Of Deutsche Marks, Lira, Peseta and Coming Troubles

(New American)  The Munich-based Foundation for Family Business has filed a criminal lawsuit against the Bundesbank, the central bank of Germany, alleging that the board of the bank has hidden the true scale of the risk borne by ordinary German citizens in the bailouts.

The sovereign debt crisis in the European Union can be summed up fairly simply: The governments of overspending nations are asking the governments of fiscally prudent nations to prop them up. The prudent nations, whose governments pay their obligations out of revenue, rather than by selling bonds, tend to be those in the more financially conservative parts of Europe, such as Finland, Holland, and Germany. Those nations that are waist deep in debt, whose bond offerings have in some cases been reduced to junk bond status, tend to be in the south of Europe around the Mediterranean Sea.  This has left the citizens in the more prudent nations rather distressed about the costs of these bail-outs.

How upset are Germans these days? Polls have shown that 56 percent of Germans want to abandon the Euro and return to the old Deutschemark.

But it isn’t just Greece which is insolvent.  Portugal, Ireland, Spain, and Italy are also in the financial danger zone.  While it seems that Greece is receiving most of the attention right now, we need to remember that Greece may actually be the least of Europe’s worries in the near future, because the Spanish economy has failed, and Italy is perched right on the edge as next-to-fall.

(New American) The latest data shows that the Italian economy shrank during the first quarter of 2012 by .8 percent, which means that the recession which has hold of Italy is growing deeper. That means the GDP is a full 6 percent smaller than in 2008. It also means that Italy, along among the major economies of the world, actually has a smaller per capita GDP than in 2000. The French economy, in the same period, posted zero economic growth.

One consequence is that the interest rates that the Italian government will need to pay in order to service its sovereign debts jumped by 16 points to 5.86 percent on ten year bonds when the bad economic news was released. That means investors want even more revenue from the Italian governments just to pay its existing debt. And that Italian national debt is really big, the third largest of any nation in the world after the €1.9 trillion, smaller only than the United States and Japan.

Romano Prodi, the previous Prime Minister of Italy, said that the European Union is risking “contagion” not only to Spain and to Italy, but also to France, if Greece leaves the union. As Prodi put it, if Greece leaves: “The whole house of cards will come down.” Angelo Drusiani of Banca Albertini warned that the European Central Bank must become the lender of last resort or Italy will face “massive devaluation, three to five years of hyperinflation, and unbearable unemployment.”

The current Italian government is led by Prime Minister Mario Monti, and Monti did not come to power in the usual fashion in parliamentary governments, via a general election. Instead Monti assumed the post of prime minister after Silvio Berlusconi resigned late last year. The projections are that Italy’s economy will contract at annual rate of 3.5 percent this year, which is three times fast that the so-called “therapeutic” pace adopted by the International Monetary Fund.

Investors are concerned. Nas Redeker of Morgan Stanley has stated that the European Union’s mishandling of the Greek sovereign debt crisis:  “The irrevocability of the eurozone is a valuable asset, and they are throwing it away. Global investors are preparing for the day Greece leaves…We are looking at this number very closely.” Redeker also noted that almost half of this is owed to foreigners, with Germany, Holland, Finland and Luxembourg looking at fleeing these wobbly nations.

Terrorists in Italy are also reflecting the rising frustration of Italians who increasingly view their political leaders as incapable of solving a crisis that pinches ordinary Italians more tightly each day. Italian banks are caught in the middle. Moody’s on Monday downgraded 26 different Italian lending institutions, noting: “Banks are vulnerable to the renewed recession in Italy, given their already elevated levels of problem loans and weakened profitability.” The Italian Banking Association struck back, accusing Moody’s of being “… irresponsible, incomprehensible, and unjustifiable. Moody’s decision is an attack on Italy, its companies, its families and its citizens.”

Speaking on the matter of European finances as they relate to the German situation, Professor Hans-Werner Sinn has not backed down from his claims of serious future problems for German taxpayers if the eurozone continues to provide bailouts and other assurances intended to keep the PIIGS afloat. The bailouts involved “Target2” transfers, which are automatic credits extended to fellow central banks (which, in practice, has been the central banks of Portugal, Italy, Ireland, Greece, and Spain). This “Target2” crisis has been a constant theme in recent German media reports, and Professor Sinn has been on German television frequently as a result.  He would seem to have a point, as fiat currencies often suffer from hyperinflation. As Kurt Williamsen pointed out for The New American in February:

By overprinting their money, 21 countries have experienced runaway inflation — essentially destroying their currencies — in just the last 25 years, including Russia, Argentina, Zimbabwe, Brazil, Poland, Turkey, Yugoslavia, often leading to horrible repercussions for the people in those countries. (In Russia, money that had been enough to buy a three-room apartment within a few months devalued and would buy only a pair of boots, leading to rampant malnutrition.)

