The Europe Crisis From A European Perspective

Tyler Durden's picture

Submitted by Chris Martenson contributor Alasdair Macleod

The Europe Crisis From A European Perspective

The purpose of this report is to give readers the essential background to the economic problems in Europe and to bring you up-to-date in what has become a fast-moving situation. At the time of writing, there has been a lull in the news flow, but that does not mean the problems are under control. Far from it.

Flawed from the Start

When we talk about Europe today in an economic context, we really mean the Eurozone, whose seventeen members are the core of Europe and share a common currency, the euro. The euro first came into existence thirteen years ago, on January 1, 1999, replacing national currencies for eleven states; Greece joined two years later. In theory, the idea of a common currency for European nations with common borders is logical, and it was Canadian economist Robert Mundell's work on optimum currency areas that provided much of the theoretical cover.

However, the concept was flawed from the start.

The euro would have made sense if the economies of the member states had been allowed to converge -- that is, evolve -- so that they had similar characteristics. While this was the intention from the outset, the mistake was to put convergence in the hands of politicians and their economic advisers, who (if not representing socialist parties) were and still are all interventionists. This meant that they pursued their own national agendas by intervening in their respective economies while paying lip-service to the greater European ideal. Therefore, convergence was never going to happen.

The point everyone missed is that the only way convergence could occur is if all member states relinquished government planning and control of their individual economies, so that an undistorted free market across national boundaries could have developed. Instead, central planning by individual member states was the order of the day. Control mechanisms, such as limits on government borrowing as a proportion of GDP and permitted budget deficits, were breached with impunity, and the fines that should have been imposed under the Stability and Growth Pact of 1997 were never implemented. Today all Eurozone members are in breach, with the minor exceptions of Finland, Estonia, and Luxembourg.

The naïve ambitions behind the Maastricht Treaty were only the start of the euro-fudge. The whole point of the euro, so far as France and the Mediterranean countries were concerned, was to escape the monetary straitjacket of the deutschemark, with which their individual currencies were unfavourably compared in the foreign exchange markets. The Bundesbank, Germany’s central bank, was truly independent of government, and operated with the single mandate of price stability, while the other national central banks were extensions of high-spending governments. It was to de-politicise note issuance that, based on the Bundesbank model, the European Central Bank (ECB) was created to be independent of all governments.

Looser Standards, Easier Money

However, while the Bundesbank was focused only on price stability, the ECB relies on a wide range of indicators to guide monetary policy. So where the Bundesbank was single-mindedly objective in its approach, the ECB has become variously subjective, being able to choose its statistical indicators at will. While the ECB is regarded by most commentators as following restrictive monetary policies, they are considerably more expansionary than the old Bundesbank.

Anyway, the result was that borrowing costs for France and the Mediterranean countries fell rapidly to a significantly lower margin over Germany’s, which was taken as the “risk-free” rate. European banks geared up their lending to benefit from the spread, locking in a one or two percent differential between German bond yields compared with, for example, Italian government bonds. Gearing (i.e., levering up with further debt) this differential ten or twenty times was a no-brainer, particularly when it was backed by the implicit guarantee of the whole system. This was party-time for banks, and amounted to ready finance for profligate governments, which was the underlying reason that Greece joined -- to benefit -- two years after the start of the Eurozone.

In order to be eligible for monetary union in the first place, the future Eurozone members had to put their houses in order to meet the convergence criteria. For those with unacceptable debt-to-GDP ratios, this meant shifting debt “off balance sheet,” typically by dropping nationalised industries from the national accounts. Various other fudges were devised to make appearances acceptable for the target year of proof of convergence: 1997.

This means that even today, declared government debt is only part of the whole government debt story, with government guarantees, actual and implied, giving a far greater potential problem than headline debt figures suggest.

