Europe has a political crisis. The economics are just symptoms.

Summary: The Euro-crisis is at root a political one. Like all such, there are several levels to it.  All different.  Mostly invisible in the analysis featured by the general media, which prefer to describe this in bogus fashion as a morality play. The economics are exhaustively covered; here we glance at the politics of the crisis.


Here we speculate about 4 levels to the political crisis gripping Europe. None of these observations are new. Links to more information are at the end.

  1. Banks are the health of the State
  2. Unification is a political process not done by economic tinkering
  3. Austerity as a leash (or lash) to reform Europe (& America)
  4. Are Europe’s leaders insane, like their predecessors in WWI?


(1)  Banks are the health of the State

{Trantor’s} dependence upon the outer worlds for food made it increasingly vulnerable … and Imperial policy became little more than the protection of Trantor’s delicate jugular vein.
Foundation by Isaac Asimov

Europe’s banks are politically powerful. But more important, Europe’s debt-laden governments (including Germany) rely absolutely on a delicate financing mechanism to rollover their loans and fund each year’s deficits. Europe’s leaders will allow nothing to put this system at risk, and their banks lie at its center. Hence the odd response to the series of crises that began on 23 April 2010: small, incremental — doing nothing to address the underlying problems. But they gain time for banks to write-down the vulnerable loans (eg, to Greece) to minimize the inevitable shock of defaults — and time for Europe’s institutions to prepare for the larger crises to come.

This also accounts for the open-handed loans by the Bundesbank to Europe’s other central banks via the Target2 system (details at the University Osnabruck’s Euro Crisis Monitor.  These loans eventually might create massive losses to Germany, but today they provide essential stability by facilitating the slow-motion exodus of funds from the PIIGS’ banks.

Why have Europe’s leaders not addressed Europe’s deep structural problems?

(2)  Unification is a political process not done through economic tinkering


It’s a dream. Can they make it real?

Europe’s leaders have had 20+ conferences, small and large, each with its communique of decisions. Legions of economists have devised scores, hundreds, of simple plans to fix Europe. All futile.

Europe must move forward to unification or back to separate States.  While both elites and broad majorities favor unification, as yet there is no consensus on its form or nature. Who will drive the New Europe?  Who pays the bills?  How are the losses from the old Europe to be allocated?

Without agreement on these things, economists’ plans for a fiscal union, eurobonds, and a euro-FDIC remain dreams.

Europe’s politicians do not believe the moment is ripe for substantial steps, as even the small steps they’ve taken have been tentative and vague. Presumably they know their business, have correctly assessed public opinion, and will act when the opportunity arrives.  After so much dithering for so long, decisive proposals might clear the air like a sudden thunderstorm.  Implementation might occur with astonishing speed.

(3)  Austerity as a leash (or lash) to reform Europe (and America)

“You never want a serious crisis to go to waste. … Things that we had postponed for too long, that were long-term, are now immediate and must be dealt with. This crisis provides the opportunity for us to do things that you could not do before.”
— Rahm Emanuel (Obama’s chief of staff) to a  conference of CEOs in November 2008. From an interview in the Wall Street Journal.

Whatever their plans to reform Europe’s economy, the crisis als0 provides an opportunity to reshape its political and social structures. Many economists see Europe’s austerity programs as incomprehensible, given austerity’s long history of failure (ie, ineffective or actually harmful). This ignores the beneficial aspects of austerity programs: their effectiveness as a leash or lash to force changes. Such as reducing the power of unions, reducing the social safety nets, and eliminating laws that force some degree of equality in the relations between employees and employers.

First they plan for the mutually reenforcing combination of austerity and a long economic downturn to work its magic, allowing “reforms for growth”.  But doing nothing that upsets the oligarchy that rules most of Europe’s nations.  For example, Greece has almost no functioning tax system. That must and will change.  Shopkeepers will pay their fair share; but will its rich do so?

Also, power might shift from Europe’s national democratic institutions to the elite-dominated EU machinery.

