Europeans borrowed vast sums in dollars in the offshore money markets when dollar credit was cheap. This was leveraged by multiples of 50 or 60 to fund whatever craze was in fashion – Russia, Brazil, infrastructure. The credit crunch has left these banks floundering. They have to pay back a lot of dollars, yet the underlying assets are crumbling. They are caught in a self-feeding spiral of "deleveraging". Even those European banks that stuck to stodgy investments are caught in a vice, since many rely to some degree on three-month loans for funds. That market is jammed shut. They cannot roll-over their loan books. This way lies sudden death, as Hypo discovered. Who in the eurozone can do what Alistair Darling has just done in extremis to save Britain's banks, as this $10 trillion house of cards falls down? There is no EU treasury or debt union to back up the single currency. The ECB is not allowed to launch bail-outs by EU law. Each country must save its own skin, yet none has full control of the policy instruments. Germany has vetoed French and Italian ideas for an EU lifeboat fund. The former knows exactly where that leads. It is a Trojan horse that will be used one day to co-opt German taxpayers into rescues for less Teutonic EMU kin. One can sympathise with Berlin. But sharing debts with Italy and Spain was implicit when they agreed to launch the euro. A shared currency entails obligations. We have reached the watershed moment when Germany has to decide whether to put its full sovereign weight behind the EMU project or reveal that it is not prepared to do so in a crisis. This is a very dangerous set of circumstances for monetary union. Will we still have a 15-member euro by Christmas? – UK Telegraph (Ambrose Evans- Pritchard)

Dominant Social Theme: Does the EU really work?

Free-Market Analysis: Evans-Pritchard is one of the better mainstream economic commentators, and he has been hitting the economic crisis hard. He certainly has hard-money sympathies, and he has written on one occasion or another that the only currency worth owning right now is bullion (gold bars) and that the current unwinding is going to be a most difficult one. In the above article excerpt he makes some important points about the European Union that we have long believed (and written about). Pritchard's point is that central banks CAN help calm systemic crises by massively inflating. Here's what he had to say about US actions later in the article:

My view is that Washington has done what is needed to prevent the collapse of the US economy. It has taken over the entire credit system, after all, surpassing Roosevelt's New Deal. The US has guaranteed the $3.5 trillion money market funds. It has nationalised the $5.3 trillion pillars of the mortgage market, Fannie and Freddie. The Fed is accepting any junk as collateral at its lending window. This week it went the whole hog after panic hit the $1.6 trillion market for commercial paper. It is now offering loans without any security at all. The US government has become a bank. Yes, this is US socialism. What is the alternative? The $700 billion Paulson rescue plan should put a floor under the colossal dung heap known as "structured credit". It is a bad plan, since it does not target the money on the recapitalisation of the core banking system. But it will help refloat lenders by raising the price of beaten-down securities somewhere nearer their true "hold-to-maturity" worth. An ugly recession is coming, as debt leverage kicks into reverse. The purge will be slow and punishing. Some 12 million Americans are already trapped in negative equity, but at least they can see where this might end. After much drama, the US institutions have risen to the challenge. The Fed, the Treasury, and Congress have managed to take some sort of coherent action. The jury is out on Europe, where the hurricane is now smashing the banking system.

Pritchard's point is interesting because it shows clearly where he comes down in the debate between various free-market factions. One faction believes that there is nothing to be done when a gigantic credit crisis slams the markets and that the only thing that can happen logically is that markets will unravel at their own pace. The other faction holds that while central bank activities cause the problem, they can make it infinitely worse by tightening credit, and can slightly delay the full impact of the crisis by printing tons of money. Pritchard obviously comes down on the side of the second point: doing nothing in these situations can cause an immediate deflationary depression; while doing something can generate, over the long term, an inflationary recession (Pritchard might not put it that way, but we will.)

The two approaches have fairly critical downsides. A deflationary depression would tend to remove capital from every part of the economic scene because people would rather save their appreciating currency than spend it. Also, in this scenario, people and institutions will tend not to spend much money, or fund many capital ventures, because the pool of jobs and opportunities is shrinking.

In an inflationary recession (or depression, depending on the severity), just as many jobs may be lost over a slightly longer period of time. But it is possible that the downturn might be less severe – especially as people and institutions are more likely to part with currency (spend it) given that the value is being eaten away by inflation.

In the case of the current crisis, it is worth noting that central banks will probably end up pumping something like US$10 TRILLION OR MORE into the world economy in a fairly short period of time. This brings up a third scenario to which the near-future may be subject and which you could call, we suppose, a HYPERINFLATIONARY DEPRESSION.

Time will tell which track we are on – and continued observation will give us a sense of whether central banking interference seems to cushion the worldwide equity slump or has no effect. Whether it does or not, the current crisis may have the salutary effect of reminding investors that a fiat-money environment is little more than a confidence game run by the monetary elite. The "value" of a stock goes up and down and it is very difficult to value a company large or small from investment recommendations and book-keeping presentations.

The exception to the above point would be, perhaps, when a company's books are fairly transparent and its assets fairly easy to assess. But there are not many such around.

Certainly, the larger a company gets, the more difficult it is to figure out how much it is worth. That is why a free-market gold and silver standard would be so much easier to implement and observe. Gold and silver are tangible assets and it is hard to have a "crisis of confidence" when money is backed to a degree, even a large degree, by precious metals. There is no question about "value" then. No worry that the money will "evaporate" as, again, it is a tangible asset.

Central bankers won't speak about such things, though. Which is why we have the current absurdities : a ban on short-selling and ridiculous finger-pointing in which reporters, politicians and businesspeople are accused of talking down the market or a stock, as if "confidence" in the market had suddenly become an asset of itself. (When was the last time you bought a cup of coffee with "confidence?")

Anyway, on a purely academic level, we are anxious to see how all this turns out. Hard-money academics have been arguing over whether or not central banks, having caused the problem, can ameliorate it, or at least smooth the downturn, by printing lots of additional money. Milton Friedman, a supposed champion of free-markets believed that central banks could. Murray Rothbard, a very hard-money oriented economist believed that once markets had reached a tipping point, all the additional pump priming in the world could not help a bit. What both probably would agree on, however, is that the addition of massive amounts of credit in an attempt to support plunging markets will sooner or later produce increased inflation, even hyperinflation. And that's probably the ultimate point to keep in mind. And another reason the honest money bull may have a long way to run.