However in the European Monetary Union there are now 17 nations and a plethora of banks.  So, to put it crudely, there is sure to be a fight to decide who gets the newly printed funds.  The ECB resolved this by what seemed like a fair rule:  All commercial banks can borrow from the ECB if they provide collateral, in the form of highly rated government and other securities, to the ECB.  So, for example, a Greek bank can gain liquidity by depositing Greek government bonds with the ECB – as long as those bonds are “investment grade”, i.e., highly rated.

This simple and seemingly reasonable rule created great dangers for the eurozone, which have come back to haunt Mr. Trichet.  The commercial banks in the zone are able to buy government bonds, which “paid” 3-6% long term interest rates (for all the sovereign bonds of members) over the last decade, and then deposit them at the ECB.  They could then borrow from the ECB at the ECB financing rate, which today is 1%, against this collateral so pocketing a profit — and then buy more sovereign bonds with the funds.  Mr. Trichet recognized this system had inherent dangers of turning into a new Ponzi game:  if nations spent too much, and built up too much debt, eventually the system would collapse. So at the foundation of the eurozone, Mr. Trichet led a contingent within the EU that demanded all nations live by a “Growth and Stability Pact”, whereby each nation could only run deficits of 3% of GDP, and they had to keep their debt/GDP ratio below 60% of GDP.

Of course, politics trumped Mr. Trichet – as it always must – and the Greeks, along with the Portuguese, used their new found cheap lending system to run large deficits and build up debt.  The cheap access to money also helped feed the real estate booms in Ireland and Spain.

Today, Mr. Trichet and Ms. Merkel are desperate for harsh changes to ECB lending rules that will stop this ponzi game.  They want to penalize profligate spenders.  They also want profligate nations to pay more interest.  Soon, due to its poor credit rating, Greek debt will be treated like poor collateral, so banks will no longer be able to borrow as much with Greek debt as collateral.  When these changes at the ECB come into effect in 2011, the days of Greece being able to borrow easily at low interest rates in the euro zone will close once and for all.  (emphasis mine)

Professor Johnson reports here that “Fitch just took the Greek rating to BBB minus, i.e., at the floor where the ECB now lets banks borrow against (“repo”) government debt.”

For the final kicker, the ECB dumped a heavy load of fuel on the fire, making it all but guaranteed that any European government will be able to engage in ever-more reckless debt issuance close to the day of reckoning.  But when that day comes, the crisis will be much larger.  Again, Professor Johnson:

Last week the ECB had a chance to dismantle this doom machine when the board of governors announced new rules for determining what debts could be used as collateral at the ECB.  Some observers anticipated the ECB might plan to tighten the rules gradually, so preventing the Greek government from issuing too many new bonds that could be financed at the ECB.  But the ECB did not do that.  In fact, the ECB’s board of Governors did the opposite:  they made it even easier for Greece, Portugal, and any other nation to borrow in 2011 and beyond.  Indeed, under the new lax rules you only need to convince one rating agency (and we all know how easy that is) that your debt is not junk in order to get financing from the ECB. Today, despite the clear dangers and massive debts, all three rating agencies are surely scared to take the politically charged step of declaring Greek debt is junk.  They are similarly afraid to touch Portugal.

I must add that The Baseline Scenario is an excellent blog, with some of the best coverage of the financial crisis and the world of Too Big to Fail.

However, while I keep the possibility of emigration in the back of my head, I am still skeptical if other countries will be more attractive than the US.  Of course, much of Europe, South America, and Africa will probably not be as attractive as the US.  India (and perhaps China, if you are OK with their government) is a possibility, as may be isolated countries in Eastern Europe and elsewhere.  If nothing else, thinking about exit opportunities is a coping mechanism when faced with the possibility of poor options at home.

Growthology addresses this issue in a recent blog post.

The consequences of U.S. fiscal calamity will go hand-in-hand with globalization. The world is in the early stages of globalization, but already member states in the EU are feeling the effects of combining tax competition with the right of movement. A 2006 BBC report noted that nearly 10 percent of Britons lived aborad, a million in Spain.  Two emigrant types dominate: retirees and workers!  Here’s a more recent report from the OECD

… the share of immigrants in the OECD population almost doubled from just over 4.5% in 1975 to 8.3% in 2005. It is also noteworthy that 45% of immigrants living in OECD countries in 2008 came from other OECD countries.

The threat America faces is a world that competes for our greatest natural resource: it’s young. If we make the tax climate hellish, the U.S. is going to suffer outmigration as places like Canada, Australia, Brazil, Mexico, Chile realize what an opportunity they have to cream our entrepreneurial talent. If we don’t, and let the deficit spiral out of control, the dollar will fall and workers will go elsewhere for value reasons. There’s already a migratory tension in Europe, waged primarily with favorable tax treatment for high net worth immigrants.

The truth is that it’s “game over” with respect to the nation’s fiscal predicament. We are hurtling irreversibly toward a budgetary crack-up that will generate the mother of all crises in global bond and currency markets….

Indeed, lacking any coherent fiscally conservative opposition party, the nation’s finances have succumbed to the raw, parochial imperatives of organized lobbies and hometown industry. These primal political forces now heap fiscal largesse on clunker cars, random homebuyers, farm-belt ethanol plants and Wall Street bankers with bipartisan equanimity….