Only then will the necessary changes be made to address Europe’s structural problems, such as the lack of a true central bank and unbalanced competitiveness between regions.

“What does that get us?  A discontented, lazy rabble instead of a thrifty working class.  And all because a few starry-eyed dreamers like Peter Bailey stir them up and fill their heads with a lot of impossible ideas.”
– Mr. Henry F. Potter, leading banker and first citizen of Potterville, discussing America’s social safety net

(4)  Are Europe’s leaders insane, like their predecessors in WWI?

“Insanity is repeating the same mistakes and expecting different results.”
Step 2: A Promise of Hope by James Jensen, by the Hazelden Foundation for Alcoholics Anonymous (1980). Available at Google Books.

The above analysis implies that Europe’s political leaders clearly see the situation and have crafted effective plans.  Consider an alternative: they are insane (in an operational but not clinical sense).  As in WWI, perhaps they refuse to see either the failure of their tactics or the cost in wrecked lives.  Instead they regard these ruined lives as downpayments to eventual success in a great project.

If so, they will continue to meet each crisis with tinkering until the terminal crash that forces a paradigm change to Europe’s vision of itself.

“The enemy undoubtedly has been severely shaken and he has few reserves in hand.”
— Said by General Haig (Commander in Chief of the British Expeditionary Force, aka “Butcher Haig”) on 1 July 1916: day one to the Battle of the Somme. Of the 100 thousand troops who attacked, 20 thousand were killed and 40 thousand were wounded. Haig’s optimism was unfounded; the eventual toll would be 624 thousand UK & French casualties.

Analysis and forecasts about the crisis in Europe, reporting their slow march to the cliff

  1. The periphery of Europe – a flashpoint to the global economy, 8 February 2010
  2. Governments cannot go bankrupt, 2 April 2010 — But they can default.
  3. About the Euro crisis: the experts are wrong; the German people are right., 7 May 2010
  4. The Fate of Europe, nearing the point of decision, 13 September 2011
  5. Europe drifts towards the brink of a cataclysm, 26 September 2011
  6. Delusions about easy fixes for Europe, dreaming during the calm before the storm, 30 September 2011
  7. Is Europe primed for chaos, as it was in July 1914?, 7 October 2011
  8. Today Europe’s leaders took another step towards the edge of the cliff, 27 October 2011
  9. Where to from here, Europe?  Some experts share their views., 8 November 2011
  10. Status report on Europe’s slow re-birth (first, the current system must die), 10 November 2011
  11. Looking ahead to see the new shape of Europe, 22 November 2011
  12. Europe passes the last exit.  A great crisis lies ahead., 21 February 2012
  13. The Fate of Europe has become visible. Only how and when the break comes remains uncertain., 6 June 2012

33 thoughts on “Europe has a political crisis. The economics are just symptoms.”

  1. Twenty Conferences, all futile.
    The Cart rolls well when moving downhill ahead of the Horse, now the road inclines, the cart begins to stall, the Horse is wandering around looking for oats.
    They are Insane.


    1. The point of #1 – 3 is that Europe’s leaders are not insane, and that they operate within the confines of political factors (as leaders should in a democracy).

  2. Should we not consider this as a manifestion of a partly broken OODA loop? A bit of ideological orientation lock, self interest (to be or to do, by their nature politicians tend towards being), a situation where Action has a long time to Observed reaction, a certain lack of precedent (politics at whole EU scale), the friction caused by multiple national systems, languages,outlooks, interests. Wallah! Crisis. Look at it from this angle and its a wonder that the EU works even as well as it does – tinkering is a feature and not a bug.

    Interesting aside, did Boyd ever explicitly discuss the role of internal friction in collective OODA loops? IIRC it is mentioned in his grand strategy…

    1. That’s a great point, one which I’ve wanted to write about for long time.

      Your question is also great. Perhaps Chet or another Boyd expert will drop by to answer it.

    2. Dear FP,

      Good question. I’ll go into this in more depth (sometime) on Fast Transients, but the short answer revolves around what “orientation” means when we’re talking about groups of people. Boyd suggested that for it to mean anything, the orientations of the members of the group need to be similar enough that it makes sense to talk about a “similar implicit orientation” or “common outlook.” Actions flow from this “common orientation.”

