Understanding This Leg of the Eurozone Crisis

Earlier this week, we got a reminder that the European Debt Crisis has not, in fact, been resolved. It amazes me that market participants can be so easily lulled by new rounds of easy money from central bankers that do nothing but buy time. The ECBs LTRO operations launched in December injected €1 trillion into the banking system, yet here we are less than 5 months later and we’re on the verge of plunging headfirst back into trouble. That should indicate the severity of the problem, and the futility of the ‘ECB must do more’ approach. Increased liquidity, lower rates, more QE and so on cannot fix a solvency crisis. It can only kick the can further down the road. At some stage, it must be picked up, and it would be better if it is done so without destroying the currency in the process.

The Strain in Spain

The problems Spain faces are well documented. Like most of the West, it was thrust headlong into a credit fueled boom in the better part of the last decade that ended abruptly in 2008. It had a massive housing boom that was proportionally larger than the one in the US and far more ingrained in the Spanish economy. It’s bursting led to a sharp decline in housing prices, but not sharp enough to return to pre-crisis price/wage ratios according to this research presentation. This, in turn put a massive strain on the banking sector in Spain, and the Spanish government upped its efforts to backstop the banking system.

The net result of this has been an increase in Spanish sovereign debt in order to support zombie banks in their endeavors to prevent the recognition of losses and their subsequent failures. It is no different to the situations in much of the Western world regarding its banking systems. Japan and the US both intervened in the 1990s and in 2008 respectively to keep institutions afloat that would have failed. The difference is that Spain is under pressure from the bond market, with its funding costs rising to levels that would prove impossible to sustain without external support.

Misdiagnosis?

So what should be done to resolve the issues facing Spain and the rest of the Eurozone? Matt O’Brien, in his latest column at The Atlantic, basically summarizes the mainstream view on what should be done – Germany should prop up the Southern states. But before that, he says that Germany has misdiagnosed the crisis in the first place.

The Germans have latched onto a misdiagnosis of the crisis. They think it’s a morality tale about profligate governments finally having to live within their means. It’s not. If it were, Spain wouldn’t be in trouble now. They actually ran budget surpluses during the boom years. (Germany was the one that broke the Maastricht Treaty’s deficit limits). What’s really going on is a balance-of-payments crisis. Capital gushed into Southern Europe during the bubble years. Then it stopped. Austerity won’t solve this.

The point about Spain running surpluses before the crisis is my focus here. Yes, Spain ran surpluses before the crisis. But once the crisis arose, they went into deficit to prop up their banking system. This fundamentally changed the quality of their sovereign debt. Paul Krugman made the same point in a column last month:

Spain had low government debt and a budget surplus on the eve of the crisis; it’s in trouble thanks to private-sector, not public-sector, excess.

The Spanish government wasn’t forced to backstop a banking system that got out of control. It could have allowed bad actors to acknowledge their losses, face bankruptcy and restructure debts. It could have allowed that creative destruction to create an environment in which capital could be allocated to profitable firms based on a sustainable price level, thus unconstrained by a housing situation that currently weighs down on the Spanish economy like an albatross. Instead, capital is diverted to the zombie firms the Spanish government now supports. A foundation for sustainable long term growth could have taken place in the end, albeit after a painful restructuring phase. That it chose to stand behind insolvent banks and their excesses, preventing the restructuring, rendered the obligations they took on to do so equally excessive. This absolutely is a case of a profligate government having to face the music. That it spent recklessly on backstopping its banking system instead of excessive social benefits like Greece did is of little consequence.

Returning to O’Brien’s solution; he states that Germany should:

…promise stimulus for southern Europe, conditional on those governments carrying out fiscal and structural reforms. That could mean Eurobonds to counteract local austerity. It could mean letting the ECB be much more aggressive — perhaps by putting a ceiling on borrowing costs for southern Europe. It doesn’t really matter how Germany does it. It just needs to do something. Eventually you need to stop kicking the can down the road, and actually pick it up.

In other words, the prescription is a heavy dose of inflation. Or, Germany taking on more debt to back Southern Europe, which ultimately is an international version of what was just discussed above. As Spain got itself into a debt crisis backing its insolvent banks, Germany will ultimately get itself into a debt crisis of its own by backing Southern Europe. It’s more likely that if anything is done, the inflation route will be the bulk of the response. Even if for some strange reason Germany goes all in and takes on debt, when it comes time for the Germans to deal with its debt, the likely suggestion will be to print it all away. Thus, printing is really the only ‘solution’ suggested by O’Brien, with the question being when it will happen.

Regardless, the implication that the Germans acting is them finally picking up the proverbial can is utterly ridiculous. The phrase ‘kicking the can’ refers to the continued efforts by sovereigns to postpone reducing unsustainable debt levels, across all sectors of the economy. Should the Germans and ECB ‘do something,’ they will continue to postpone the reduction these debt levels, and even increase them, thus continuing to kick the can down the road.

In reality, both the inflation method O’Brien and Krugman advocate, and the Austerity method they both rail against essentially achieve the same thing: the preservation of existing debt loads. Austerity seeks to maintain debt loads by saddling the burden of the debt upon the average individual in an explicit manner, via taxes and cutting deficit spending. The inflation method seeks to maintain debt loads by burdening the average individual implicitly, through devaluing the currency and robbing the average of their purchasing power. The end result is the same: the average individual ends up footing the bill for the excesses taken on in government. Both methods result in minimal to negative real growth, social unrest and high unemployment. The only real solution has been, and will continue to be through nominal defaults by troubled nations and a remaining in the Eurozone. Debts must be written down or forgiven, prices must be allowed to fall and the chips must be allowed to fall where they may. The consequences will be difficult, but they will be swift, and they will give the generation of youth plagued by high unemployment an opportunity to gain meaningful employment once the price level drops. The alternative, inflating the woes away will lead to the destruction of the currency. As I stated at the beginning of this piece €1 trillion of new funds only bought the market 4.5 months of calm. For the ECB to print enough to buy more temporary calm will require much, much more easing, and ultimately when prices rise and growth subsides, a severe problem will await.