But after the Panic of 2008 there was no mysterious demand leakage — just the final exhaustion of a 30-year borrowing binge by households and businesses. So “counterfeit demand,” based on unsustainable borrowing that had swelled the boom economy, has now been irrevocably dissolved. This means that honestly measured gross domestic product is lower than before, and the nonbubble job count is about 20 million fewer (counting part-time and discouraged workers) than previously reported. Permanently adding trillions to an already staggering national debt, to re-create spending and jobs that were an illusion in the first place, hardly constitutes sound economic policy….

The collateral damage to the fiscal policy process from this Keynesian consensus, however, is palpable. At 15 percent of GDP, Federal receipts are at their lowest since World War II, yet both parties pile on jobs, housing and investment tax credits that further dismantle the revenue base. Similarly, spending is at an all-time high of 25.5 percent of GDP, yet white-elephant stimulus projects, such as high-speed trains that local taxpayers would never pay for, push the spending ratio ever higher….

Thus, the Obama budget assumes real growth of nearly 4 percent per year in an economy still listing from the collapse of a 30-year debt spree. More improbably, it assumes nominal GDP grows by 6 percent annually for five years — though the world economy is caught in a powerful deflationary downdraft, and nominal U.S. GDP has not grown at anything close to a 6 percent rate since early 2006, before the day of reckoning arrived.

The laws of compound arithmetic extract a painful toll when these numbers are reset to more realistic values. Nominal GDP could easily grow at only 3 percent, meaning the size of the U.S. economy forecast for 2015 is overstated by $2.5 trillion and Federal receipts by $500 billion annually — while spending is probably understated by several hundred billion more. Thus, adjusted to real-world assumptions, the White House budget projects a $1.5 trillion deficit out as far as 2015, and $10 trillion of incremental bond finance in the interim….

And finally, ending on a pessimistic note:

After 30 years of evisceration, the ingredients for successful fiscal governance are gone. The current drift toward doomsday is likely irreversible.

I am starting to warm to the idea of a tax on financial transactions (trades in stocks, bonds, currencies, derivatives), also discussed in the article.  It probably won’t hurt the efficiency of the markets much at all, it might reign in some of the more useless speculation, and could bring in a large amount of revenue.  Chance of this happening: < 5%, in my opinion.

About 47 percent [of U.S. households] will pay no federal income taxes at all for 2009….

The result is a tax system that exempts almost half the country from paying for programs that benefit everyone, including national defense, public safety, infrastructure and education. It is a system in which the top 10 percent of earners — households making an average of $366,400 in 2006 — paid about 73 percent of the income taxes collected by the federal government.

The bottom 40 percent, on average, make a profit from the federal income tax, meaning they get more money in tax credits than they would otherwise owe in taxes. For those people, the government sends them a payment.

"We have 50 percent of people who are getting something for nothing," said Curtis Dubay, senior tax policy analyst at the Heritage Foundation.

First, such a skewed tax system clearly creates a disincentive to work hard and to invest in oneself so that one’s future income will be greater.  Given the federal government’s poor fiscal situation, taxes are almost certainly going up (and probably not just on the rich), creating an even greater disincentive for young people to invest in themselves.  But perhaps more worrying is the fact that roughly half of Americans don’t recognize the burden of government.  They think it comes for free.  In fact, as the article makes clear, roughly 40 percent “make a profit from the federal income tax”.  To quote George Bernard Shaw, “A government that robs Peter to pay Paul can always depend on the support of Paul.”  Hence, the current structure of the tax system threatens the integrity of our democracy.

Actually, I would point out that lower-income individuals definitely do feel the burden of government.  More government intervention (through barriers to trade, red tape, labor-market regulations, and even through secondary effects of taxation, such as lower investment) often tends to reduce their standard of living, although they often do not realize this.  Rich people will generally find a way to get by, but poor people have less flexibility, fewer exit options, fewer contacts, etc.  Hence, it would be more accurate to say that lower-income Americans suffer greatly from the burden of government (except when it comes to the direct burden of income taxes), but just don’t realize it.  Often, they wrongly believe that more government is in their interest.

(HT: Chris)

Fact from the video: Uncle Sam has issued some $2.6 trillion in debt since the beginning of 2009.

From my previous post, quoting former CBO director Douglas Holtz-Eakin,

By 2020, the federal deficit — the amount the government must borrow to meet its expenses — is projected to be $1.2 trillion, $900 billion of which represents interest on previous debt.

Furthermore, raising taxes now (along with at least modest reform of benefits) is better than completely kicking the can down the road, at which point the options will be even less palatable: even more tax increases being weighed against even greater benefit cuts, along with a more-enfeebled economic position for the US in the global economy.  If the recommendations are heavy on the tax-raising side, at least it will introduce Americans to the reality of the fiscal problem in a very poignant way, by hurting their pocketbooks.  This, hopefully, will result in more libertarians.

Simply put, without getting into the nuances of the trade-off between the two, I would value more libertarians above short-, or even long-term policy successes.  Of course, policy successes are great, and ultimately, that is what most people are after.  However, more libertarians will eventually lead to more liberty-friendly government, and in a more sustainable way.  Does it really matter if the government is more libertarian for a few years, only to be voted out of power?