      What can happen is that under conditions involving such things as menace, uncertainty, and mistrust, the group can shatter into subgroups of similar implicit orientations. If the differences between these orientations are great enough, the subgroups can act as “many non-cooperative centers of gravity,” and the conflict between them pumps up friction and impedes timely and effective actions. Einheit, in other words, breaks down. See, for example, the section on moral conflict in Patterns, beginning at chart 120.

      Apparently the Europeans don’t have the level of Einheit that would enable effective actions.

      Hope this helped.

  3. How much did Europe expand its “shadow banking” sector compared to us? I understand they don’t have FDIC equivalent to us, but I assume they do have reserve requirements and money multipliers like we do. We avoided these restrictions on leverage by expanding the so called shadow banking sector. What about Europe?

    1. I’m not a fan of the “shadow banking” theory, which IMO is largely a story — as those activities don’t differ greatly from standard private sector credit activity.

  4. “This ignores the beneficial aspects of austerity programs: their effectiveness as a leash or lash to force changes. Such as reducing the power of unions, reducing the social safety nets, and eliminating laws that force some degree of equality in the relations between employees and employers.” Am I wrong but doesn’t the opposite of this describe Germany and the Nordic countries?

    Well, I guess, it all depends upon what the definition of “benefited” is. But it does seem that those countries which have healthy unions, well crafted social safety nets, and more rather than less political and social equality have done better than otherwise. But then, we’re not really talking about benefiting the general populations of countries but rather particular segments of those populations.

    Assuming this – the quotation – is the actual goal of the mainstream European politicians (?), then I would suggest that, although they may not be insane, they may be overly confident in the stability of their own situations and foolishly ignorant of other political possibilities. Of course, it all depends, but I don’t see the rise of the violent far right in Greece as a good sign. The rise of Ms Le Pen in France, who combines a strident nationalism with a populist “left” economic agenda, also raises a few questions. What happens if Mr. Hollande, who seems very intent on saving France’s banks, fails amidst a general and severe economic downturn and the far right comes to power? What happens if certain European countries which received bailouts in the form of loans default leaving the German taxpayers with a pile of bad debt? The history written about the major political players in Europe today will not be a happy one.

    The European crisis was caused by an orgy of foolish lending and borrowing, some of it enabled by fraud. It’s prolonged by politicians unwilling to let bankers suffer neither the economic consequences of bad lending decisions nor the legal consequences of their, well, other behavior. See Rubini. This tends to rob the political elite, which pushes austerity, of its moral authority, and in the end, its political legitimacy. Such problems won’t necessarily be solved by more cops in the streets. We’ll see.

    1. FM,

      Having reread your post, if I didn’t know better I’d say that the entire post is a very refined April Fool’s Day spoof. Very nicely done. But I’m new here, so what do I know? Gen Haig! Really? No. These leaders are not insane. The best that can be said is that they are trapped in the conventional wisdom of their age. And I’m being kind. Oh, and historical example is inapplicable to them because “it’s different this time.

      1. I don’t believe you got the message.

        (1) What’s incorrect with the Somme analogy? They do 21 rounds of the same solution while conditions deteriorate, and appear to have learned nothing.

        (2) The “insane” scenario is explicitly given as an alternative to the others.

        (3) “they are trapped in the conventional wisdom of their age.”

        Perhaps. Scenario #3 suggests that might no be correct.

        (4) “historical example is inapplicable to them because “it’s different this time.”

        Is that a joke?

    2. (1) “upon what the definition of “benefited” is”

      The elites use their definition, because its their game.

      (2) “The European crisis was caused by an orgy of foolish lending and borrowing, some of it enabled by fraud.”

      No, it wasn’t. This has been explained countless times, but the news media continue to propagate this myth. The primary causes were structural defects in the EMU, which many economists saw when it was designed.