The Party Kicks into High Gear

Greece was a special case, joining the Eurozone two years after the start. She had so mismanaged her affairs before entering the euro that membership in the Eurozone amounted to a rescue of Greece’s finances. Interest rates for government borrowing in drachmas had been over 20% for much of the 1990s. By 1999, when her plans to join the Eurozone began to be discounted, Greece's short-term government debt yields had fallen to 7.25%. By 2005 they had fallen to only 2.5%, and even 10-year government bonds yielded less than 3.5%. At the same time, Greece’s official central government debt rose from €83.22bn in 1999 to €175bn in 2006, rising further to €264bn by 2010.  

Bank lending was expanding rapidly in other countries as well, particularly Ireland, Portugal, and Spain. And it wasn’t only government: The private sectors of these latter three countries experienced property bubbles on the back of easy credit that sooner or later were certain to burst.

When things are booming, politicians take the glory and revel in their supposed success. At the domestic level, they loosen constraints on spending. They delude themselves that the boom is the result of their economic policies, so they extend planning and controls over the private sector at the behest of favoured pressure groups. Most European parliaments are coalitions, whose cohesions are bought through favours and money, corrupting the whole political system. And at the pan-European level, boom-times also encouraged politicians to grab their share of glory on the bigger stage by trying to outdo each other in their support of a common European ideal. Theirs is still a world of imagined power and uncontrolled spending. The EU budget, an expense on top of national accounts, is seen as a source of funds for everyone to grab before the annual budget allocations are used up. The result is that the EU budget has been unable to pass an audit by its own auditors for the last seventeen years.

With this gravy-train in operation, it is hardly surprising that the politicians and their favoured appointees lost touch with economic reality. The extraordinary lack of humility from European leaders is evidence of this, and entirely human.

Reality Intervenes

Economic conditions have now changed, with fear of deflation replacing easy money from before the credit-crunch and the Lehman crisis. From then onwards, banking changed from a world of expansion, of using all devices, including off-balance sheet vehicles, and hypothecation of collateral, to expand their lending. It was replaced with a sudden awareness of risk, of falling property prices and over-extended construction businesses.

This rude shock was a global phenomenon, affecting the US and the UK as well as mainland Europe. To stop the global banking system from going into a systemic melt-down, Sovereign states agreed to stand behind their commercial banks, guaranteeing all deposits. In effect, they were committed to underwriting balance sheets that totalled multiples of their own GDPs, turning a banking crisis into a sovereign debt crisis.

This was bad enough for countries with their own currencies, but Eurozone governments cannot support themselves with monetary printing, control of this function having been passed to the ECB (the exception is the TARGET settlement facility, which is described below). So while the US and UK were able to print dollars and sterling respectively via quantitative easing (QE), Eurozone governments were unable to do so.

The Importance of TARGET

The reason quantitative easing has been so useful to governments elsewhere is that it allows government deficits to be funded without paying interest rates demanded by bond markets. For that reason, interest rates in US dollars, pounds sterling, and Japanese yen can be held artificially low despite government guarantees to underwrite their banks’ liabilities. The further advantage of QE is that it provides commercial banks themselves with liquidity to offset contracting balance sheets. In the absence of QE, Eurozone governments cannot so easily address their immediate financial and economic obligations, and so they face the scrutiny of risk-averse bond investors.

Of course, central banks are careful to de-emphasise the reasons for QE stated above. But the publicly stated reason, which is to help kick-start an economy, is obviously relevant where economic recovery is prevented by the actions of banks worried about deposits walking out of the door. This problem and that of capital flight are generally avoided in the EU periphery countries by the smoothing operations of the national central banks, which control the cross-border settlement system known as TARGET (an acronym for the Trans-European Automated Real-time Gross-settlement Express Transfer System).

Money flowing, say, from Greece to Germany is replaced by the Bank of Greece issuing euros to leave the quantity of money in Greece unchanged, and the inflow into Germany is neutralised by the Bundesbank withdrawing euros from circulation for the same reason. Both trade imbalances and capital flight are accommodated by these means, and there is therefore no net currency issuance to accommodate them. By this mechanism, local banks facing depositor withdrawals in favour of stronger banks in other jurisdictions are kept solvent without recourse to the ECB.

