed them to borrow so much so cheaply.

2 - Do not bail out failing economies/banks, especially if you are also in debt

For a start transferring money from one place to another does not solve a debt problem, if you are £20 out of pocket and your friend gives you £20 then your friend now has the debt instead of you.  Whilst this may be OK if your friend has £20 to spare, our debt riddled home nations are not so affluent, in actuality borrowing more to bail out your buddy will result in you owing even more money.

Easy example;

If you owe £10 and pay 5% interest a year and you pay back the debt at a rate of £2.50 a year. You will owe £8.00 after year 1, £5.90 Yr2, £3.70 Yr3, £1.38 Yr4, finally paying off the debt in Yr5 costing £1.45.  The total cost of paying off this debt is £11.45, £1.45 in interest.

If you owe £10 and borrow an extra £20 to bail out your friend at 5% interest a year whilst paying back £2.50 a year it takes 19 years to pay back the debt.  Costing a total of £51.96 to pay back, £21.96 in interest payments.  Even if your friend repaid you the £20 at a later date you would still be substantially out of pocket compared to your initial £10 debt.

Whilst this is a rather severe example, tripling your current debt level, it highlights the extra expense in taking on more debt in order to cover other bankrupt debtors.  If this extra bill causes you to go bankrupt who bails you out?

Not to mention that bail outs encourage the very practises that caused the debtor to go bust.  For example if you know that someone else will pay off your gambling debts there is no incentive to stop taking risks.

I expect these warnings to fall on deaf ears, as the pursuit of generating pseudo economic growth and attempting to defeat the inevitable recession (re-adjustment) are too much of an entertaining challenge for some.  The fact that the "Bank of England" continues to fiddle with interest rates in a vain attempt to improve the British economy shows a complete lack of willingness to learn.  But as a long term opponent of the Euro; from an ignorant favouring of  familiarity in youth, to a better understanding of global economics in adult hood, the looming 'I told you so' speech is becoming too much to contain.