via ZH
The euro system and its currency are descending into crisis. Comprised of the ECB and the National Central Banks, the system is over its head in balance sheet debt, and it is far from clear how that can be resolved.
Normally, a central bank is easy to recapitalise. But in the case of the euro system, when the lead institution and all its shareholders need to be recapitalised all at the same time the challenge could be impossible.
Bonus! Make sure to read the article. It's eye opening. But the reader that sent me the link added his take on things and I wanted to share them here. I know you guys. Many of my European readers will be punching walls so I won't name names. Check it out below.
1) The first and most obvious point the article makes is that the Euro is in crisis (big time). You (and most people) already know that — the European inflation is over 30% per year at the producer price level for several months now (which will eventually seep into the prices the end-consumers pay), growth rates are dropping into recession levels, threats of an energy shortage and industrial shutdowns threaten to make this far worse, the Euro has lost about 20% of its value against the dollar recently making foreign imports (like oil) even more expensive in local currency terms to Europe, going into next year fuel and food may really become scarce, the market for European exports (luxury goods, autos, machine tools, specialty food stuffs, chemicals, tourism) is dropping due to world-wide recession concerns and the screwed up supply chain and shipping situation, etc. Maybe not everyone understands just how bad the economic forecast is …. But most people get that ‘hard times are coming’.
2) What people probably are not expecting is the total collapse of the currency and banking system (rather quickly). Because it has survived (seemingly on life-support) for so long, there is a normalcy bias that ’they will just print up more money’ or ’somehow rig it’ to keep the Euro and the European banking system going. This article gets into some detail as to why that is not likely to be true.
3) The first part of the article describes how the EU Central Bank (ECB) has been printing money to cover COVID government spending across the EU (just like in the US), but it also points out that since around 2008 the ECB has been printing money (and holding interest rates negative) to help the poorer European countries with public deficit spending (Portugal, Italy, Greece, Spain … and a few of the smaller ones … the so-called PIGS). Basically, these countries economies boomed when the Euro was first formed around 2000 because suddenly they had low interest rates like Germany and the Netherlands and all kind of investment pored into those places. This investment built summer homes for wealthy Northern Europeans, built infrastructure, etc — but also undermined the local economies and businesses since they now had to compete with the more efficient German firms without the benefit of a weaker currency (e.g. Lira). These PIGS went from low-cost and relatively poor members of the EU to higher cost, ‘rich’ countries with spiralling housing prices and debt based prosperity etc. In 2008, the housing and other crashes removed this ‘cocaine high’ and the local housing markets and government debts defaulted, and further ‘investment’ from the north stalled and plunged these economies and governments into bankruptcy. The debt that funded all this ‘growth’ in the prior years was loaned to the PIGS by the wealthy Northern European states (e.g. Germany, the Netherlands). Defaulting on all this debt would have made German banks, pension funds, retirees bankrupt as well - so the EU governments and ECB stepped in, printed new money, and ‘loaned’ it to the PIGS to pay-off the bad debt. This made the Northern European states (and their investors) whole, but saddled the PIGS with new debt to pay off the old debt (hence all those Euro ‘bailouts’ really served to protect the people back home in the North not the people of Greece or Italy, etc.) Plus, whatever could be taken-over and sold was given to the Northern creditors. At this point, the PIGs were trapped — they couldn’t depreciate their currency and try to stimulate their economy and export their way out of trouble (like they had repeatedly done in the 1950’s-1990’s), their local industries were wrecked by stronger Northern European competitors, their government debts were maxed out and controlled by the EU banks, the tax base collapsed, their people had to take huge cuts in entitlement payments (e.g. retirees), their banks could not make new loans because all of their capital was stilled tied up in all the bad loans made in the decade before, etc. What to do?
4) The ’solution’ since 2009 has been to keep the government spending in the PIGS as tight as possible (as tight as possible meaning still in deficit otherwise the people would literally revolt but not high enough to really juice or rebuild the economy), run budget surpluses in Northern Europe, keep interest rates low or even negative (to make that new debt cost as little in interest charges as possible), and hope for better days. That was the situation until COVID hit and then the cap came off of spending everywhere: northern Europe, the PIGS, etc. The number of euro’s in circulation (and government debt) sky-rocketed far far beyond where it had been in 2018. On top of that, you now have the Ukraine war — more debt and printing.
5) So, now, what’s the plan? Can they keep doing the same? Probably not for many, many reasons. The most obvious reason why they cannot keep going on like they have been is because inflation isn’t stopping. The inflation is caused both by real shortages and by money printing. The real shortages are not likely to stop any time soon. Supply of needed stuff (fuel, fertiliser, special parts, food) just does not equal demand (or civilisation's ability to get the stuff to where it is needed). There are all kinds of reasons why supply won’t likely catch up any time soon (the war, the weather, the supply chain, the fact that more people are demanding a western lifestyle all over the world which needs oil and meat etc). A catastrophic depression would help with demand — imagine major industries shutting down (perhaps permanently) in Germany due to lack of natural gas, or millions losing their jobs — that would affect demand for gasoline, travel, entertainment, retail consumption, etc — and some (or all) of that will happen and remove ‘demand’ and thus bring demand back into equilibrium with supply (thus lowering prices). But the fact that there is all this money printing means that each dollar or Euro just buys less stuff than a five years ago and that means that there is a floor on prices through which they probably won’t fall. The fact that some economies in the world are raising interest rates a bit (and Europe and Japan are not) only makes this inflation (and currency deflation) affect worse for Europe and Japan.
