Guest Post: The Dynamics Of Doom: Why The Eurozone Fix Will Fail

Tyler Durden's picture

Submitted by Charles Hugh Smith from Of Two Minds

Guest Post: The Dynamics Of Doom: Why The Eurozone Fix Will Fail

The only way out of the Eurozone end-game is massive debt forgiveness and a return to national currencies. The first will destroy the banks, the second will destabilize the German export economy. "Extend and pretend" is an endgame, not a fix.

Despite having described why the Eurozone is doomed on numerous occasions, I missed certain dynamics of the EU's endgame. At the risk of overwhelming you, here are a few of my Eurozone-related stories over the past two years:

The European Model Is Also Doomed (February 7, 2009)
When Debt-Junkies Go Broke, So Do Mercantilist Pushers (March 1, 2010)
Why the Euro Might Devolve into Euro1 and Euro2 (March 2, 2010)
Why the Eurozone Is Doomed (May 10, 2010)
Ireland, Please Do the World a Favor and Default (November 29, 2010)
Why The European Union Is Doomed (March 28, 2011)
Greece, Please Do The Right Thing: Default Now (June 1, 2011)
Why the Eurozone and the Euro Are Both Doomed (June 23, 2011)
Greece Is a Kleptocracy (June 28, 2011)
500 Million Debt-Serfs: The European Union Is a Neo-Feudal Kleptocracy (July 22, 2011)

Let's dig into the dynamics of doom:

1. The consequences of austerity. The kleptocratic "fix" is to divert more of the debtor nations' national incomes to debt service. In other words, money that once went to labor (wages) and social services now goes to debt repayments and interest.

What are the consequences of this massive diversion of income? The economy shrinks. Less income means less spending, which means negative growth.

The Eurozone's "happy story" counts on debtor economies "growing their way out of debt." If labor's share of the national income is falling, and both private and government spending and income are falling, precisely where is the "growth" supposed to come from? As private income falls, tax revenues fall, causing the government to raise taxes and junk fees. This further reduces private income, and so on in a self-reinforcing feedback loop of contraction.

Austerity sets up a positive feedback loop of less income and less spending. The people in these debtor economies can look around and see the consequences: everyone has less money, and less confidence that the "austerity fix" will do anything but put debt-junkies into fatal withdrawal.

Once an economy becomes dependent on debt that rises faster than the resulting "growth," then that economy is set on an unwavering path to implosion. (The Cycle of Dependency and the Atrophy of Self-Reliance).

As belief in the system fades (When Belief in the System Fades March 12, 2008) and institutions lose their legitimacy ( The Three Ds: Delegitimization, Definancialization, Deglobalization July 1, 2011), then people naturally save more as insurance against an uncertain future. Fewer people are willing to risk their capital in new ventures, and as the economy loses vitality then these trends reinforce each other.

2. This loss of faith and confidence triggers hoarding and capital flight. As Ludwig von Mises noted long ago, the only way to organically "grow" an economy is for capital to accumulate faster than the population, that is, capital increases on a per capita basis. Capital means savings/cash, not debt, that is invested in productive assets and enterprises.

So what happens when you skim more of a nation's income to service debt? There is less capital accumulated, and thus less capital available for investment.

What happens when people lose faith in the financial institutions and their coercive "fixes"? They move their capital to less-risky, more productive climes. In other words, capital flight is another positive feedback: as people move their capital out of the country, then there is less available per capita for productive investment. Toss in a kleptocratic government which increases taxes while misallocating precious capital on crony Capitalism and corruption, and you get a death-spiral of capital flight and risk avoidance.

The irony of a loss of faith is people instinctively place their capital in non-productive savings: in gold, Swiss lock boxes, and so on. This instinct removes capital from the pool of investments in productive assets.

3. Taxes must be raised to fund higher debt service. There is no other way to service sovereign debts, so taxes must rise, adding another positive feedback to the contracting economy: higher taxes reduce net income, create disincentives to earning more via productive enterprises and incentivizing tax avoidance and capital flight.

4. The frantic rush by the EU and European Central Bank (ECB) into a domino-like series of short-term "fixes" effectively destroys the possibility of long-term solutions. Injecting more debt into debtor nations is like "fixing" the debt-junkie's withdrawal symptoms with massive doses of euro-denominated smack: the "fix" dooms the "patient" in the long run, even as it "makes everything better" for a brief interlude of faux "normalcy."

But like any other addiction, resistance to the "fixes" rises and the interludes diminish in length.

The dynamics of austerity without massive debt renunciation doom the EU, and the dynamics of using taxpayer-funded debt to "fix" over-indebtedness also dooms the EU. Massive debt renunciation will doom the big European banks, and of course those banks are the raison d'etre for the entire project: it's all about saving the banks, isn't it?