If it wasn’t for TARGET, the ECB would have had to step in to stop banks in the periphery countries from collapsing. Instead, TARGET has bought time by smoothing capital imbalances and can be expected to continue to do so. The effect has been for national central banks in the periphery nations to operate their own, hidden version of QE, concealed from public scrutiny because it is offset by money being drained elsewhere from the system, mostly by the Bundesbank in Germany. 

Dangerous Imbalances Are Building

In the accounts of the central banks, the withdrawal of money in Germany by the Bundesbank is balanced in this example by a loan to the Bank of Greece, and since the Bank of Greece is guaranteed by the Greek Government, this is an extra, hidden government debt of which bond markets are generally unaware. Loans under TARGET by the Bundesbank and other national central banks to the Bank of Greece at end-2011 stood at about €100bn, which is a combination of Greece’s cumulative trade balance with Eurozone partners and capital flight. To put this in context, Greece’s GDP is estimated to be about €220bn, so the other national central banks are stuck with unsecured loans on their books that amount to 45% of Greek GDP. And remember, this does not include capital flight over the last three months, which in all probability will have accelerated.

Other TARGET “assets” in the system at year-end were €195bn owed by Bank of Italy (11.7% of GDP), €170bn owed by Bank of Spain (12% of GDP), about €120bn owed by Bank of Ireland (75% of GDP), and €55bn owed by Bank of Portugal (30% of GDP). Exposures in the form of loans are over €500bn to the Bundesbank, and a further €370 to the Netherlands, Luxembourg, Finland and the ECB itself.

These are serious imbalances, particularly for the smaller countries, and without them not only would their commercial banks have already folded, but asset prices would also be considerably lower. While these outcomes have been avoided so far, growing imbalances (if left unchecked) can only result in the eventual collapse of the TARGET system. 

Conclusion (of Part I)

The above summarizes the essential background to the problems faced by the Eurozone.

In Part II: What Lies in Store for Europe, we address the logical next question: How will the tragedy play out from here? 

We look at the critical roles played by Germany and the ECB, the only two entities with enough clout to determine a permanent outcome for the current Eurozone. And we examine the fast-eroding fundamentals for Spain, Italy, and France that will soon force a decision on the euro's fate.

Lastly, we recognize that the European credit crisis offers a rare opportunity for investors: a near-certain bet. 

Click here to access Part II of this report (free executive summary; paid enrollment required for full access)

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Nussi34's picture

Bagus rules. great book. You can read it on a week end. Phantastic insights into EU central planning.

francis_sawyer's picture

Nice foto... But this graphic would have been better...


GeneMarchbanks's picture

Superficial and clumsy, if you want to be generous. Perhaps you might want to encourage the non-Euro readers to read up on some history of the idea? Just a thought. The common currency is only the latest installment in this ongoing 'project'.

This 'straightjacket' nonsense needs to end, as if somehow the euro is holding back would-be Full Bloom economies.

Sudden Debt's picture

Government debt is backed with what you'll make next year.
It's actually a guarantee to the banks that they'll be able to take it from you and give it to the banks.
So: the government sells people to the banks by going deeper into debt.

People thinks it's normal but it's still slavery as we know it.
How can people take from others for their own profits without anybody questionning it?

Robosigning used to be a big deal, BUT WHERE'S MY SIGNATURE THAT SAID I WANT TO PAY FOR ALL THIS CRAP?!?!?



battle axe's picture

Only thing that will end this joke, is if the Bundesbank grows a set, and says enough. Until that happens, nothing changes, print, print, and repeat. 

Ghordius's picture

Meanwhile one big currency printing is less wobbly than 17 trying to outdo themselves in it. All this propaganda is from banks that would love to tap the streaming force of 17 times (17-1) FX pairs.

AnAnonymous's picture

Ah, a US citizen canadian is behind the economical theory so why not a name like nunatsiavut economics, I dunno, a name that stops from associating this theory with US citizens...

Would work in the same intent as voodoo economics.

TheFourthStooge-ing's picture

AnAnonymous said:

so why not a name like nunatsiavut economics, I dunno, a name that stops from associating this theory with US citizens

Perhaps the better name would be Zhou Enlai blobbing up Chinese citizenism Tibetan indentured servitude economics.

