Europe On The Brink Of Financial Catastrophe
Simon Johnson, who has made a career of studying and intervening in countries that have sovereign debt crises, has a very blunt post today, “Europe Risks Another Global Depression.” Notice the full stop; there is no passive aggressive question mark at the end to give him any wiggle room should it all blow over. Considering his expertise about identifying when countries have gone past the event horizon, that is quite worrying.
Things could get real ugly real fast, with the financial markets demanding some sort of intervention immediately.
Julian Callow from Barclays Capital said the EU may to need to invoke emergency treaty powers under Article 122 to halt the contagion, issuing an EU guarantee for Greek debt. “If not contained, this could result in a Lehman-style tsunami spreading across much of the EU.”
According to Johnson, the powers that be don’t seem to understand this. Or maybe they do, but they refuse to believe the inevitable logic of the situation: the Eurozone is a failure. Critics of the Euro have long predicted that it wouldn’t be able to hold together when faced with difficulty, because it would be impossible to have monetary policy for the whole that would be beneficial to the parts. This is exactly what happened, with Germany dictating the policy to its greatest advantage, leaving countries such as Greece and Spain out to dry. This critique has now been blessed with the Common Wisdom tag, as bestowed by Paul Krugman. While Krugman bends over backwards to absolve government spending of any blame, he is absolutely correct that it isn’t the primary contributor to the problem.
Things are quite a mess.
Update: Yves Smith has a post up and refers to the possibility of a “Global Margin Call.” This is precisely why I referred to the problem as a “financial catastrophe” as Europe is still way too leveraged and a disorderly drop in debt markets — even for relatively small countries — will have vast implications when it comes to total exposure.
27 Responses to “Europe On The Brink Of Financial Catastrophe”
I didn't know Spain, Italy, Portugal, Greece and Ireland is the entirety of Europe.
The US isn't the entirety of the world, either… yet our near collapse sent some fairly significant shockwaves.
Given the EU and the attempt at a European economy, I'd say you're pretty much at the epicenter, Axel.
This is why I selected the word “financial” in the headline. The issue isn't fundamentals in the whole of Europe, but financial system liabilities and how the contagion will spread. All of Europe's banks are insanely large and leveraged, including Germany's. The fallout from a debt unwinding will be massive, and no country will escape unscathed.
The reason why our troubles didn't hurt Europe even more was because the assets involved were a) largely protected by AIG, and the government transferred tens of billions to European banks and b) were priced in USD, so the Fed opened up trillions of dollars of currency swaps to allow it to unwind. In this case we're not in that same position.
You're right, we're in a much different position now. And I don't think (most) people really realize how much $$ went out to hold the European banks together. (Not sure whether that ignorance is good or bad, either…)
Thanks I didn't realize that Europe was is such a bad financial position. We don't really get much information from the main stream media about Europe.
Nor much of anything else…
That's why internet sites make more sense than TV or a local newspaper.
You have to stop agreeing with me, it really throws me of my game…
“While Krugman bends over backwards to absolve government spending of any blame”
[snicker]
Good choice of thread, Mikkel. Note that the problem with Greece and deficits is nothing compared to what Europe faces in its future, which stands to be more bleak than our own here in the States. Europe has worse economic woes, more government than we have, and most importantly of all, worse demographic change coming (which in part has already been underway and causing problems already). Meanwhile, there already is concern with deficits even now, at the same time that in recent years, authorities have already been worrying about how they will afford retirement social spending programs, and the slightest hints at reforms (including pathetic partial reforms of early retirement, a worse problem there than here) are met with work stoppages and mass protests.
It's still Europe that is likely to face a debt trap before the USA, not vice versa.
However, Mikkel, your bringing up this thread reminds me of what I thought of last night — given what we've seen this past year with the Dems in the States as well as with the goings-on in Europe. While some critics ask aloud if China is going to start making demands of the US to keep its currency from slipping (and will the world really shift from dollars to euros — I doubt it), I wonder if what we're begging for eventually, as well as Europe, is the need to subject ourselves to the same kinds of not only audits (I've advocated GAAP for the federal government, for years, too), but subjection to the IMF or to IMF-designed austerity programs. An austerity program is what we're going to be begging for if we continue or if Europe continues misspending and other misconduct — right in time for a big slump due to aging and mass retirements.
I'm pessimistic enough to think that we're very close to the point where money and debt “don't matter.” Our financial system has an insane amount of positive feedback loops and our policies are turning up the gain factor immensely (the primary reason why I am against them) to the point where a shock like this will probably make everything fall apart. If Europe has a minor meltdown then the dollar is going to skyrocket and per Roubini — who said that the dollar carry trade dwarfs anything in history and would lead to an unimaginable backlash — that will cause catastrophic unwinding, massive deflation and pretty much kill global trade. At that point the system will really be dead and it'll be a geopolitical battle and quick move back towards localization. I think that social cohesion and innovation will be far more important than any numbers.
These dynamics have happened an extraordinary number of times in history, and we always forget it.
Mikkel,
[oink]
http://blogs.wsj.com/marketbeat/2010/02/05/piig…
“The issue isn't fundamentals in the whole of Europe, but financial system liabilities and how the contagion will spread. All of Europe's banks are insanely large and leveraged, including Germany's. The fallout from a debt unwinding will be massive, and no country will escape unscathed.”
Greece is not alone.
http://news.bbc.co.uk/2/hi/business/8503090.stm
Don't forget our situation here at home.
http://online.wsj.com/article/SB200014240527487…
http://www.businessweek.com/news/2010-02-02/u-s…
(What will happen with states that have relied on federal stimulus money this past year to pay for current operations?)