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16 comments

  1. You write, the only real solution has been, and will continue to be through nominal defaults by troubled nations and a remaining in the Eurozone. Debts must be written down or forgiven, prices must be allowed to fall and the chips must be allowed to fall where they may.

    I agree that the likely outcome will be a ongoing Euro Union. If debts are written down or forgiven, then I see banks and nations being integrated into a Euro zone Federal Monetary and Fiscal Union.

    But I do not see debts being written down and forgiven; rather I see debts being applied to every man, woman and child in the EU as leaders meet in summits and waive national sovereignty, and pool sovereignty regionally. Through leaders framework agreements, banks and countries will be uninted into a EU Federal Union with the ECB empowered as a bank and both a monetary pope and a budget commissioner appointed with broad powers.

    The degree to which Europe shares have now fallen suggests that Europe is characterized by sovereign insolvency and banking insolvency. The peripheral nations are insolvent sovereigns and have insolvent banks are entirely dependent upon the ECB. The ECB, through its LTRO and debt purchases has become both the monetary and fiscal backbone of a Federal Europe. Furthermore, the ECB’s policies have effectively chartered it as the Euro zones bank.

    Insolvent sovereigns and their insolvent banks, cannot govern; the EU has new government, that being regional global governance. And it will increase in greater authority as leaders meet in future summits and waive national sovereignty to pool sovereignty and announce regional framework agreements providing for new monetary authority consisting of monetary cardinals, under a monetary pope, overseeing public private partnerships for management of regional resources, production and labor; and also providing a fiscal commissioner, overseeing austerity measures and structural reforms, such as abolishment of national wage contracts and constitutional right to work in state employment.

    The global investment tectonic plates have shifted, and an authoritarian tsunami is on the way. Investment capital that has governed capitalism is failing as the dynamos of growth and profit are winding down on the exhaustion of the world central banks’ monetary authority. Political capital is rising to govern regional global governance as the dynamos of regional security, stability and security are winding up, as investors derisk out of stocks and delever out of commodities.

    There has been no genuine independent buying of peripheral nation treasury debt for a long time. There is no real market place for sovereign debt of the PIGS. The sole buyer of the peripheral nation Treasury debt has been the ECB. This makes the ECB both the Sovereign, the ruler, of the PIGS, and their Seignior, the top dog banker who takes a cut for the issuance of money. The ECB, not the independent world government bond market place, is underwriting the continued operation of the peripheral nations and providing for their fiscal spending.

    The PIGS have lost their debt sovereignty, and as such they are now longer sovereign nation states. The PIGS exist as client states of a Federal Union, and in as much as they affirm the debt brakes of the recent Leaders fiscal compact, they are part of a defacto Fiscal Union. The EU ECB and IMF Troika are now the sovereign authority in Europe replacing sovereign nation states.

    Creative destruction coming from the first and second Greek bailouts has established a region of global governance as called for by the 300 elite of the Club of Rome, who envisioned a ten toed kingdom of regional government, as they met and wrote in various papers during 1972 to 1974. Those living in the peripheral nations are no longer residents of sovereign nation states, but rather residents living in a region of global governance.

    The age of speculative investing is over and the age of diktat is commencing. The fiat money system is crumbling and the diktat money system is coalescing. Fiat money is being replace by diktat which will soon serve as both credit and money. Monetary cardinals will provide directives as credit; and budget commissioners will provide austerity measures as money.

    The PIGS are not fiscally viable countries. Their fiscal viability rests solely with the ECB and upon the Leaders mandate of austerity measures imposed via the Leaders fiscal compact with its balanced budget agreements to be enacted in each state. Fiscal capability, fiscal resource, and fiscal spending comes from the authority of EU ECB and IMF Troika, as well as the Leaders’ Fiscal Compact.

    New sovereigns are coming to rule the new age. Fate, not any human action, Revelation 6:1-2, and Revelation 2:26-27, is passing the baton of sovereignty from formerly sovereign nation states to these two new sovereign authorities. The EU ECB IMF Troika and the Leader’s Fiscal Compact now govern Euroland. The Milton Friedman script of choice for the age of Neoliberalism is history; and the Herman van Rompuy and Angela Merkel script of diktat for the age of Neoauthoritarianism is coming. Europe will be characterized as a gulag of debt servitude, statism, and totalitarian collectivism.

    Out of soon coming Financial Armageddon, that is a credit bust and a global financial breakdown, Germany will arise to be preeminent in the EU, and will rule as a type of revived Roman empire. David C Park Publisher of The Real Truth asks, Will Europe’s Economy Collapse? And provides biblical answers which relate that by God’s authority, from the ashes of Europe’s financial collapse, a Beast power as foretold in Revelation 13, will with seven heads and ten horns to rule Europe and eventually mankind.

    Such change in governance is significant as it is part of a larger picture prophesied long ago in Daniel 2:31-33, where it was foretold that the UK and US hegemony, that has ruled the world as two iron legs would give way, and fall into ten toes of iron and clay, where iron is symbolic of diktat and clay of democracy. This unstable mixture will also one day give way, and a terrible one world government.

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