Wednesday, July 18, 2012

Long, hot summer in the European economic crisis

"Italien und Spanien bleiben akut gefährdet. Es wird ein heißer Sommer." ("Italy and Spain remain in acute danger. It will be a hot summer.") - Wolfgang Münchau, Mogelpackung vor dem Bundestag Spiegel Online 18.07.2012

The European economic/financial crisis is in a state where it could stumble along for months or the current patchwork solutions could start unraveling at 2008 "Lehman event" speed on almost any day. We could come up with various metaphors: a dam about to break; an impending avalanche that needs only a small shift in a few rocks to start; a line of traffic traveling 100 miles an hour on the freeway spaced only inches apart from each other so that one driver suddenly braking will cause a multi-car pileup at high speed.

Munchau's metaphor in American English would be that of a long, hot summer where one event could easily set off a catastrophic chain of troubles.

In the non-metaphorical world, the question of the moment is, when will a bank run begin in Spain? A rush of panicky withdrawals from Spanish banks is the most likely event at the moment that could spread rapidly to a bank run in Italy and overwhelm the eurozone's existing rescue arrangements in a matter of days.

The drama will inevitably create false impressions. The particular problems created by the euro common currency zone that are now a reality were identified by a number of economists as risks two decades ago when the eurozone was first being planned. The flood of capital from the wealthier nations to the "periphery" countries in the eurozone such as Greece and Spain were well-known events as they were occurring. The danger of this kind of currency-related bind in an economic downturn was played out in Argentina in 2001-2. The weakness of the European banking system has been highly visible since the current economic depression began in 2007. And the weakness of the banks started manifesting itself as an acute sovereign-debt crisis with Greece in 2009.

So the current crisis didn't develop overnight. And, like the currency problems created by the gold standard during the Great Depression, it won't be solved overnight, nor can all the affected countries be expected to respond at the same pace. For Greece, Ireland, Italy, Portugal and Spain, getting out of the euro and restoring their own currency seems to be their only realistic hope at this point of addressing the economic crisis in their countries in a substantial way any time within the next decade or more.

Even if German Chancellor Angela "Frau Fritz" Merkel's current governing coalition in Germany were to fall apart prior to the scheduled 2013 parliamentary election, there's no obvious prospect that a change of government in Berlin would provide any drastic change in German policy. The main opposition party, the SPD, is on board with Angie's program of impoverishing the periphery countries to enrich the German One Percent and to allow European banking corporation to avoid regulations that would provide more substantial stability to the European financial system.

Wolfgang Münchau's column focuses on a vote in the German Bundestag (lower house of parliament) on Thursday (tomorrow). They have to decide to approve German participation in the European Security Mechanism (ESM) as currently proposed - which includes financial support to the ESM. The ESM is the financial fund designed to provide emergency relief to eurozone countries. The EU summit of two weeks ago agreed that the ESM could provide direct aid to Spanish banks that are currently undercapitalized and going under.

(The option of taking those troubled banks over by the Spanish government and resolving them according to the processes established for routine bank insolvencies seems to be effectively off the agenda, a whole interesting topic in itself.)

The reason the EU summit decision to allow direct aid to Spanish banks from the ESM was important is that Frau Fritz wanted Spain to take on more state debt to bail out the private banks. That would make Spain debt-to-GDP ratio worse, putting upward pressure on bond rates that are already bouncing up to 7% there on some days, a level which would force Spain into bankruptcy. If Spain borrowed the bailout money for the private banks by taking on more sovereign debt, they would find themselves under even more drastic pressure from Frau Fritz and her subservient EU government collaborators for austerity, austerity, austerity for the periphery countries, though not so much in Germany itself.

The EU summit decision looked to optimists (Pollyannas?) like an alternative. The ESM would provide the funding directly to the Spanish private banks and the Spanish government and public debt would be off the hook for that burden.

But, as Münchau points out, Frau Fritz is insisting that the ESM support to the Spanish banks be in the form of credits for which the Spanish government would be on the hook for paying back. Yes, the idea is as "witless" as it sounds, to use Münchau's description. In explaining why it is so, he reminds us of a fact far too little mentioned in discussions of the European crisis (my emphasis):

Indem Spanien seine Banken rettete, geriet der Staat selbst in Schwierigkeiten. Genau das war vor einigen Jahren auch das Problem in Irland. Der irische Staat hatte kein Schuldenproblem, bis er auf deutschen Druck anfing, mit Milliardenaufwand seine Banken zu retten.

[Insofar as Spain rescues its banks, the state itself comes into difficulties. {I.e., the worsening debt-to-GDP ratio} Exactly that was also the problem a few years ago in Ireland. The Irish state had no debt problem until it began under German pressure to rescue its banks with outlays of billions.]
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