November 30, 2011

“Why are we having a depression, Daddy?”

It’s a clarifying exercise to try to explain complex issues to a 14-year-old. Like my daughter, for instance. If you can do it, you’re probably focused on what matters. If you can’t, you’re probably caught in the weeds.

It’s not easy to meet this test when it comes to the impending catastrophe in Europe. But let’s try.

Why do we have currencies, sweetheart? To make it easy to trade things. It’s better than saying, “I’ll fix your plumbing if you cook me some food.” That’s called “barter.” If we agree that coins, papers and computer entries have certain values, we can all produce and consume a lot more.

Europeans got together 12 years ago and decided they would benefit if they had one currency instead of a bunch of different ones. Trade would be easier. Their businesses could serve a bigger market with less risk and hassle. It’d be like the United States, which once had many currencies and now has just the dollar.

But there was a downside. When the countries had their own currencies, they could control their own money and interest rates. With a common currency, they had to create a shared central bank to do that. Countries thus lost the power to respond to economic problems at home by lowering interest rates or by cutting the value of their currency to make their goods cheaper for foreigners to buy.

Also, while the United States has one central government, the eurozone has 17. They run their budgets independently — that is, they control the taxes they raise and the money they spend on roads, health care and pensions for their people.

The pluses of having one currency seemed to outweigh the minuses so long as countries were responsible in managing their affairs. For a while that seemed to work.

But then deceptive politicians and greedy bankers created a fatal mess by borrowing too much money.

Politicians in places like Greece found they could stay in office by giving people public-sector jobs or by letting workers retire at 50 with hefty pensions, while not collecting enough taxes to pay for this. They spent lots more than they took in, borrowed the rest and lied about it. Government debt went through the roof without anyone knowing.

Meanwhile, Europe’s top bankers found they could get really rich if they ran their banks with as little “capital” as possible. That means that for every dollar they lent or bought in assets, they only put up a few pennies in hard cash themselves. The other 97 cents they borrowed. So if the value of the things they bought or the loans they made dropped even slightly, it would wipe out their investment, and the bank would go bust.

As it turns out, a lot of the money these banks lent went to governments like Greece’s. Europe’s banks got rules passed that said if they lent their money to supposedly risk-free governments, they could run the banks with two cents of capital instead of three. As a result they could pay themselves even more.

So you had way too much bank borrowing funding way too much government borrowing for a long time.

One day Greece had to admit it couldn’t pay back what it owed. This caused a crisis because the whole system runs on trust and confidence. Trust that governments will always repay what they borrow and confidence that bankers know what they are doing (or why would they be paid so much money to do it?).Greece’s admission scared everyone. Maybe lots of governments were lying and couldn’t repay. Maybe lots of bankers didn’t know what they were doing and the banks were all shaky.

When people get scared, they stop lending money that even responsible banks and governments rely on to fund their operations. This creates ripple effects. If governments can’t repay, the banks that lent them money might go bankrupt. And if they go bankrupt, other banks that deal with the bankrupt banks might lose their money, too. Since thousands of financial firms deal with each other, the whole system could implode.

By the end of 2011 people thought there was still a chance to avoid disaster. Germany was the one country with enough money and discipline to bail out all the other borrowers. And Germany had the clout to get the European Central Bank to print enough money to keep things going until all these debts could somehow be restructured.

But frugal Germans didn’t want to bail out reckless Greeks or Italians.

So: We’ve reached the precipice because political and banking elites found it useful to run up colossal debts and pretend it was all manageable. And once it became clear it wasn’t, it was too late and too complicated to get all these people and countries and cultures to agree on a less bad way to untangle the mess.

There’s more, but that’s basically why we may have a depression, sweetheart. And that’s why we put our money under the mattress when it looked like this might happen.

The moral of the story? When you’re an adult, never trust politicians and bankers who say they know what they’re doing, because they’re only looking out for themselves.

Matt Miller, a co-host of public radio’s “Left, Right & Center,” writes a weekly online column for The Post. His e-mail address is mattino2@gmail.com.