Editor's note: David
Frum is a contributing editor at Newsweek and The Daily Beast and a CNN
contributor. He is the author of seven books, including a new novel, "Patriots."
(CNN) -- The European financial crisis is poorly understood in the United States.
Because so many Americans misunderstand the crisis, they fail to appreciate how -- and how much -- the crisis threatens them.
Americans tend to think
(and are encouraged by politicians to think) of the European crisis as a
debt crisis. Governments overspent, got into debt, and now the day of
reckoning is at hand.
David Frum
Yet that version of the
case is demonstrably untrue. Spain's debt-to-GDP ratio is substantially
lower than that of the United States. Germany's debt-to-GDP ratio is
neck and neck with the United States. Yet it is Spain, not Germany, that
is in trouble.
Europe is not having a
debt crisis. It is having a currency crisis. It's not that European
countries have bumped up against their ability to borrow. The problem is
that some European countries are bumping up against their ability to borrow in euros. That limit is imposed not by markets, but by the European Central Bank.
Nobody doubts that the
U.S. can generate dollars to pay its bills. Nobody doubts that Japan can
generate yen, or that Britain can generate pounds sterling. But they do
doubt that Spain or Italy can generate the euros they need, because --
unlike the U.S. or Japan or Britain -- Spain and Italy lack the power to
create their own money. Maybe not Greece, which is a special case, but
the other troubled countries could recover their borrowing ability
tomorrow if they quit the euro and resumed their former national
currencies.
Americans need to understand this truth, because otherwise they will be blindsided by the real risks out there.
The hard-pressed
countries of the eurozone have an escape hatch: They can quit the euro
currency. Quitting the euro would not be pain-free -- but it might well
become a less painful alternative to what those countries are suffering
now: Great Depression levels of unemployment, rising taxes, massive
social security cutbacks. Over the past two years, for example, Portugal
has cut government spending by almost 8 points of GDP. To achieve the
same scale of cut in the United States, we'd have to abolish both Social
Security and Medicare.
The sacrifices countries
make to stay inside the eurozone fall mostly on their own people. But if
they quit, the pain is exported -- and will be heading our way.
Consider for example a working Spaniard, earning, say, 40,000 euros a year and holding a 2,000 euro balance on his credit card.
Spain quits the euro.
The Spaniard's salary is converted from 40,000 euros to 40,000 new
pesetas. Quickly, the new peseta loses value against the euro. A month
after the conversion date, the Spaniard's 40,000 new pesetas are worth
only 20,000 euros.
He is poorer than he
was. But at least he's working. At Spain's new lower wages, other
Spaniards quickly find work too, just as Americans rapidly went to work
when the U.S. quit the gold standard in 1934. Imported goods become more
expensive. But not rents -- they are denominated in new pesetas too.
When our Spaniard buys his morning cup of coffee, the beans will be more
expensive and the sugar too. The wages of the barista who makes the
coffee, however, will have declined in tandem with his own. Ditto the
mortgage on the coffee shop. And those nontraded inputs account for most
of the cost of the cup.
Now look at the other
side of the ledger, the Spaniard's debt. What happens to that 2,000
balance on his credit card? It is (presumably) also redenominated into
new pesetas. It also falls in value, to just 1,000 euros. Good news for
the Spaniard. Bad news for the credit card company.
Or is it?
In the 2000s, Spanish banks emulated U.S. banks in the aggressive use of securitization. As of 2010, the
European Central Bank reports,
Spanish banks had issued more asset-backed securities than the banks of
any other European country except the Netherlands -- and vastly more
than the banks of France and Germany
combined.
Which means that our
Spaniard's credit-card debt is probably not owed to the company that
issued his credit card. That debt is owed to some other financial
institution, somewhere else on earth. Where? Who knows?
Even the people who own
the debt may not know. As we learned during the subprime mortgage crash,
bad loans get sliced and diced, recombined and repackaged, into bonds
whose contents are not always understood by the pension funds and
insurance companies that buy them. Those bond buyers often only
discovered that they had bought bonds based on subprime mortgages after the mortgages failed.
Financial institutions
that have bought Spanish credit-card debt (or Spanish mortgages or
whatever) may discover equally shockingly late that their bonds also
will not and cannot pay off in full.
Think of those
potentially redenominated Spanish bonds as toxic admixtures into bond
portfolios all over the planet -- including possibly the bond portfolio
that supports your pension or your life insurance claim.
And then understand why
all this talk of "We could be like Greece" so radically misses the
point. We're in the same boat already with the Spaniards and the
Italians and, to a much lesser degree, the Greeks -- and not because of
the way the U.S. government taxes and spends, but because of the way
world financial institutions borrow and lend.
The opinions expressed in this commentary are solely those of David Frum.
Universal Pictures has already acquired the film rights to the trilogy
