Debunking Two Myths About the EU Bailout

U.S. Capitol
U.S. Capitol

A number of myths are emerging about the European Union's sovereign debt stabilization package. During a TV appearance Monday morning to discuss the EU's program, I was sandwiched between people promoting two interpretations that are becoming widespread: The first is that the U.S. taxpayer are putting unlimited dollars into bailing out Europe; the second is that the Fed's loose money will produce out-of-control inflation.

Before getting into the little details of these myths, let's look at the EU's $957 billion bailout plan. According to The New York Times, the money will come from three sources: $560 billion in potential loans, made as needed, through so-called Special Purpose Entities, $321 billion in potential loans from the International Monetary Fund, and $76 billion under an existing lending program.

Like the U.S. financial bailout, very little of this deal involves near-term, certain cash outlays. Simply put, only 8% of the EU bailout involves actual cash loans. The remaining 92% comes in the form of potential loans. The U.S. bailout totaled a whopping $23.7 trillion in various forms of cash and loan guarantees. But its actual cash cost to taxpayers and the government is now estimated at $87 billion -- or 0.4% of the total.

The anchor who introduced me Monday repeated a few times that the EU's $1 trillion financing package was a bailout funded by unlimited quantities of U.S. tax dollars. For those in the audience who are interested in reality, it is worth pointing out that this television personality was referring to a so-called Fed swap line. And if that Fed swap line puts unlimited U.S. funds at risk to bail out Europe, I will gladly follow Sam Walton's example and dance the Hula on Wall Street in a grass skirt.

Unlimited Risk to the U.S. Taxpayer? Actually, Almost No Risk at All

Why am I so confident about this? According to Real Time Economics, a Fed swap line is a loan to a foreign central bank in which the Fed exchanges dollars for the foreign currency. Such loans are made at the market exchange rate, and the foreign bank agrees to repay the Fed at the exchange rate from the day the Fed loaned out the money. Therefore, the Fed takes on no risk from currency fluctuations, and it receives interest on the loan. Rather than putting unlimited American tax dollars at risk, a swap line makes a profit for the Fed with virtually no risk.

The second myth, in this case delivered by U.S. Rep. Ron Paul (R-Texas), who appeared on the program just before me, was that this Fed swap line would contribute to out-of-control inflation. There are two flaws with this theory. First, despite the Fed and the government flooding the market with cash since the financial crisis began, inflation has remained very low, at around 2%. Second, a quick look at the history of the Fed funds rate reveals that the Fed raises interest rates when it sees a risk of inflation (1981 was a case in point). If inflation becomes a threat again, the Fed will once again intervene.

So despite the efforts of a well-financed media network to convince you otherwise, the U.S. is not putting unlimited amounts of tax dollars at risk to bail out the EU; nor is inflation likely to careen out of control.

To quote the great Simon Cowell: "Sorry."