Moral hazard and sovereign debt

So, once again, we (the world's taxpayers) have bailed out the banks that decided it was a good idea to continue lending to a country (Greece) that had no hope of paying back the loans. Be clear that these loans are not bailing out Greece, just reducing the interest rate that the banks are charging to lend to them.

If this sounds a lot like the bailout of the banks when they decided to lend mortgage funds to people that had no hope of paying back those mortgages, it is.

At some point, governments of the world must realize that every dollar they borrow must be repaid with interest. For taxpayers, that means that deficit spending now means higher taxes in the future - not a reduction in government spending because no politician is willing to do that. Witness the deadly riots in Greece, the hung parliament in England and the soap opera that is the American government. There is one exception to this rule: those countries with sovereign currencies can choose to pay off their debts by printing money. This is true for Britain, Japan, the US and Canada. Unfortunately, for the countries that signed on to the euro, this is not an option. A country that chooses to monetize their debt faces a future of higher inflation rates and a greatly reduced effectiveness of monetary policy.

The core of the current world economies can be traced back to the misguided belief that expansionary Keynesian fiscal policy can actually work. The evidence suggests otherwise. Greece's massive debt has produced a GDP growth rate of -2%. Spain, Portugal and France are not doing well either. The US is in a unique position - China's refusal to revalue the yuan has, in part, fuelled the massive trade imbalance with the US. Only the US has enough outstanding sovereign debt for the Chinese to purchase. US fiscal policy is being funded by China.

The recent bailout of the banks creates a moral hazard problem. Governments around the world know that they can continue to borrow and the big banks will continue to lend to them because the big governments will continue to bail out the banks. What incentive then, do the PIIGS have to control their deficits?

Today's 10-year bond yields tell the story:

Greece down 467 basis points (one basis point is 1/100 of 1%)
Italy down 30 basis points
Spain down 51 basis points
Mexico down 16 basis points
Germany up 16 basis points
Switzerland up 8 basis points
UK up 9 basis points
US up 13 basis points
Canada up 7 basis points

You get the point. You have just witnessed a massive wealth transfer from taxpayers in responsible countries to taxpayers in irresponsible countries.

Don't say you weren't forwarned.