6) So, if the inflation is bad — and on the border of hyper inflation — and if continued printing of money only makes this work, why not raise interest rates? If the economy is going to crash anyway (because of global recession or war or whatever reason), why not ‘get it all done in one wash’ and get inflation and debt in order — take the pain all at once? The reason why not is covered in this article. The whole European financial system (banks, pension funds, government debt) is a web of interconnected bankrupt assets. Before COVID and the explosion of money printing, it was just possible to imagine that (although things were pretty much hopeless), Europe could limp through its bankruptcy problems with zero percent interest rates and some money printing in the hope that something magically might appear on the horizon. “Pretend and extend” is the phrase used in banking for this play — pretend that the client you are loaning money to is able to repay its bills and to keep loaning (some) money to them — because if you recognise that the client is bankrupt, then your own financials have to recognise that you are bankrupt as well — so better to ‘pretend’ and hope for a miracle.
7) Basically, most of the PIGS financial companies, retail firms, and local governments are totally bankrupt — they cannot hope to repay any of their loans or even make interest payments on them if interest rates are above zero percent. The banks that own these loans know this, but can’t recognise that fact in an accounting way, because that would make those banks bankrupt as well. Because these banks are full of ‘bad loans’, none of them can make new loans to new or the better existing companies (or consumers) to fund investment, consumption, or new economic growth. The national governments (e.g. Italy) don’t want the local banks to be bankrupt because that would wipe out the savings of just about everyone in their country (to a large extent) and require the national government to ‘bail out’ those banks. And since the credit cards of the national governments are fully maxed out, they can’t bail out those banks if they wanted to. Plus, they are using those same banks to ‘buy’ all the new debt (eg Covid spending) that they have been doing these past years. These banks are really the only entities that are willing to buy Italian debt at impossibly low interest rates (i.e. they are forced to). If the governments recognised that the national banks are bankrupt, then the governments would have to acknowledge that they too are bankrupt and unable to continue to fund services, retirements, healthcare, defense, etc. as well.
8) This problem doesn’t stop with the PIGS however — because the ECB has been covering for the bankrupt PIGS (by printing money and keeping interest rates at zero) but loaning money from the northern national central banks to the southern ones (the references in the article of having the German Central Bank loan money to the southern banks via the Target 2 system — basically IOU’s between national central banks managed by the ECB). Basically, the Italian Central Bank (and others) owe trillions to the German Central Bank (separate from all the government debt) but since it all comes under the banner of the European Central Bank, these debits / credits across the various national banks net to zero …. Until someday they don’t. That’s what the article is implying. If the PIGS for some reason crap out (because of depression, revolt, wild inflation) then the Italian Central Bank defaults … which means that the German Central Bank (to whom it owes so much money) defaults etc. The entire financial system of Europe (and to some extent the western world) comes down in a crash. If the PIGS don’t default, then the inflation will get so bad that the ’stable’ central banks like Germany might just ‘leave the Euro’ to save itself — basically, write off all of the loans it has made to Italy and others, bankrupt its own banks and pension funds, etc but save at least a shred of its wealth by making some kind of new currency (perhaps a gold backed one) — Germany’s debt by itself (even writing off all of its now worthless financial ‘assets’ elsewhere in Europe) might be manageable if it goes by itself — but if it stays linked to the rest of Europe, then the amount of claims on its wealth (Euro notes and debt) will certainly swamp Germany for sure. It will be an interesting and macabre story of individual versus group survival. Whether a non-Euro Germany, without natural gas or raw materials, can make it at that point — and whether economically associated states like Poland, the Czech Republic, Hungary, Austria, etc can do so as well is also an open question.
Geopolitically, if the Euro collapses relations between France and Germany, the PIGs, etc will be wrecked. The economic devastation awaiting all of them is severe … and the fact that national survival may require some of the EU states to go out on their own will only make the in-fighting worse. It is even possible that the economic and political elites of the EU are stronger than national self-interest and the EU will ride together over the waterfall together all the way to the deepest, rocky bottom. Japan is in as bad a state as the EU. The Canadians, UK, and Austrailians are more like the US —— not financially or economically stable at all but in a different class than Japan or the EU. Japan and the EU going over the edges may doom them as well — or maybe their path will be equally bad, but just different. Either way, at the other side of this you could see a total realignment of Europe — and economic survival itself may make an accommodation with Russia a necessity. It will be an interesting decade to come.
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