Despite Professor Whelan’s talk about us all living in “a world of fiat currencies,” Milton Friedman once famously said: “There is no such thing as a free lunch.” Modern history has more than once proven Professor Friedman to be right.

And so it seems that Europe faces a very difficult path – Elections in Greece and France have presented a clear message from voters, and it is against “austerity” i.e. cutting back public spending.  In all, 16 European governments have fallen or been voted out since the beginning of the Euro-Crisis.  The Dutch, Czech, and Romanian governments have all fallen on “loss of confidence” or outright resignation in recent months, due to conflicts over implementing the austerity measures which the stable Euro-nations have demanded. But disposing of the present austerity measures is essentially a negative referendum on the preservation of the Euro Zone itself.

It is reasonable to posit that the situation must come to a head in the immediate future – more than half of Europe has changed government since the beginning of the crisis in 2010, yet there is no unified plan, nor any consensus of confidence among European leaders on how to stabilize, let alone resolve this massive debt bomb.  Meanwhile, citizens of the various European states are waking up to the conclusion that they may have been robbed, manipulated, and lied to regarding the very nature of the EU.  As a result, pathogenic strains of both nationalism and communism have surged in popularity across the continent, with national socialists (Nazis) gaining influence and political power in Greece, Germany, France, and Britain.

In Britain, David Cameron has defended his comments about the break up of the euro. His remarks came right before a conference with besieged Chancellor Merkel in Germany and incoming Socialist President Hollande of France. Cameron said that it was “… more dangerous to stay silent than to speak out.”  What Cameron had said Wednesday, during Prime Minister Questions in the House of Commons, was that the eurozone “either has to make up or it is looking at a potential break-up.”

With British Prime Minister Cameron speaking so bluntly and with Chancellor Merkel, governing by far the largest economy in the eurozone facing such strong and growing opposition, it is not hard to see how the default of Greece and then, like dominos, several other nations like Portugal, Spain, and Italy could follow. If Italy is forced into even a partial default, the situation will suddenly have assumed unmanageable proportions. The banks of other nations, particularly France, hold significant amounts of Italian government debt.

Even barring an Italian default, at this point is seems clear that many of the major banks in currently “safe” parts of Europe will have to restrict their lending if the crisis grows worse, which will affect many otherwise healthy businesses across Europe. Should investors lose confidence in Italy, or other circumstances cause Italian banks to falter in any way, then the contagion will engulf Europe, and the end of the Euro currency, with most of the other Euro-Zone provisions such as open borders and duty-free commerce, will disolve over night as the various European states collapse into postures of national protectionism.  We are already seeing the beginnings of state protectionism, vis. currency controls, new banking restrictions, and the recent amendments to the EU Charter/Treaty which provides for the closure of national borders “for up to 30 days”.

At the risk of sounding hackneyed, I present the observation that, “we have seen these things before”.  Both WW-I and WW-II were fomented in periods of economic difficulty, and in both cases, war was preceded by economic aggression where currencies, tariffs, and preferential trade treaties were the first weapons used.  If the Euro-Zone collapses into a frustrated collection of nation-states practicing individual protectionism, then we will most assuredly see war again on the continent within a decade, if not much sooner.

America, and the rest of the world, are presently at great risk as a result of all this, and only a successful defusing of the Europeans’ debt bomb will allow the US to address its twin looming  crises of debt and public confidence to any positive effect whatsoever.  I say this for two reasons – the precipitous risk of Europe substantially limits our economic maneuverability at present, and; per haps even worse, the Euro-drama is a powerful distraction across the worlds’ markets, artificially inflating American bonds and US-denominated Equities, resulting in a false sense of security regarding the US’s own sovereign and market risks, which are far larger than all of Europe’s’, combined.

The light at the end of the tunnel, if there is any at all, seems very faint indeed, and a very long ways off.

      
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