An explanation of the European financial crisis

Simon Johnson, writing on Bloomberg, provides an explanation of the Irish financial crisis in particular and the European crisis in general.

A short summary of a short article that is well worth a read:

  • Despite assistance from the  European Union, ‘presumably with IMF involvement’  (Johnson posted his article on Nov. 19, before the EU made its move) which turned out to be the case, investors will realize that Ireland’s future debt path is unsustainable and Europe and Ireland will have to resolve underlying problems and restructure banking and sovereign debt.
  • “there won’t be any quick jump to a solution; it will be slow, painful-to-watch chess match in Dublin, Brussels and around the IMF headquarters in Washington, with obvious and costly spillovers to Portugal, Spain and perhaps other countries.”
  • While there is some truth to the claim made by European politicians that their economic crisis is a result of the U.S. housing market  meltdown, Johnson writes, “The main proponents of unconstrained financial globalization may have been U.S. Treasury officials in recent decades, but it was European banks that really became too large relative to their economies. Along the way, they captured their regulators and engaged in incredibly irresponsible behavior.”
  • Mentioning two books, David Lynch’s “When the Luck of the Irish Ran Out” and “Ship of Fools: How Stupidity and Corruption Killed the Celtic Tiger,” by Irish journalist Fintan O’Toole, Johnson mentions  that “Both lay out the web of connections between politicians, bankers and real-estate developers that accounted for the frenzied growth and subsequent crash of the Irish economy.”. This web of connections would seem a simple key to understanding at least what went down in Ireland. David Lynch can be heard on an interview at the 37 min. mark on Ian Master’s Daily Briefing on KPFK.org.
  • When Ireland defaults, big German and French banks will take a major hit, and the problems will probably spread to Portugal and Spain, whereupon the European Central Bank, Germany and the IMF will be expected to step in with further injections of money. But the German taxpayer won’t pony up and the ECB doesn’t have the resources and Johnson asks if the IMF has the resources to deal with Spain or an even larger country like France or Italy.
  • Drawing the whole saga to a possible conclusion, Johnson notes that the IMF might turn to China to recapitalize it and help save European creditors.  Since IMF rules say that its headquarters should be in the capital  of its largest shareholder, the IMF would be relocated to Beijing, ending with the question:

    wouldn’t that make for an interesting chess game?

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