Summary: Europe nears the brink, with the potential for a severe crisis if its leaders cannot agree on a solution before the G-20 meeting in Cannes on November 3-5. The clock ticks towards some eventual but unknown deadline. Here we examine the situation, and seek relevant historical analogies.
“Le pier nest jamais certain.”
— The worst is never certain (French proverb)
Contents
- Summary of the situation
- Bulletins from the front
- Is this like July 1914?
- Grim analysis from well-wired economists
- For more information
(1) The current situation
Europe’s leaders remain obsessed with preserving the bankers, not just the banks (the latter is essential for the national economy, the last is essential because they are the masters). Investors (the class owning everything, with the bankers the center of their universe) are euphoric about an imminent deal to recapitalize the banks (ie., a massive transfer of risk and wealth from the taxpayers) — and perhaps even a pre-packaged default for Greece.
We have seen these rumors before, repeated this year (see this post for one example). These widespread rumors (even I’ve heard them; like urban legends, always from a friend of an insider) suggest that someone is leaking highly confident information (which is what Central Bankers do as standard operating procedure, to influence markets and generate front-running profits for their bankers). These are trial balloons, representing surface ripples from deep efforts to arrange a deal.
Assessing the odds of an effective deal materializing lies beyond my pay grade. My knowledge of euro-politics is almost nil, but the political foundation for such a move at this time seems low. Loans and guarantees of loans to banks and Greece seem destined to eventually become (to a large extent) liabilities of the core EMU states. This is not small change, unlike the US S&L bailout to which is so often compared. The man in a Friedrichstraße cafe must know that by now, and (from what I can tell) does not want that — irrespective of his/her opinion about eventual unification (see below for more about this).
This all looks esp doomed by the Europe’s leaders (especially the Germans running the ECB) continued insistence on relatively tight monetary and fiscal policy (see austerity, under “failed policies” in the economists’ cookbook).
The need and desire for bold action is obvious, but that gap between that and reality seems to require literally a quantum leap. That is, an instantaneous shift from here to there.
Two weeks ago experts said that Europe’s leaders 12 months to resolve this crisis.. Now they speak of 180 days, or 60, or even 30 (see below for more about deadlines).
(2) Bulletins from the front
While great deeds are discussed, some reports say that Europe’s leaders still squabbling over how to spend the existing EFSF fund, as in this article from Handelsblatt (a business newspaper published in Dusseldorf; circulation 40% of the FT’s): “Berlin and Paris argue about EFSF“. I don’t know how accurate is this Google translation, but the gist is clear.
Between Germany and France, a debate has erupted over the extent to which the euro rescue fund EFSF may buy government bonds in the future. France wanted to make the EFSF respect no rules, told the Handelsblatt by a senior EU diplomat. This would theoretically mean that the EFSF could not use its entire volume of funding expended to buy bonds of a single Euro-state.
EFSF has a total of 440 billion euros. Part of it, however, has been scheduled for the loan packages to Ireland and Portugal. The federal government wants to limit the amount used for bond purchases {per euro government}, it said in Brussels. Think Germany will also want a time limit on bond purchases.
The purchase of government bonds is one of three new instruments of {the extended} EFSF. The design of these new instruments will be governed by guidelines {written by} high officials of the euro finance ministers now in Brussels. The guidelines must then be approved by the Budget Committee of the Bundestag. The German Parliament has made this a condition for agreeing to extended EFSF.
Why so much caution by German’s leaders? See the polls..
(a) This article in BusinessWeek nicely describing the situation in Germany. German leaders love the euro, and will support almost anything necessary to bailout the banks and Greeks. But:
“Seventy-five percent of Germans oppose expanding the EFSF, according to a FG Wahlen poll published Sept. 23. At the same time, 68% of respondents said a Greek default would harm the German economy. The Sept. 20-22 poll of 1,229 people for ZDF television has a margin of error of as many as three percentage points.”
(b) More evidence from Bloomberg on 18 September:
“A euro skeptic political party in Germany would find strong support among an electorate increasingly fed up with bailouts for free spending euro zone partners, according to a poll published on Sunday. Some 40% would consider voting for such a party, and 50% said they would welcome such a group on the political scene, according to a study by Emnid Institute, published in Bild am Sonntag newspaper. The poll canvassed 500 Germans.”
