EU dances the tango right off a cliff
Truthfully, I was a bit baffled by all the talk of central banks, private bondholders' haircuts, ECB, liquidity, and so forth. By coincidence, I ran into several articles today all talking about Spain and, to a lesser degree, Italy, the collapse of the Belgium government, and so forth. I think I finally have a grasp on this, and will so describe if you are confused like me and then opine on why a EU collapse seems to be unavoidable at some point.
It starts with the European Central Bank (ECB), funded mainly by Germany and also France (if the Socialist defeats Sarkozy, France will shovel money at the ECB even faster). The ECB transfers money to the central banks of member EU countries by buying the sovereign bonds issued by the governments'. The central bank of each country then pumps money into their respective countries by buying bonds issued by the major private banks therein. Ecco. This is currently how the richer EU countries are propping up the poorer ones. If the ECB turns off the spigot, the central bank runs out of money and can not payoff their sovereign bonds, and the private banks and their investors are left holding the bag; either that, or the taxpayers end up subsidizing the private banking industry (which is what happened in our country).
You see, normally the central bank of a country can sell their sovereign bonds on the open market, but some (PIIGS) have budget deficits that are too high, and cannot sell them. So, here, the ECB has stepped in as the buyer of last resort. In return, the ECB demands budgetary austerity, but this is not always politically feasible (not unlike the way our government works). This, in response, depresses the economy, decreases national income, and decreases government tax receipts. This actually increases the budget deficit, necessitating more ECB purchases. When I was a kid, we called this a 'vicious circle'.
Stepping back, once the central bank of a country accepts ECB money, it is difficult to see how things will ever improve enough to allow repayment of bonds held by the ECB, short of a miraculous, worldwide, economic explosion. Our stock market goes up and down in response to the media remarks by EU officials fresh from the latest crisis meeting. It reminds me of a couple doing the tango right next to a cliff: one false move, and it's game over, dude. Why a cliff? Because EU members no longer have 2 key tools normally used to rescue disaster: precipitously lowering interest rates and devaluing the currency.