    3. The European elites want unity. Fine. So how best to achieve it? The experts say that the EMU, without political and fiscal union, is impossible. That the crisis was caused because of productivity disparities between Greece Spain etc and Germany etc. But it’s also said that this caused artificially low interest rates in the Med countries and led to out of control borrowing in these countries. The feeling was that there would always be a back up for these loans, if things got bad, because of the need to “defend” the euro. Lower rates and confident lenders and big profits lead to more and perhaps too much debt.

      Now, as you point out, people knew of this potential problem well in advance – including the European elites. This structural defect was well known from the beginning. Foolish loans that threaten Europe’s banking system (your issue #1) and the structural defects of the EMU are two sides of the same coin. Of course it’s a structural problem. And of course it resulted in too much debt.

      Unity is a political problem (#2). Of course. And with the threats to the banks from too much debt, the politicians and central bankers chose austerity (#3) which is not a great way to make very different populations happy with one another and willing to trust one another in a political union. All the old hatreds and prejudices are now making a new and powerful reappearance. Not to mention the cops in the streets. This is a failure of politics.

      Gen. Haig was not insane either professionally or clinically. He appears to be a conventional professional of his time and did what he thought would work. He just needed to gather a greater mass of men next time to charge the machine guns. If Haig were a contemporary central banker, he would do what ever he could to save the banks with the least amount of loss to them no matter how many Europeans had to suffer under ever greater levels of austerity. And you’re very correct. This is no joke.

      What to make of this? If the goal was peaceful unification, and if the political elites of Europe continue like they have been, they will have failed. They failed primarily by failing to control the lending of their own “politically powerful banks”. Ruthless control of bank lending should have happened precisely because of the known structural problems of the EMU. Now they’re failing by trying to save these banks by unhealthy forms of austerity on their populations.

      The peaceful unification of a continent that’s been at war for 3,000 years is a very difficult project. If attempted, it needs to be done by extremely serious and immensely disciplined people who have the willingness to exercise strict power over their “politically powerful” banks. They didn’t do this and so now we have a mess. A politically explosive one.

      I am skeptical of a policy that uses a crisis to impose substantial economic pain on peoples as a way to get unity in a place like Europe. “The elites use their definition (of benefit), because its their game.” OK. But an alternative thought is to say that these are very conventional politicians who were side tracked by their inability to control the banks, and have fallen into a crisis.

      I hate long comments.

  5. > The primary causes were structural defects in the EMU, > which many economists saw when it was designed.”

    Indeed, and these defects were analyzed cogently right from the day the Maastricht treaty was signed, 20 years ago: “Maastricht and All That“, Wynne Godley, London Review of Books, 8 October 1992.

    1. Godley is correct that the inability to devalue is a tool these countries gave up to join the EMU. It’s also a tool that, for example, American home buyers “gave up” when they borrowed in a currency they can’t devalue in order to purchase homes that had artificially high prices due to artificially low interest rates.

      Without being burdened with debt denominated in a currency they can’t devalue, countries can always lower wages and profits to become competitive which happens anyway in a currency devaluation. Internal devaluation is always possible – except for the debt. Greeks, in a sense, are in no different situation than hapless American home buyers. My point is that the European elites knew this when they went all in. This knowledge wasn’t the sole preserve of Anglo-American commentators who like to give the impression that they were the only ones who ever knew this.

      Presumably, the EMU was done with its limitations because it was all the “unity” that could be achieved at that point in time. That’s OK. Hopefully the prosperity and good feelings among Europeans that could have resulted might have made it politically possible to take further steps toward unity.

      But the EMU should have been created with the absolute understanding that there would never be bailouts for private banks; that in light of the EMU’s structural limitations and the possibility of artificially low interest rates in some countries along with the inability of those countries to devalue their euro denominated debt.

      What to do now? Default on the debt. Even if Greece could devalue its currency, it would still have to default on its debt. If a bank makes a loan to an insolvent person or country, the bank should take a loss. This for the very practical reason of discouraging non productive speculative lending. Without the bad debt, countries as well as American home buyers could go on.