5. These dynamics set up a double-bind endgame. The EU Overlords and the ECB can busily move their last knight around their king, but the game is already lost. Austerity triggers a positive feedback of economic contraction, debt fixes to over-indebtedness launches a cycle of diminishing returns, and the reliance on short-term fixes over long-term solutions sets off self-reinforcing losses of legitimacy and faith in the system's sustainability.

The only real solution to the Eurozone end-game is massive debt forgiveness and the resulting destruction of "too big to fail" banks, and a return to national currencies, which will enable structural imbalances to be resolved via currency devaluations. This will of course destabilize the German export economy; but that is inevitable.

"Extend and pretend" is an endgame, not a fix.

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TooBearish's picture

Not gunna happen....wouldn't be prudent...NWO Pres G Bush I

TradingJoe's picture

Meanwhile on Bl(D)oomberg the spin has begun! "Gov can still pay its bills and pay interest", "Gov doing the right thing will raise debt ceiling in time", yada yada yada Jesus how much shit will/are Americans still able to take?!?!

carbonmutant's picture

Gasparino saying Obama told bankers August 2nd default won't really be a default- Zerohedge tweet

TruthInSunshine's picture

Merkel is toast (as is the 'Union of European Member States,' once word spreads far and wide).

After pledging to Germans that Germans would not have to bail out the PIIGS or Banks, the Greek default has now officially revealed that Germans are bailing out BOTH, bitchez!

To quote Joe Biden (Tyler, you may want to run with this), "[t]his is a big f*cking deal!":

Propping Up Banks, as Well as Greece


By Published: July 25, 2011

FRANKFURT — Europe’s latest plan to prop up Greece seems, on closer examination, to look suspiciously like a plan to bolster European banks....

...The irony, of course, is that Chancellor Angela Merkel of Germany went to Brussels last week vowing to make banks pay their share of the cost of aiding Greece. She inadvertently seems to have done them a favor instead.

SheepDog-One's picture

The ONLY solution to ALL of this crap is HAIRCUTS! Thats all! End of story!

kito's picture

nope, the head has got to go off with the hair.

Amish Hacker's picture

Kind of adds new meaning to "basket case," no?

Transitory Disinflation's picture

TPTB are either:

Stupid and incompetent,

Clever and deliberate,

They know some disaster is coming ie: Elenin, EQ's, Asteroid (remember that space rocks are now classified)

FEMA Camps are set up and ready for something

DUMBS (Deep Underground Bunkers) are prepared for something

They are following the plan that the pyramid on the dollar bill is complete by 2012 (count the blocks in the pyramid as 20yrs each starting at 1776) Pyramid being a ponzi / pyramid scheme.

I could go on......


DOOM to the MOON

old naughty's picture


I got all of what you say until I got to the last sentence. Why/What is the Moon?

Are you seeing things?

Either way, thanks for sharing.

SMG's picture

Today's weather forecast: cloudy with a chance of DOOOOOOOOOOM!!!!!!

HedgeAccordingly's picture

If a Euro falls in the middle of the night in a forest... does it make a sound?

agent default's picture

The way I see it, and I am a bit of a conspiracy theorist here, I think Germany is just buying itself time to prepare their exit from the eurozone or, they are preparing some sort of transformation of the eurozone.  There is no way the PIIGS can be rescued, and there is no way the core of the eurozone is bailing them out.  they couldn't afford it even if they wanted to.

knukles's picture

Dude... that's no conspiracy theory.  That's rational planning.
Like saying trying to escape from a burning building is conspiracy thoery.

carbonmutant's picture

Take the money and run...

Sudden Debt's picture




Transitory Disinflation's picture

Sadly that is what Amy Whinehouse probably said :(

Long-John-Silver's picture

I hope that last hit was worth dieing for.

nodhannum's picture

There are no hits worth dying for.  Sort of reminds me of the scene from "King Rat" where the guy says to the doctor that's a fate worse than death...the doctor dryly returns son there is no fate worse than death.

legal eagle's picture

Obviously never been to a full length ballet.

TruthInSunshine's picture

Debt junkies all suffer the same fate, forever thoughout history, without exceptions.

In this crispy Ponzi scheme of fractional reserve banking planned economics, they should include an 'expiration date' for each participating economy.

A few simple functions of math should provide some fairly accurate guidance as to when the 'when' will be.

Id fight Gandhi's picture

Nothing good can come from usury, it's been known since the beginning of commerce.