On the other hand, the rumor that Germany is secretly printing Deutsch Marks (preparing to leave the European Monetary Union) is an urban legend.
(3) Is this like July 1914?
Could something large and bad happen? We — leaders, investors, serious experts — tend to underestimate tail risks (in the “tail” of the probability curve) because it makes career sense to always bet against tail risks. These things happen only once a every generation or so.
In practice that makes us confident that our ramshackle global financial machinery will avoid a crash — because our leaders have managed (with spit and bailing wire) to hold it together through every previous crisis. The similarity between today and July 1914 is striking (substituting money for bullets).
Look at July 1914. In hindsight WWI was inevitable and obvious, the result of growing tensions in Europe. William Lind explains …
One pebble touched off an avalanche. It did so because it occurred, not as an isolated incident, but as one more in a series of crises that rocked Europe in its last ten years of peace, 1904-1914. Each of those crises had the potential to touch off a general European war, and each further de-stabilized the region, making the next incident all the more dangerous. 1905-06 witnessed the First Moroccan Crisis, when the German Foreign Office (whose motto, after Bismarck, might well be, “Clowns unto ages of ages”) compelled a very reluctant Kaiser Wilhelm II to land at Tangier as a challenge to France. 1908 brought the Bosnian Annexation Crisis, where Austria humiliated Russia and left her anxious for revenge. Then came the Second Moroccan Crisis of 1911, the Tripolitan War of 1911-1912 (a war Italy actually won, against the tottering Ottoman Empire) and the Balkan Wars of 1912-13.
By 1914, it had become a question more of which crisis would finally set all Europe ablaze than of whether peace would endure. This was true despite the fact that, in the abstract, no major European state wanted war.
But this was not obvious to people at that time! Harvard historian Niall Ferguson looks at the prices of UK bonds (gilts). These show complacency right up the brink. City investors read of the mobilization orders, panicked, and the markets imploded. Of course, we are much smarter than they. We would know if the world was on the brink of a crisis. For more about this, please read “Political risk and the international bond market between the 1848 revolution and the outbreak of the First World War“, Economic History Review, February 2006.
If Europe crashes and burns (economically, not physically), future experts will see it as inevitable.
(4) Grim analysis from well-wired economists
(a) (update) Dr. Robert Shapiro, an advisor to the International Monetary Fund (bio here), speaking on the BBC’s Newsnight, 5 October 2011:
“If they can not address this [the financial crisis] in a credible way I believe within perhaps 2 to 3 weeks we will have a meltdown in sovereign debt which will produce a meltdown across the European banking system. We are not just talking about a relatively small Belgian bank, we are talking about the largest banks in the world, the largest banks in Germany, the largest banks in France, that will spread to the United Kingdom … it will spread everywhere because the global financial system is so interconnected. All these banks are counterparties to every significant bank in the United States, and in Britain, and in Japan, and around the world. This would be a crisis that would be in my view more serious than the crisis in 2008.”
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(b) Worthwhile reading by Dr. Philippa Malmgren (bio here) posted at her website
News to expect in the coming days and weeks:
- Greece defaults
- Germany protects German banks but other countries cannot do the same thus quickly provoking multiple sovereign defaults and or bank failures, all of which may easily lead to a payments crisis in the global banking system. Derivatives are particularly at risk in terms of operation and execution.
- The Euro falls in value especially against the US dollar
- The Germans announce they are re-introducing the Deutschmark. They have already ordered the new currency and asked that the printers hurry up.
- The Euro falls even more on any news that Germany is withdrawing from the Euro.
- Legal wrangling begins as to the legality of Germany’s decision. Resolution takes years.
- Germany insists that the Euro continues to exist even they do not use it any longer. They emphasize that European unification will continue and suggest new legal instruments to strengthen European Unification including new EU Treaties.
