Cliff Diving

My understanding — or, more accurately, since I don't actually understand the subject or know what I'm talking about, my understanding of Paul Krugman's and Paul De Grauwe's et al.'s understanding, since those are the people I'm choosing to believe, even when I don't understand them — is that the most dangerous problem right now isn't Greece, and isn't banks' exposure to Grecian debt (though this is dangerous), but Italy. Or, not really Italy itself, since its economy isn't actually doing so poorly compared to similar countries, but the perception that its debt will become unsustainable because people will refuse to continue sustaining the debt. (Repeat for emphasis: the debt will become unsustainable because creditors will refuse to sustain it.) In other words, we'll have the equivalent of a bank run, but on a country rather than a bank, the run being in the form of investors selling off their Italian bonds. As with a bank run, the bank doesn't have to have any fundamental problems, and investors don't have to believe that the bank does have fundamental problems, all they have to believe is that other investors are about to start withdrawing their funds (in this instance, selling bonds). So the first investor will sell his or her bonds so as not to get caught broke if other people sell theirs first. And the run is on. And Italy, which right now is able to pay its interest, will then have enormous interest to pay.



There's a sure-fire way to prevent the run from happening: the European Central Bank declares that it will unconditionally back Italian bonds by offering to buy them if the interest rates get out of hand. (Interest rates on bonds go up when investors sell, right? As I said, this is not my subject.) And the ECB can do so because in effect it can print its own money or do something equivalent, and in the current situation, owing to principles of quantum mechanics some detailed macroeconomic stuff I won't go into but it concerns the zero lower bound, there's little risk of inflation if it does so. And if the ECB declares its willingness to buy the bonds it most likely won't have to anyway, because investors will lose their fear of a run and their incentive to sell out.

( But the European Central Bank won't do this )

( Occupy update )