Monday, November 29, 2010

Establishing a background

My first few posts will be used to build a foundation and establish a frame of reference so-to-speak, for future discussions.

Currently, the American and World economies are hurting. A few months ago, the European Union (EU) had to bail out Greece (111 Billion Euro - $145 Billion). This week, the same EU (with input from the IMF - International Monetary Fund) approved a 85 Billion Euro (roughly 111 Billion US Dollars) bailout for Ireland.

That article states that the U.S. Stock market is down 1% so far today and that Andrew Lim, head of financials research at Matrix, said: "The Irish bailout doesn't solve the euro problem … We are looking at Portugal then Spain next."

History from the late 90's, when Argentina's economy had issues, shows that meeting IMF's terms may not be feasible, and result in total economic collapse. Also taken today, from the same source cited above (different story):

Similar cases from the past are easy to find, and this is where the Argentine case sheds light on the issue. During 2000 and 2001, Argentina failed to satisfy IMF conditions and support was withdrawn. Previously, the quarterly goals and corresponding revisions had generated day-to-day uncertainty that impacted adversely on the financial markets. In the end, those markets virtually ground to a halt. Investors feared Argentina's inconsistent ability to satisfy IMF demands and decided to stop lending. The economy then fell into debt default and recession, with immediate consequences for ordinary Argentines. Social chaos ensued as the rate of unemployment and poverty rose dramatically, while the number of presidents in one week scored a record five.

Back in 2008, Zimbabwe entered a period of "hyperinflation" where they had printed so much currency, they had to resort to printing $100,000,000 bills, and were considering printing $200,000,000 bills as well, just so citizens did not have to have a truckload of money to go buy a day's worth of groceries.

A "fiat" money system, one where the money has no inherent value (paper money with a value printed on it) as opposed to a real money system (where precious metals are coined, and paper redeemable for given amounts of precious metals are used) can suffer this kind of failure. Need more cash or carrying too much debt, just print some more! That also has the added benefit of devaluing your currency (supply and demand, more circulating, less demand) so a nation can repay it's debt with devalued currency.

Example: Borrow $100 Billion, print another $10 Billion, then your $100 Billion originally borrowed, may only be worth $91 Billion now, so you pay it back, and the loser is the bank or country that loaned you the money initially. That is where nations and banks run screaming from nations that engage in this practice excessively, which grinds that country's economy to a halt.

This is also known as "Monetization of debt" or to use a recently in the media term "Quantitative Easing".

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