(5) For more information
Other articles about Europe on the FM website:
- The post-WWII geopolitical regime is dying. Chapter One , 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
- Can the European Monetary Union survive the next recession?, 11 July 2008
- The periphery of Europe – a flashpoint to the global economy, 8 February 2010
- A great speech by the PM of Greece. How soon until an American President says similar words?, 3 March 2010
- Governments cannot go bankrupt, 2 April 2010
- Our government’s finances are broken. How do we compare with our peers?, 8 April 2010
- The EU does Kabuki for Greece. Is it the next domino to fall?, 14 April 2010
- About the Euro crisis: the experts are wrong; the German people are right., 7 May 2010
- Former Central Bank Head Karl Otto Pöhl says bailout plan is all about ‘rescuing banks and rich Greeks’, 20 May 2010
- The Fate of Europe, nearing the point of decision, 13 September 2011
- Europe drifts towards the brink of a cataclysm, 26 September 2011
- Delusions about easy fixes for Europe, dreaming during the calm before the storm, 30 September 2011
It’s the economy!
As William Mitchell explains: “…the public conversation is mired in misinformation, paralyzing policy-makers, while the public interest is being sacrificed and a lost generation of unemployed is emerging.”
Yet, our policy makers continue to pursue either no policy or the wrong ones. As Mitchell continues, “Neoliberal economists and their supporters failed to predict the recent crisis and offered no effective solution once it arose. Organizations such as the IMF and the OECD advocated policies that contributed to the crisis.”
Here is the full article: “Beyond Austerity“, William Mitchell, The Nation, 16 March 2011.
For a more in-depth view, with very specific policy recommendations on deficit spending as a cure, look here at James Galbraith’s “Maastricht 2042 and the Fate of Europe – Toward Convergence and Full Employment“, by James K. Galbraith, University of Texas Inequality Project, 22 September 2006.
Thanks for posting links to these two excellent articles!
“our policy makers continue to pursue either no policy or the wrong ones”
Absurd. Our policy makers consistently pursue a coherent set of policies, with determination and boldness. And certainly not the “wrong ones”. Few people stupid or lazy people achieve high political rank in western nations.
It’s a matter of cui bono? Who benefits? They implement policies that benefit the great powers in their nations. That may not suit you or I, but then shepherds do not consult the sheep. If you don’t like that, then work so that we’re no longer sheep. Whining about the outcomes changes nothing. Saying our leaders are stupid is delusional, which changes nothing.
It’s totally incorrect to say “EFSF has a total of 440 billion euros”. It has very much less than that to hand, because it operates by borrowing money from global investors and lending it on to distressed eurozone states. And those global investors are beginning to lose confidence in the bonds issued by EFSF, as reported here: “Investors Losing Money on Sovereign Bailout Bonds: Euro Credit“, Bloomberg, 6 October 2011:
As predicted here last week: “M&G’s Riddell: Ten reasons why the EFSF is not the Holy Grail“, Investment Week, 28 September 2011
There are multiple levels of misinformation here.
(1) “M&G’s Riddell: Ten reasons why the EFSF is not the Holy Grail”
The dumbest headline I’ve read this week. A bizarre strawman. Nobody thinks the EFSF (esp the current version, EFSF 2.0) is a panacea — let alone the “holy grail.” It buys time for Europe’s leaders to craft a larger solution. That’s no small thing, as time is the essential element of crisis management.
(2) Investors lost money on the the first tranche of bonds
Investors have lost money at various points during the last year on all sorts of bonds. California bonds, Italian government bonds, etc. All of those entities can still sell bonds, as can the EFSF. Perhaps they must pay higher rates, but that’s a cost of doing business.
(3) “It’s totally incorrect to say ‘EFSF has a total of 440 billion euros’”
That was a Google translation from the German, giving the gist of the story. Don’t obsess over technical details beyond the ability of automated software to get right (and the story itself might have glossed over this; journalists are sloppy).
The EFSF has an issuing authority of 440B euros. It’s not cash until they issue the bonds. Nothing in these articles suggests that the EFSF will not be able to raise the funds.
“US Bank Exposure To Euro Crisis May Total $640B“, Dow Jones, 7 October 2011 — Opening:
Germany is not the only player in this game with options. If pushed to hard (and they may have already been pushed too hard), Greece can also exit the game. See “How Greece could escape the Euro“, New York Times, 6 October 2011
It seems increasingly likely that the Euro is done for with Germany pulling out. Wonder if and when other countries will decide the same?
