Thursday, March 24, 2011

Would You Lend $100,000?

Rumors are coming from overseas this afternoon that the Portugal bail out cost could reach $100 billion.

The European bail out system makes very little sense.  The bail out money comes from other countries and the IMF and only provides a temporary loan to push back default.


Imagine if your friend owed a total of $300,000 in credit card debt, made $2,000 per month at his job, and had monthly expenses of $5,000.

To cover the difference he borrows $3,000 every month in new credit card debt, plus he borrows the cost to pay the interest.

To help him out you tell him you will lend him $100,000, but he has to pay you interest on the loan.

Anyone who finished 7th grade math understands this is not an intelligent decision.  However, this is the structure used to bail out Greece, Ireland, and now Portugal.

These countries will never be able to pay back the orginal debt, nevermind the new "bail out" loans.

Your friend above should declare bankruptcy, wipe away his current debt, and start fresh.  It will take many years to rebuild his credit and his lifestyle will be severely impacted in the short term, but that is the only logical choice.

The EU has this option available (restructure the debt) plus one more.  The ace up the sleeve.

The European Central Bank can print money and buy government bonds.  This scenario is far easier in the short term because the restructuring comes in the form of lowering the value of the currency which simultaneously lowers the value of the debt.  It is a hidden default that shows up at the grocery store and gas station, not in the news.

The United States, which is also insolvent, has decided to pursue this option.  The man in charge calls it Quantitative Easing.  Investors call it rocket fuel for precious metals.

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