Ah, but that would require self indiction and not allow Chinese citizenism face savery...

Would work in the same intent as Chinese citizenism roadside doodoo economics.

Chinese citizenism new world odor.


AnAnonymous's picture

That could do. Everything that avoid association with US citizenism, US citizens, will be welcomed.

TWSceptic's picture

Anyone with a mirror site of part II please post it.

dick cheneys ghost's picture

Is the US killing the EURO?


an intesting read....

Vampyroteuthis infernalis's picture

This article points out the problems with the USD, but fails to mention how f*^cked up the Euro is. Jibberish.

Sudden Debt's picture

I don't think the euro needs anything else to fuck itself into oblivion

HAhyperion's picture

I had posted over 8 months ago on my blog "Systematically Undermining the Euro and Social Safety Nets"

The two goals they had in mind: killing two birds with one stone and remember we threw the first stone. 

all future wars will be fough through finance and technology.

tim73's picture

"The euro would have made sense if the economies of the member states had been allowed to converge -- that is, evolve -- so that they had similar characteristics."

So what does the economy of Alabama and New York have common? Or Vermont and Texas? Eurocritics always use double standards that no group of nations in the world could even implement.

USA is weak because so many states are weak and many are dependent on useless federal pork projects, especially military ones. Eurozone is quite strong because it is diverse, much more shock resistant. Germany is now experiencing quite good times, eight years ago it was doing badly while Italy and Spain were doing very well.

Sudden Debt's picture

3000 years of history shows that europe will never merge.
All those who ever thried failed.
Charles magne, Napoleon, Hitler....

tim73's picture

OK, let's go back 2000-3000 years. What was Rome then? Greeks before that? And from where did the white Americans came from? Did they somehow magically change mid-Atlantic from being "barbaric, mutually hostile" Europeans to Americans on their way to the "promised" land? Aliens dosed them with radiation to change their brain structure?

I am betting for USA breaking apart instead. EU is still quite loose free trading union, Holy Roman Empire (the one after the fall of actual Rome) was somewhat similar and that one lasted in various forms almost one thousand years.

Lednbrass's picture

The US may very well break up eventually, and this will force a major change in Europe.  For the first time in three generations they will actually have to pay for their own military defense instead of just handing the bulk of the cost off to the US.

In any case there is probably going to be an eventual limit on how much the Germans will tolerate in the name of having intergenerational guilt shoved down their throats, the bills are going to be tremendous for keeping much of the rest of the zone floating. At this point it is quite clear that they will pay to keep things going and some of the other countries are going to use that in their own favor. Germany will get fleeced for awhile but it cant last forever.

For what its worth Europeans didnt change mid-Atlantic, there is plenty of mutual regional hostility here. Probably more than in Europe.

tim73's picture

It just a myth that Americans "paid" for the defense of Europe. There are lot of more men who had to go through obligatory army service in western Europe than in US during Cold War. You got selective concription during Vietnam but that was it. Of course the mandatory training was only up to one year and mostly basic training plus some advanced training but more than what it was in the US.

France, Germany, UK are all quite big weapons dealer in the world and can manage to defend their own nations just fine. In matter of fact there is still a large surplus of weapons, mainly tanks, that even UK is considering STORING them to Germany due lack of storage space! We are talking about thousands of tanks.

Germany has sold a lot of tanks all around at the price of scrap metal because there is no need for them anymore. There was a huge buildup of weapons during Cold War.