In this series of posts I have attempted to explain at (some length) that such forecasts are bold — but beyond the evidence. There are many possible scenarios. The big three, which might start tomorrow — or in 6 months (perhaps even longer):
Greece might leave (perhaps with others)
Any of these might occur in an orderly fashion. Or, IMO more likely, amidst turmoil.
None of these paths look simple or easy. All look painful, with large risks of failure. Some other factors to consider:
(1) About Germany leaving the EMU: The governing coalition includes the euro-skeptics (esp the FDP). If that falls, the opposition coalition (led by the SPD) is the pro-EU party.
(2) The Masastricht Treaty (1992) does not include provisions for a State to leave the EMU (nor does the US Constiution). That does not make it impossible, but suggests that the process might be complex, chaotic, and painful (see 1861 – 1865).
(3) The steps to unification would be no cakewalk. For example, Greece might get massive aid in exchange for loss of sovereignty — somewhat like the partial takeover of NYC by New York State (1975-2008).
Excerpt from Reuters, 9 October 2011:
Sarkozy opines: “…he added, saying it was too early to enter into details.” By which he means the Crisis is not fully ripe and when it is, the Details will be as always! On the backs of the stupid, the Citizens will once again pay for the profligacy of the Bankers and their fellow travelers.
“Stop us if you think you can afford it!”
We shall see who has the most to lose. Fascinating denouements up ahead. Will they leave enouigh on the table?
It’s easy to mock them, but that’s more heat than light. Sarkozy and Merkel are leaders of republics, not monarchs. Forging a political resolution of this would tax Solomon’s wisdom — a gift from God (1Kings 3-7), a boon the rest of us lack.
My guess: only a crisis will provide the consensus necessary for a full resolution of Europe’s economic dilemma. That implies that the resolution will occur during a crisis, which makes devising and implementing solutions possible but difficult and painful. Perhaps it will like birth, the start of a new and better Europe.
Some good questions raised, but I don’t think that the analogy with 1914 works well here, for the simple reason that the economic crisis since 2007 (and that includes the Euro crisis itself) is rooted in contagious policy blunders of the United States more than in Europe per se. Furthermore there’s massive, crucial difference in the geopolitical power balance compared to 1914, which makes it all but inevitable (however painful it might be) that Europe has to coordinate its economies. The Euro happens to be the first major stab at that, but even in the event of worst-case scenarios, it won’t change the overall direction. Specifically:
1. The global economic crisis that began in 2007 is a consequence fundamentally of policy failures. that began in the United States (and Britain to a lesser extent), then spilled into Europe, i.e. the reverse of 1914. Going against the intelligent, smartly-regulated, and well-balanced economy that it had in earlier decades, the USA instead began tossing out its sources of real wealth (outsourcing its manufacturing and tech industries), and replaced them with debt-driven bubble industries like financial services, housing and derivatives on student debt. The middle and working classes (the bulk of the US population and its consumer economy) were deprived of solid jobs that could produce wealth, and stupidly encouraged to load up on debt instead. When this bubble predictably burst, it took the unsustainable US economy with it, and then a chunk of the world economy (which had inevitably been selling into the US and British bubble economies). In contrast countries like the Netherlands, Germany and China kept their manufacturing and tech at home. Their economies of course have flagged somewhat due to their weakened customer bases in the US and elsewhere, but have held far steadier than ours have. So while Europe is suffering, it’s nowhere near the brink that it was in 1914, and Europe’s heartland is an island of stability. If anything, it’s the US that’s closer to the brink (maybe 1861 in our case as you suggested), which would if anything push Europe’s nations paradoxically closer together, as a hedge against a collapsing United States.