* * *
I suspect Roger Bootle may have something to say about this in his new book (available late last year in the UK, available next month, March, here in the States). He's dedicating an entire book to the theme he began developing in “Money for Nothing” as a small note there — that the markets ran rampant. As opposed to the likes of Krugman, what Bootle has to say in this book I look forward to
with true interest and intellectual curiousity.
http://www.capitaleconomics.com/rogerbootle/boo…
“The supreme danger in all this now is that we will throw the baby out with the bathwater. Outside the world of finance, this crisis has not revealed any widespread failure of capitalism—although capitalism is in crisis as a result of it.”
“We do need to fix the financial markets, and that means, in a variety of ways, a bigger role for government. But we do not need bigger government. Nor, except in relation to the powers of corporate executives, do we need to fix the market economy in general.”
http://www.imf.org/external/pubs/ft/fandd/2009/03/pdf/...
“If there are two places about which Roger Bootle gets animated, they are China and Chicago: the first because of its huge trade surpluses, which partly caused the global downturn he terms the 'Great Implosion', the second because of the free-market economic dogma that played a key role in causing the recession.”
“Countries should now endeavour, he argues, to rein in the financial sector, recognising that leaving the markets to themselves is a recipe for disaster.”
http://www.guardian.co.uk/business/2009/oct/18/…
Meanwhile, I hope the likes of Paul Volcker can at least prevent things here from otherwise getting worse.
The silence on state (and local) budgets is incredible to me. Dozens of major cities and about half of the states are in 25%+ holes and moving towards massive layoffs and social net cuts, but I've read close to nothing in major newspapers — other than aggregate stats like $200 billion in deficit for the next two years or individual stories that have no greater framework. This is why it is amazing to me that people are predicting a strong recovery.
“If Europe has a minor meltdown then the dollar is going to skyrocket”
That's despite the risk to our own (USA) credit rating being downgraded because of our fiscal follies.
That's before fiscal problems erupt for real in the states here, and pleas to Washington for assistance.
Wait, weren't we just reading at TMV about how American Exceptionalism was dead and we are all a bunch of fuddy duddies for not rushing to adopt the ways of enlightened Europe?
“how American Exceptionalism was dead”
[exasperated elite lefties]
Of Course [tm] it will be up to the USA to Do Something if there's a crisis. Get angry, bash the USA.
By the way Mikkel, again — good thread. This is refreshing from, say, Palin obscession (~10 threads!).
“The silence on state (and local) budgets is incredible to me.”
Me, too, Mikkel. By the way, you're right to note that cities are suffering along with states. In most of the USA we don't think about cities because we're a suburban nation, but some central cities do still matter, and even those that don't (Detroit) are heading for disaster. (Detroit has sought federal assistance before. Federal aid directly to cities, which violates constitutional federalism, actually has a long history; that's why we still have that freakish, palentological Department of Housing and Urban Development that outdoes even the Detroit automaker “bubble” in being stuck in an ancient time.) It is not simply a case of New York City playing with liberal politics and bankrupting itself (though there are echoes in cities like Detroit). These places were ill before the downturn, and they're suffering even more now.
“Dozens of major cities and about half of the states are in 25%+ holes and moving towards massive layoffs and social net cuts, but I've read close to nothing in major newspapers”
It's as if many in the media are like many in government (including state and local government) and believe that if they're in trouble again later this year, more stimulus money (in addition to more borrowing and more taxes, if the states and even cities can get away with this), and blithefully assume or presume that if or when there's a need for more federal money, more of it will come from the federal government. If there are any pending bankruptcies, the states or cities will rush directly to the feds for a bailout. (Note that the bailout of the banks in addition to the stimulus being spent on a combination of frivolous political goods and given to states and cities merely to continue their operations, has created an enormous moral hazard and set of expectations.)
I still don't believe we're going to see printing vast sums of money, and inflation and monetizing of debt.
We might see New York-style debt “moratorium” events and payment of government employees with IOUs by the states and cities, though. I figure California could end up seeking a bailout, starting a train of other states with similar demands. (Hmmm — like what I expect to see in Congress after the examples with health care set recently by those representing Nebraska and Louisiana, and learned in Alabama.)
Greece is in trouble and the EU will need to deal with it. I live in Europe…pay attention to politics and finacial news. No one here is predicting a Great Depression.
Maybe this little attack on socialist Europe has something to do with being embarrassed by Palin and the tea party?
Hopefully, but I've read a lot of Simon Johnson and he is permanently cool and understated. Also he has many foreign contacts and has worked intimately on the politics of these sorts of situations.He is very upset, which I find troubling.
Sorry. I'll have to study politi-speak so that both people that agree with you, and those that don't, will think that I'm on their side.
There is no doubt that Greece is in serious trouble, but they won't pull Europe, let alone the world, into a Depression.
I think a lot of people jumped into the Euro thinking it was a safe currency against the dollar. Maybe that is why some people are not happy?
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What is the difference between what Europe is doing to Greece and the U.S. does to some place like El Paso, Texas. The U.S. sets a minimum wage independent of local conditions that causes the unemployment rate in El Paso to go up. The U.S. sets monetary policy to help Wall Street even if it hurts placed like El Paso. The U. S. sets immigration policy to lower the costs of living in Manhattan even if it hurts El Paso Texas. The U.S. sets education policy so that the schools in placed like El Paso will never get better.
Anything said about the economic policies of Europe could apply to a great extent to the U.S. What has the Obama Administration done to help Buffalo, NY
The DAX was up 1% today.
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“There was to be an emphasis on 'modernizing the European social model, investing in people and combating social exclusion' and a drive to 'improve the quality and sustainability of public finances.'
The European Union is in need of a new economic strategy …”
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