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Obama's collect call to Madrid

President Obama has his own problems controlling the U.S. budget deficit,
having recently farmed the issue out to a bipartisan commission. But that
didn't prevent him from calling Spain's prime minister, Jose Luis Rodriguez
Zapatero, the other day to kibitz about getting Spain's fiscal house in
order.

Specifically, the president "encouraged" (the White House's word) Zapatero
to follow through with an austerity
plan<http://www.eitb.com/news/politics/detail/419742/obama-praises-zapateros-courageous-measures-facing-crisis/>
much
tougher than any deficit reduction contemplated in the U.S., including a 5
percent cut in public servants' salaries and an end to cash benefits to
parents of newborn children. I'm sure Zapatero found the message especially
welcome coming from a U.S. leader who insulted him last February by
belatedly canceling a trip to the European Union summit in Spain and letting
Zapatero find out about it through the press.

But, from Obama's point of view, it was justified -- and necessary.
Justified, because much of the money the U.S. is borrowing these days goes
to underwrite the International Monetary Fund; and some of that money is
being funneled to the European mega-bailout of which Spain is a principal
beneficiary. So, via the IMF, the U.S. government has essentially co-signed
a piece of Spain's debt and has a right to make sure the Spanish get their
act together to pay it.

But the president's nudge to Zapatero was also necessary, because, even more
than Greece, Spain poses a menace to the stability of the U.S. economy. And
for that, of course, I blame the French.

Here's why.

Along with their German counterparts, French banks hold hundreds of billions
of euros worth of the public and private sector debt of the PIGS (Portugal,
Ireland, Greece and Spain). The French financial sector has more than $220
billion worth of exposure to Spain, according to the Bank for International
Settlements.

Losses on that would be a huge hit to French bank capital, which would be a
disaster for the U.S. because French banks happen to be the largest issuers
of commercial paper in U.S. money market funds -- to the tune of $219
billion, according to data provided to me by analysts at JPMorgan.

If the French banks take losses on Spain and Greece, then their paper gets
downgraded by ratings agencies, U.S. money market funds can't accept it any
more, and suddenly we could be right back in the scary situation we faced in
September 2008, with suddenly illiquid money market funds "breaking the
buck," and facing a run that would ruin the U.S. economy.

That's why Obama had to place his call to Zapatero, and why one of the key
pieces of the big Euro bailout was the Federal Reserve's offer to extend
dollar swaps to the European Central Bank. The French banks can now go to
the ECB for the U.S. currency they need to fund dollar-denominated business
activities, instead of recurring to the U.S. money markets.

Which brings us to Rep. Mike Pence (R-Ind.), who, along with several
colleagues from his party, has introduced a bill called European Bailout
Protection Act.<http://voices.washingtonpost.com/right-now/2010/05/republicans_introduce_legislat.html>The
election-year measure would prohibit any U.S. funds that have yet to be
drawn by the IMF from going to Europe until all the countries in the
Eurozone are in compliance with the EU's own debt-to-GDP ratio requirement.

Since that's an impossible goal, the bill would force the U.S. to abort the
IMF mission in Europe, providing Americans with great emotional
satisfaction, probably followed shortly thereafter by the aforementioned
economic meltdown.

Back in the real world, Obama's use of the IMF bailout as leverage to impose
austerity on Spain and the others would exact the requisite pound of flesh
with less risk of damage to ourselves. In this case, the hypocritical course
of action is the only responsible one.

--
Eric D. Schwerin
Rosemont Seneca Partners
(202) 333-1880
eschwerin@rosemontseneca.co