2. Europe’s crisis itself is also a direct consequence of the corrupt bubble-economy system championed by the Anglo-American financial interests and the crony capitalism that they broadly represent. It was Goldman-Sachs, an American investment bank, that allowed Greece to hide its debts and corruption in the form of derivatives and other off-balance approaches- similar to Enron (another US company). It was US-fueled property bubbles (also financed with derivatives) that collapsed in the UK and Ireland among other places, and a US-style unsustainable tax system that led to disaster in Ireland. While US banking interests didn’t always have salutary effects on Europe, the disaster of 1914 was largely of its own making, whereas even Europe’s crisis of recent years is fundamentally an American crisis at its core. And considering the amount of Greek, Irish and British debt to which American banks are exposed (again, the aforementioned derivatives), as well as the USA’s general reliance on financial services, it’s the US that’s also in the most danger from Europe’s crisis, in contrast to European core countries that have kept their manufacturing. Once again, this would if anything tend to push Europe’s economies closer together and in vitriolic opposition to the Anglo-American financial system which set this off (which is definitely a common theme throughout Europe’s angry electorates, and not only in Greece and Ireland themselves).
3. Europe tends to think longer-term than the US, and perhaps because of its history, be better able to ride out the storms. The data from Europe these days is mixed, some bad but some good. Germany’s unemployment continues to fall, it’s still growing at a decent clip, there’s still plenty of wealth generated there, same for Scandinavia, the Dutch and the French. There will probably be somewhat of a downturn given the weakness of the US economy, some short-term declines, but in the long term a much more workable economy in Europe than we have in the US.
4. US military spending (including on NATO) will inevitably plummet as the US heads off a fiscal cliff. Given the power vacuum, Europe is far more likely to prefer a flawed and imperfect stabilizing force (i.e. the EU and its common market) in the absence of the US presence.
5. China. That’s the big factor now that was not present in 1914. Europe’s fragmented statelets really have no choice but to unify and to pool together their resources, otherwise they’ll be utterly crushed by China’s superpower of manufacturing and export. Once again, it’s a delusion to think that the EU’s obvious flaws (and there are many) would push the countries away, since there’s really no realistic alternative. They may not like it, but there really is no other choice for the continent.
The upshot of all this is that the details may vary, and we may see some ups-and-downs. Greece may indeed be kicked out of the Eurozone and the EU altogether, as they’re clearly more of a developing country than a modern economy- their government was so corrupt that they were paying tax collectors not to collect taxes, allowing wealthy ship-owners to go without taxes at all, and other forms of corruption that you’d expect to see in a failed state like Pakistan more than in Europe. So Greece may have to be pushed out- it’s going to be ugly for them no matter how they do it, but their government and their elites need to learn a hard lesson, there’s no way around it. There may also be reforms to the currency regime (e.g. a two-track Euro, with some of the Mediterranean countries and Ireland on the slower track compared to the manufacturing centers to the north and east), and Germany imposing more of a Deutsch-mark like regime whether or not they go in and out of a “new Mark” itself.
But the thing is, the financial crisis if anything is pushing Europe closer together rather than apart, especially as the US dwindles as a world power and China applies more pressure. There’s inevitably going to be some trial and error, some fits and starts and failures in places. But Europe realistically has no viable alternative outside of more integration. It’s only the details that are uncertain about it.
Just to add- I wouldn’t be surprised if this also leads to some nationalization of the banks, given that the predatory form of capitalism that they espoused has clearly been an unmitigated failure. The banksters like Goldman-Sachs need to be put on a tight leash as it was before Glass-Steagall and other regs, or otherwise nationalized altogether.
Too Early to Sound the All Clear?, Tim Duy (Asst Prof Economics, U OR), 10 October 2011 — Excerpt:
And although there is optimism the European situation can be resolved in three weeks, they seem to be walking a very fine line between attempting to recapitalize the banking system without undermining sovereign debt ratings while maintaining what effectively amounts to a pegged exchange rate system that is fundamentally inconsistent with the economic needs of more than one nation. In addition, they have an odd situation where every nation needs to issue Euro-denominated debt, but no nation can actually print Euros as a backstop. It’s as if each nation issues only foreign-denominated debt, with ultimately no lender of last resort on a national level. Of course, the European Central Bank could fill this role, but will they?
My experience is that when a financial landscape is as ugly as we see here, there is no rescue plan. Things tend to get much worse before they get better. That seems to be what financial market are telling us.
A sign of rising social stress in Europe: “Left-wing terror group blow up railway line in EIGHTEENTH attack in three days“, Daily Mail, 13 October 2011
For more details see this AP story.