The European Central Bank will become insolvent

Most people are unable or unwilling to imagine what is coming in Euro land. Despite all efforts, a scenario similar to the following will unfold. It will trigger a domino effect which will eventually destroy the Euro.
We are headed for a similar fate as a result of our profligacy. Our debt cannot be paid off. It is too large. Eventually defaults will come. The form they take are as yet unknown. Four possibilities seem most likely:

1. defaults on social programs (think much of welfare plus social security and medicare)
2. outright defaults on Treasury debt (less likely and not enough to solve our problem)
3. devaluation of sorts (more likely than either of the first two in my opinion).
4. a Greece-like ending

The first two are self-explanatory. The third one is less so. A devaluation could play out in numerous ways. The simplest is the replacement of the dollar with a new currency, say the “NewDollar.” This could presumably be done under some invented rationale (an emergency, foreign counterfeiters, who knows what “crisis” could be dreamed up?) that would be used to  issue a new currency. Issuing 2 NewDollars for one old dollar and then making it illegal to use old dollars would be the equivalent of a 50% devaluation if existing contracts could be honored in NewDollars. Obviously matters are not quite as simple, but this approach would instantly halve the debt burden of the country and its citizens, drive up asset prices, etc.

The final option is a Greece-like ending. To understand the implications of such an event,  the following article from The Telegraph may be useful. Some of the same events are likely here. Note that this ending always defaults to item 3 above.

What happens when Greece defaults

It is when, not if. Financial markets merely aren’t sure whether it’ll be tomorrow, a month’s time, a year’s time, or two years’ time (it won’t be longer than that). Given that the ECB has played the “final card” it employed to force a bailout upon the Irish – threatening to bankrupt the country’s banking sector – presumably we will now see either another Greek bailout or default within days.
What happens when Greece defaults. Here are a few things:
- Every bank in Greece will instantly go insolvent.
- The Greek government will nationalise every bank in Greece.
- The Greek government will forbid withdrawals from Greek banks.
- To prevent Greek depositors from rioting on the streets, Argentina-2002-style (when the Argentinian president had to flee by helicopter from the roof of the presidential palace to evade a mob of such depositors), the Greek government will declare a curfew, perhaps even general martial law.
- Greece will redenominate all its debts into “New Drachmas” or whatever it calls the new currency (this is a classic ploy of countries defaulting)
- The New Drachma will devalue by some 30-70 per cent (probably around 50 per cent, though perhaps more), effectively defaulting 0n 50 per cent or more of all Greek euro-denominated debts.
- The Irish will, within a few days, walk away from the debts of its banking system.
- The Portuguese government will wait to see whether there is chaos in Greece before deciding whether to default in turn.
- A number of French and German banks will make sufficient losses that they no longer meet regulatory capital adequacy requirements.
- The European Central Bank will become insolvent, given its very high exposure to Greek government debt, and to Greek banking sector and Irish banking sector debt.
- The French and German governments will meet to decide whether (a) to recapitalise the ECB, or (b) to allow the ECB to print money to restore its solvency. (Because the ECB has relatively little foreign currency-denominated exposure, it could in principle print its way out, but this is forbidden by its founding charter.  On the other hand, the EU Treaty explicitly, and in terms, forbids the form of bailouts used for Greece, Portugal and Ireland, but a little thing like their being blatantly illegal hasn’t prevented that from happening, so it’s not intrinsically obvious that its being illegal for the ECB to print its way out will prove much of a hurdle.)
- They will recapitalise, and recapitalise their own banks, but declare an end to all bailouts.
- There will be carnage in the market for Spanish banking sector bonds, as bondholders anticipate imposed debt-equity swaps.
- This assumption will prove justified, as the Spaniards choose to over-ride the structure of current bond contracts in the Spanish banking sector, recapitalising a number of banks via debt-equity swaps.
- Bondholders will take the Spanish Banking Sector to the European Court of Human Rights (and probably other courts, also), claiming violations of property rights. These cases won’t be heard for years. By the time they are finally heard, no-one will care.
- Attention will turn to the British banks. Then we shall see…

(H/T to reader John Roll for referring the article.)
At this point, there is no conventional way out of the mess. Options were possible years ago, perhaps as late as 2000. Now, I fear, we are faced with one of the above alternatives, all of which represent defaults.