The good being dragged down by the bad or the domino affect. Call it what you will as peakprosperity take a look at the growing crisis in Europe.
You don’t have to be an economic genius to understand that the perpetual uncertainty over the Eurozone’s future has led to a widespread freeze on industrial investment and development. Industrial production is collapsing at an accelerating rate, falling 7% year-on-year in Spain and Greece, 4.8% in Italy, and 2.1% in France. The downtrends for industrial production are readily apparent in the chart below:
The businesses that are doing well are in the stronger countries.
The businesses that are doing well (and there are some) are those businesses with strong balance sheets and solid export order books for non-Eurozone markets; unfortunately, they are concentrated in countries like Germany, Holland, Finland, and Austria. They are not located where they can contribute to economic progress in Spain, Italy, Greece, or France, and so they are not adding to the tax revenue desperately sought by those governments.
Then there is always Greece.
Despite the recent deal worked out with Greece, the old cliché about kicking the can down the road is close to becoming no longer possible. Deferring the inevitable is only a political option so long as there is no immediate damage from doing so. But this is no longer true in the Eurozone, where political procrastination is now identifiably responsible for social unrest. It’s not just the trade unionists in revolt; now it is the middle classes as well. Doctors and teachers in Greece do not get paid anymore, and it is going that way in Spain, with regional governments surviving by simply not paying their bills. Government is destroying society, proving the falsity of the heretofore accepted belief (in Europe, anyway) that government makes society better. But then, anyone who has bothered to read Hayek’s The Road to Serfdom will not be surprised.
What was not anticipated in Hayek’s masterpiece is the divided state that is emerging. Greece is part of a larger EU and Eurozone bureaucracy and cannot achieve statist ends by turning her citizens into serfs. The government itself is subservient to higher authorities and is now having that medicine applied to it by its peers. Every visit by the Troika (collectively the European Central Bank (ECB), International Monetary Fund (IMF), and the European Commission) screws the Greek government further towards its own serfdom.
Keep in mind just one thing: Greece is utterly broke and cannot escape that fact. All of the posturing by the three Troika members is designed to avoid facing this reality. The political elite drive this party line and rigidly conform to it. However, there is increasing unease among powerful elements in the background, and in particular, sound money advocates in the Bundesbank are deliberately pushing for different solutions than those pursued to date.
Weidmann: No solution for Greece.
Jens Weidmann, who is the Bundesbank’s chief and its representative on the ECB’s Governing Council, is remarkably outspoken on this issue. In a recent interview with the Rheinishe Post, Weidmann pointed out that the ECB and other national central banks in the Eurozone are now Greece’s largest creditors and cannot take a haircut on Greek debt. Furthermore, they cannot write off this debt, since that would amount to monetary financing, which is forbidden under Eurozone rules. So, he concludes, the ECB is trapped.
Is Greece the dry run for the others?
The concern, obviously, is that Greece is a dry run for Spain and Italy. It is also, as I argue below, a dry run for France, which is in terrible shape and deteriorating rapidly. This is why the protector of German savers, Herr Weidmann, is worried. He is signalling that the precedents set in dealing with Greece will ultimately destroy Germany.
The ideal for the EuroZone would be
In my last article for PeakProsperity.com, I argued that Germany, not Greece, should and will leave the Eurozone, perhaps taking Holland, Finland, Luxembourg, and Austria with her. It has always been clear that this is the last thing the political elite would consider, but unless Mrs Merkel reconsiders her position, she will be overruled by the Bundesbank, and perhaps also her own finance minister, Wolfgang Schäuble, who is known to be extremely concerned.
ECB has manipulated bonds in an effort to keep the price low but this can’t last forever.
The only reason these bond yields have fallen to thee low levels is because the ECB forced them there. But when these yields rise, which they probably will because there is little doubt the ECB’s manipulation cannot succeed for very long, the accumulation of TARGET2 imbalances on the Bundesbank’s book will quickly exceed €1 trillion.
And there is a further problem. One of the reasons French ten-year government bond yields are only 2.1%, and have even been briefly negative for her six-month bills, is that some of the capital flight out of Spain and Italy has been deposited in French banks, only to be then lent on to the French government.
France itself is going to be a major problem.
But France, as I argue later in Part II of this article, is itself a basket case, only not yet widely recognised as such because it has benefited from this capital flight from Spain and Italy.
At some stage, probably in the next six months, these accumulated deposits in the French banks will, in turn, seek a safer home elsewhere – and where else but in the German banks? And so the Bundesbank faces the prospect of a second wave of capital flight and escalating TARGET2 imbalances.
Of course, this would not matter if it was certain that no one was leaving the Eurozone, and the TARGET2 system was constructed on the assumption that no one ever would. One could argue that Greece leaving would not be too much of a problem, other than the precedent it would create. This is why it is so important to keep Spain and Italy in the system.
After all, TARGET2 is a settlement system with offsetting cash creation and destruction carried out by the national central banks on delegation from the ECB. But nonetheless, it is understandable that the sound-money guardians at the Bundesbank are increasingly alarmed at the progression of events.
To borrow from Dirty Harry, it leaves those tied to Europe’s future pondering a seminal question: “Do I feel lucky?” Well, do ya?