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How Did Europe’s Debt Crisis Get So Bad?



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Over at AEI, economist John Makin has an interesting new piece on why things got so bad in Europe. He makes three main points:

  • The quickly worsening European debt crisis—preordained by a false belief that sovereign governments do not default—constitutes the biggest threat to the US economy and its financial system.
  • Europe is caught in a vicious cycle where an intensifying financial crisis slows growth and raises borrowing costs, exacerbating the crisis.
  • Europe has three ugly options: (1) borrow more money from outside; (2) have the European Central Bank (ECB) buy more government bonds; (3) allow the European Monetary Union to collapse. In the end, the ECB will probably be forced to triple its balance sheet.

I am particularly interested in the assumption that governments won’t or can’t default. The belief that “governments don’t go out of business” is one of the main arguments behind the idea that there isn’t a pension crisis in the states. It’s also behind the incredible denial of some analysts about the risk to taxpayers posed by defined-benefit pensions, and the fact that public pension plans use accounting gimmicks that could never fly in the private sector to mask their true costs.



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