With small arms there are even more huge collections everywhere, not to even mention the weapons left behind from USSR era in the other side. Americans think they have a lot of guns but it is nothing compared to vast weapons depots still existing in Europe. We are talking about a machine gun or rifle to every single citizen.

michael_engineer's picture

Hey you, ZH editor. You should do an article to debunk this asteroid mining concept. This link is a good start : The asteroid mining news blurb may have been part of some disinformation campaign or an attempt to mislead the public perception on resource depletion issues. Or somebody might have been looking to dupe some investors. Questions for those mining guys : What concentration of valuable minerals are you expecting to find out there? Are those concentrations typical in meteorites that are already on the earth? If these minerals are embedded in rock or iron or manganese and impure and separation needs to be done then exactly which process is going to be used? Which machines and chemicals will you be taking to an asteroid? Do those processes work in zero gravity and zero atmosphere? How much tonnage are you bringing back per mission? What are the energy calculations for de-orbiting that mass? How big a heat shield will be needed? Shirley, someone must have done some calculations on weight, volume, and the amount of fuel to get out of orbit, get back, and de-orbit. Is the back of that envelope or that napkin still available? Or did it get tossed out after those "wannabe mining" guys ate lunch together? Talk about building a proverbial bridge to nowhere. Hope they are not going to be using government money for any funding. WAIT!!! That just might be it. Maybe they are just tring to divert some public funds to pad some corporations bottom lines with no real hope for a profitable business model. Wouldn't that be a swindle?

AnAnonymous's picture

Made me laugh.

Who cares? All those questions, while being relevant and sound, are already answered. And the answers do not matter.

Black friday on world's resources, US citizens credit cards is throbbing.

AnAnonymous's picture

The euro would have made sense if the economies of the member states had been allowed to converge -- that is, evolve -- so that they had similar characteristics. ________________________________________________


Well, converge? The US exhibits economical divergence between states so what?


This is US citizen cultural thing. You know, they call you to behave a certain way because so they say, it is the way they have achieved success.

Here, economies should have been left to converge etc...

Yep, save that was not the trick and still not is the trick.

Curtis LeMay's picture

With this gravy-train in operation, it is hardly surprising that the politicians and their favoured appointees lost touch with economic reality. The extraordinary lack of humility from European leaders is evidence of this, and entirely human.



It is entirely European...
manhunter's picture

There is nothing wrong with the euro; it will not break apart. No one is leaving, they even have a new unofficial member, Swizerland. In Europe governments can go bankrupt but the euro is not affected; the ECB will not print to save the countries. Price stability.

Sudden Debt's picture

Price stability?
Today they showed how prices have increased since 2000.
On average goods and services cost 62% more here in europe.
Our wages did increase but not 62%!

A few months ago I had to hire 9 new people for my department. All fresh from school. My budget was 2k a month per person... That's as much as I got when I came out of school 13 years ago!

michael_engineer's picture

SD, you've been around a long time.  I haven't seen Trav777 in a while.  Any insights?

Lednbrass's picture

Im not SD, but Ive seen posts that he was banned.

michael_engineer's picture

He could cross the line with all his toes.

Sudden Debt's picture

How do you get banned on ZH?

Ghordius's picture

SD, wages are under pressure since then, it's the China effect. In the last Globalization Age, this made the Left to ask for trade tariffs.

Upps, I wrote Trade Tariffs. 5 Minutes for the black helicopters...

q99x2's picture

Under the tenticles of the squid it is best not to be too certain--all bets are off.

Nels's picture

The point everyone missed is that the only way convergence could occur is if all member states relinquished government planning and control of their individual economies, so that an undistorted free market across national boundaries could have developed.

Convergence?  Of what and to what end?  Convergence in flscal matters, that no one goes broke unless everyone goes broke?  Convergence on monetary units, which was never an issue when metals were used?

I think the original point was to force a centralization of government planning and control of all economies.  Undistorted free market access was never the plan anywhere.  The goal was to drive everybody slowly to bankruptcy, penury, debt slavery, without being able to point a finger at any single culprit.

Why would anyone believe that convergence in any behavior between Germans and Greeks is a reasonable thing to expect in a free society?  And why would it be necessary for a shared money to work?   The idea that Germany and Greece should get the same rates on borrowed money was always a idiotic idea, and more so when the equal rates appeared long before it was clear that equal behavior never would.  Well, I suppose it was clear to everybody who had never drank the water in Brussels that Greeks were not Germans and vice versa.  But what potent water that must be to generate the dreams of the Eurocrats.

DrunkenMonkey's picture

Together we stand, divided we fall.