The Profit Prophet's picture

"Neither a lender nor a borrower be." - Lloyd Blankfein

T.E.I.N. everyone!

tim73's picture

Outhouse USA is shouting to everybody, "you guys suck!". Just look under your collective asses, yanks. 

Caviar Emptor's picture

Debt forgiveness is one solution.

Cost forgiveness is the other: the debtors work for free. 

The endgame will involve some formula that mixes the two. 

FeralSerf's picture

The Germans get Greek slaves?  Hasn't a similar "solution" been tried in the past?

A question that is sure to come up eventually is: "What about sex?"

AnAnonymous's picture

As belief in the system fades (When Belief in the System Fades March 12, 2008) and institutions lose their legitimacy ( The Three Ds: Delegitimization, Definancialization, Deglobalization July 1, 2011), then people naturally save more as insurance against an uncertain future.

Belief in the system? People save more?

A loss of belief for a currency happens when people refuse to be paid in this currency and matters most for essential goods.

Now Europe has a large service economy, which tops other kinds of economies. People in service has little interest blocking the payment of their services via the Euro (or any other kind of currency)

Wont happen. The triggering event would be that commodities rich countries no longer accept the Euro. Less unlikely to happen than for the USD but still unlikely to happen.

As long as the Euro buys, people have no cause to lose belief in the system.

Ye Ye's picture

Agreed that austerity and bailouts are a fail.  However it is not clear the Euro needs to disintegrate ... after all California is f'd beyond belief over here but we're still using the dollar.  Pan-European bond issuance, stronger pan-European government, and net financial transfers from strong core to weak periphery would also get the job done.  Whether that's politically palatable to the core is unclear.

Ghordius's picture

Someone in the City decided Eurobonds and Eurotaxes rhymes deliciously with Fees and CDS.

Does the IMF need (yet) Worldbonds and Worldtaxes?

edotabin's picture

politically palatable or not, this is where it is headed.  When you have the Greek finance minister dismissing Moody's you know this is the plan.  I say they will go for it come hell or high water.


Ghordius's picture

This is not Smith's Best.

That talk about "slave bondage" is full crap. too much SM?

Nobody invades Greece if it defaults, in fact Smith himself wrote they should default.

Sovereigns default from time to time, it's a fact. Yes, the TBTF system is unstable and might crash. But they are not European, in fact they are transnational.

And this destabilize the export economy business? Mises would not approve.

Shameful's picture

Of course Greece should default, but wouldn't that require Greek politicians to act in the best long term interest of their nation? Please show me a group of politicians who are more concerned about the well being of their nation and not pillaging the placed, I'm interested in see this mythical unicorn. Simply put the politicos know that when default happens the gravy train ends, and that simply is unacceptable, better to kick the can for another day and steal what they can for the life after.

Shameful's picture

Of course the EU fix will fail.  Everyone is just playing for time and hoping to not be the first one to die.  First guy to fall loses.  Because every other player after that can point and say "Well, we were on the road to recovery, and then ___________ blew up" giving the local political class a free pass.  And even if 1st to die want to prolong it to feather ones won nest.  extend and pretend until there is no capital left.

aleph0's picture

@Charles Hugh Smith .. Short ,  to the core , and exact .

Your posts are much appreciated . Thanks.

PulauHantu29's picture

Jim Rogers commented today (I think it was to the NYT) that he is Bullish on the Dollar...very short term in expectation of a rush into dollars from the EuroFire. I agree with his assessment and added a handful of UUP today and will sell when it rises 10%...a quick buck.

Interestingly, he said he was bearsih on Treasuries...still..and is shorting them.

Spitzer's picture

Jim Rogers has been short term bullish on the dollar for 3 years now. What a shitty trade, closet deflationist.


MFL8240's picture

But he fails to mention that Goldman Sachs and JP Morgan can steal some Real Estate in Greece cheaply using taxpayer money.  

Species8472's picture

What matters is the source of the borrowed funds, savings or central bank inflation money. Paying it back with interest will not reduce available capital, provided it is paid back with real earnings and not funny central bank money


jack stephan's picture

The Wizard: The Children of Doom... Doom's Children. They told my lord the way to the Mountain of Power. They told him to throw down his sword and return to the Earth... Ha! Time enough for the Earth in the grave.

Peter K's picture

Finally, a speaking truth to power moment :)

dervish's picture

europe is chasing the pink dragon, with germany beeing the pimp-dealer of the rest of europes debt-crackwhore-junkies. people here in germany are totally ignorant about whats actually going on in their country and/or europe and the rest of the world. they will enslave us all in a totalitarian single-money, single policy, single surveillance system NWO where the slaves will be visible, but the masters unknown, as they are today. order out of chaos bitchez! (that you control of course)

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