      Why doesn’t the United States devalue its currency by 50% in order to jump start its economy? More to the point, why doesn’t the United States allow bankruptcy judges to reduce the principal on homes used as residences? Why aren’t American students permitted to discharge student loan debts? All this is a drag on the American economy. American elites won’t let this debt be discharged for the same reasons that Mario Draghi says all debt obligations must be paid. The fault lies not in the EMU structure so much as in the political elites which currently rule.

      1. “Why doesn’t the United States devalue its currency by 50% in order to jump start its economy?”

        (1) Because our foreign debt is manageable, and large-scale devaluation is an extreme measure — with serious long-term ill effects. It would be the equivalent of getting a lobotomy to treat a typical migrane.

        (2) Devaluation is not magic. It can increase the competitiveness of a nation’s exports, but not easily or quickly expand the size of the sector. US exports are only 13% of GDP, so the economic benefit wouldn’t be large.

  6. “Why doesn’t the United States devalue its currency by 50% in order to jump start its economy? More to the point, why doesn’t the United States allow bankruptcy judges to reduce the principal on homes used as residences? Why aren’t American students permitted to discharge student loan debts? All this is a drag on the American economy. American elites won’t let this debt be discharged for the same reasons that Mario Draghi says all debt obligations must be paid. ”

    Good questions. I anxiously await ANY answers!


    1. It’s as Lincoln said (or would, if he was an American leader today): Government of the banks and creditors, by the banks and creditors, and for the banks and creditors.

  7. We are still hoping to reflate our economy as an alternative to the debt deflation route you describe. It’s not working. Soon we will be doing all the things you mention above and more. Be careful what you wish for. Debt deflation is a curse one would not wish on a worst enemy.

    1. Can you cite any supporting evidence for your assertiong?

      I see few signs that the ECB is attempting to “reflate”. In fact, I see few signs any major nation is attempting to reflate, even though standard economics (eg, the Taylor rule) suggests that greater monetary action is appropriate due to the zero bound on nonimal interest rates.

      1. “I didn’t say they were trying, I said they were hoping”

        OK, how do you know that they’re “hoping” to reflate?

        Also — if Central Bankers are “hoping” to reflate, why wouldn’t they try to reflate? How else does inflation happen?

        “Inflation is always and everywhere a monetary phenomenon in the sense that it is, and can be produced only by a more rapid increase in teh quantity of money than in output>”
        — Milton Friedman, The Counter-Revolution in Monetary Theory (1970)

    2. The central banks, our Fed, their ECB, find themselves in uncharted waters. Normally, central bankers bring the punch bowl (inflate) by lowering short rates, and take away the punch bowl (deflate) by raising rates. They do so by buying short maturity treasuries (inflationary since they use printed money here), or by selling same (deflationary). Currently, the zero bound prohibits them from further rate reduction, so they have adopted “unconventional” measures. This amounts to CB balance sheet operations involving purchase and sale of other assets than T-bills. So far here (USA) they have bought impaired assets from shadow banking entities like Ginny May and Freddie Mac. In Europe the ECB buys impaired sovereign debt from regional banks who hold impaired home loans. Eventually, if asset prices (mostly homes now, but soon equities) don’t turn around, this will induce realized losses which will flow through to taxpayers both here and there which will cause central bankers to get yelled at. Using printed money to buy impaired assets is not a central bankers first choice. It is an act of desperation. Therefore they drag their feet. Can we blame them?

      1. (1) All this is irrelevant to your assertion that central bankers “hope” for reflation. If they wanted inflation, they would generate inflation. The criticism of the Fed and ECB has been that they’ve not done sufficiently expansionary monetary action. See DeLong, Krugman, or the dozens of others explaining this.

        (2) “Normally, central bankers bring the punch bowl (inflate) by lowering short rates, and take away the punch bowl (deflate) by raising rates.”

        Changing interest rates is not inherently inflationary or deflationary. That was the error of the fresh water economists who made loud and wrong forecasts of inflation during 2009-2011.

        (3) “Using printed money to buy impaired assets is not a central bankers first choice.”

