STOCK MARKET WATCH, Thursday, December 15, 2011

[Demeter]

73. Simple Explanation of Why Night Falls over Europe

http://econintersect.com/b2evolution/blog2.php/2011/12/14/simple-explanation-of-why-night-falls-over-europe

Europe’s leaders gambled, attempting monetary unification before fiscal unification as a step towards full political union. The fatal flaw was its lack of a mechanism to modify the treaties, correcting design errors and adapting to changed conditions.

Germany exploited its control of monetary policy for its own benefit, allowing rapid growth in their exports to southern Europe — financed by its loans to southern Europe. All prospered.

All good things eventually come to an end. The system started to collapse from a combination of the too much accumulated debt AND malinvestment in southern Europe, plus the shock of the great financial crisis.

Banks are the vulnerable part of a capitalist system. French and German banks hold much of the southern european debt; defaults (soft or hard) would bankrupt them.

Europe’s banks own Europe’s governments, as American banks own America’s government. Hence in 2009 recapitalizing the banks became the primary imperative.

The crisis might allow Germany to push Europe another step towards unification, giving Germany the power to influence individual national budgets in the EU or EMU, allowing them ever great ability to exploit their neighbors (this is the traditional way nations use power).

Since the Greek crisis began in early 2010 Europe’s leaders have sought ways to rebuild the banks. Guarantees and loans from their government have proved insufficient. The only remaining alternative to nationalization (as done in Sweden, Russia, and to US S&L’s) is ECB printing hundreds of billion euros for the debtors, so they can pay the banks. Any resulting inflation would also help in this great work.

Not realizing that bankers are western civilization (or own it), Germany’s people refused to see the wisdom of massive ECB printing. Europe’s leaders despise public opinion, but shirk from taking so large a step in the face of such strong opposition. They see lamp posts and fear what the public might do.

Instead they resort to increasingly baroque proposals, hoping to create a facade behind which the ECB can print sufficient euros to save the banks. This effort ignores the actual problems afflicting Europe, burning scarce political capital and still scarcer time. But they encounter two obstacles:

The creditor nations are not stupid, so they will not all monetization without some form of fiscal unification (otherwise the core nations finance fiscal deficits in the periphery without the ability to control them)

The debtor nations are not stupid, and so will not allow fiscal unification on Germany’s terms (as they did with monetary unification).

The end game will come eventually, as they pass some invisible tipping point. Continued capital flight will create disorderly markets. The coming recession will scuttle the austerity plans. And the austerity programs will intensify the coming recession — drastically increasing social stress throughout Europe (imagine Spain starting a recession with 23% unemployment).

This will get interesting for Europe. Survival is always interesting; all their political regimes might not survive.

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Addendum

On a deeper level, a driver of this crisis is a misreading of history by the German people. They believe that the NAZI rise to power resulted from the hyperinflation six years earlier (1921-24). They don’t see the proximate cause: Weimar imposed austerity during 1929-32 (after the crash). For details see A lesson from the Weimar Republic about balancing the budget.

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Update: About the results of the latest euro-rescue summit

(1) The real results concern aid for the banks (see the Financial Times). Necessary actions to improve bank liquidity, but ineffective without broader policy action.

(2) Approval for more and deeper austerity policies. In fact, locking EU fiscal policy into a straitjacket as a recession looms ahead. Europe’s leaders have learned nothing from 1929-32, and nothing from the great progress in economic theory since then. This could have horrific results! Future generations will not understand.

(3) They hope (again) to get more aid from the BRICs (Brazil, Russia, India, China) via the IMF. This is delusional. The BRICs did nothing earlier this year, when hopes were higher for effective EU action AND the BRICs were stronger. Now all four BRICs have serious problems at home; substantial help for the rich folks of Europe from the poorer BRICs seems unlikely.

(4) Most important, they have done nothing to address the imbalances within the EMU that caused the crisis — and drive the current downturn.

(5) “Never let a crisis go to waste”, so they wisely use this opportunity to push for Treaty changes. But the emphasis on this is bizarre. It is, as others have said, like the Captain of the Titanic convening a seminar on metallurgy after they hit the iceberg (later analsyis showed that its steel became brittle when cold).

(6) For details see Europe’s disastrous summit“, Felix Salmon, Reuters, 9 December 2011.