        The ECB has been doing that. The other central bankers have not done that since 2008-09.

    3. Here is one possible answer to your question: “The Real Libor Scandal“, Paul Craig Roberts and Nomi Prins, 14 July 2012

      If the CB’s must choose between re-inflating, and preserving the solvency of the banks, there’s your answer. They talk of inflation targets (Bernanke says 2%) but really focus on lowering rates, because rising rates (predictable if expansionary re-inflation works), are deadly for the banks who will realize instant (and non fudge-able) losses on their bonds.

      1. Freshwater economics is truly a wonder of our age! So often wrong, but loved because of its theoretical beauty and political utility.

        Its adherents predict inflation inflation inflation during long downturns, as during the Great Depression and the current Great Recession (remember the big inflation scares of 2008 and 2010?). Totally false but, like other forms of zombie economics, these viewpoints will not die.

        Robert’s theory as to what’s pushing rates lower is almost certainly wrong. To mention just one reason, rates are falling around the world — not just in nation’s in which Wall Street does interest rate swaps.

        For more about this see “On The Curious Persistence Of Inflationary Obsession“, Paul Krugman, at the NYT, 17 July 2012.

    4. Not a freshwater guy myself, more of a Steve Keen is right guy here. There are two monetary routes out of the current debt overhang problem:
      1. Dilute the debt by monetary expansion. Since the private sector debt is now $40trillion or so, dilution in half requires $40trillion of FED printing. We need more than dilution in half IMO.
      2. Our elites lose their minds and decide to transfer their wealth to the middle class, and industry so that debts can be repaid.
      Amazingly, neither of these is happening. What a puzzle. What a conundrum. Krugman is surprised. Ok. There is more than ye have imagined in your philosophy.

      1. It’s a lot more complex. There are, broadly speaking, four ways to cope with debt.

        • grow out of the debt
        • inflate the debt away
        • default on the debt
        • socialize the debt — spread it out over a larger population (within a nation, or among nations)

        They are not exclusive, and offer countless variations and combinations — each with a unique combination of advantages, costs, operational requirements, and risks. There is no one-size-fits-all solution. Especially since situations vary so widely: private or public debt, strength of the economy and public/private institutions, phase of the economic cycle, and history (people’s priorities, usually based on their history).

        For details see

  8. Protecting the rich in Spain at the expense of the middle class

    Christopher Wood, CLSA, 12 July 2012 — Excerpt:

    Meanwhile, a Financial Times article on Wednesday stated that, in return for recapitalisation, Spanish banks taking aid will have to write off their preferred shares and subordinated bonds, according to a leaked draft memorandum of understanding for the Spanish bailout (see Financial Times: “Spain pressed to inflict losses on small investors“, 11 July 2012). The article also noted that Spanish banks have €67bn of subordinated and hybrid debt outstanding, much of which was sold to retail investors as savings products. This point will be discussed in more detail later.

    … The Spanish owners of junior bank debt may also wonder why he or she is being treated so differently from Ireland where the ECB seemingly forced the Irish Government not to impose losses on subordinated bondholders thereby putting the Irish taxpayer on the hook. GREED & fear would not like to be viewed as a cynic. But the difference could be that the Irish subordinated debt was owned by big institutional investors whereas in the case of Spain it appears to be the little guy.

  9. FM offers: “It’s as Lincoln said (or would, if he was an American leader today): Government of the banks and creditors, by the banks and creditors, and for the banks and creditors.”

    Many thanks.
    A great late night chuckle!
    Why am I laughing?
    Well, I did ask for ANY answer and that is surely one of the best of the possibles.


  10. “This ignores the beneficial aspects of austerity programs: their effectiveness as a leash or lash to force changes. Such as reducing the power of unions, reducing the social safety nets, and eliminating laws that force some degree of equality in the relations between employees and employers”.

    That sentence grates, capitalism is a monster, undemocratic, exploitative,the balance between capital and labour is not anywhere near equality, But this was ever such, a crisis in capitalism requires a race to the bottom.


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