Why Europe Is Still In Peril, In Two Charts

A lot of analysts, including myself, have given the European situation a rest since last year. There were certainly some signs that the ECB and IMF had slowed (if not stopped) the deterioration by providing liquidity backstops to the addled banking system. But perhaps that was just the calm before the storm.

In truth, things were still was probably just as perilous as ever up until yesterday when the ECB and IMF decided to start a banking panic by enforcing a haircut of up to 10% on bank depositors. That was literally the stupidest thing that anyone has done since the Euro crisis began, and while it may not lead to utter disaster, there is a significant chance that it will. Not only is it excruciatingly unjust (it’s theft!), it is also incredibly suicidal. Many, many Spaniards, Italians, Greeks and Portuguese will have looked at the Cyprus haircut in horror, and wondered “Am I next?” Some of those will withdraw their money from the bank and stuff it in a mattress or into tangible assets, furthering stressing the already-fragile and highly-leveraged European banking system. Even a 1% drop in European deposits would lead to over €100 billion of withdrawals.

The background to this is soaring European unemployment:


The people running the European financial system and engineering the bailouts and austerity (ECB, EU, IMF, Germany) have ploughed on through with more and deeper austerity even as European countries (other, of course, than Germany) have run up to higher and higher unemployment levels. Spain and Greece are above 25%. Italy is above 10%, and Portugal above 15%. Hiking taxes and cutting spending is leading to more and more people in unemployment oblivion. That isn’t healthy. Let’s not forget what happened to Germany the last time when over 25% of its people found themselves unemployed:


If bank runs materialise across Europe next week, the unemployment situation is most likely to worsen even further. If that happens, expect more and more unemployed, underemployed and angry Europeans to start voting for increasingly radical political parties. This is suicidal. Europe needs to not only reverse the awful, stupid Cypriot haircut, but also to put fiscal consolidation on hold (it has, lest we forget, so far been counterproductive) and start worrying about unemployment levels.


Austerity & Extremism

I noted yesterday that anything the government gives you, the government can take away, and that dependency on government services — which might be withdrawn — leaves citizens weak and unfree.

One cause for the withdrawal of government that I neglected to mention (intentionally, as I hoped someone would pick it up in comments) was the matter of austerity. While the example I was bouncing my ideas off — of denying treatment to smokers or the obese — remains theoretical, the withdrawal of government services and spending as a result of austerity is very much a reality, especially in Europe.

To wit:

That more austerity produces less GDP (and very often bigger deficits due to falling tax revenues — as exemplified by Portugal) is self-evident. That society is — for lack of a better word — pissed with this outcome is the clear reality on the ground. Made dependent upon government largesse, society now finds the crutch of services, spending and government jobs withdrawn. And of course, this has political blowback.

As Tyler recently put it “nationalism is back with a bang”. But it’s not just the nationalists who are doing well, so too are the far left. Just as in the 1930s many people who have been failed by the mainstream parties are angry, and their instinctual reaction is to reject the political mainstream and look to the fringes.

Let’s look at Greece.

From the WSJ:

Two political mavericks—one a soft-spoken former Communist, the other a firebrand nationalist—are tapping into public anger at incumbents and the harsh austerity measures Greece must adopt to stay in the euro, as support for mainstream parties withers ahead of May 6 elections.

Right-wing economist Panos Kammenos and left-wing lawyer Fotis Kouvelis are poles apart ideologically. But they are currently among the most popular party leaders in Greece, and their parties have sprung from nowhere to challenge Greece’s political establishment and the austerity policies that many Greeks blame for deepening their country’s economic crisis.

Between them, Mr. Kammenos’s Independent Greeks and Mr. Kouvelis’s Democratic Left could win around 20% of the vote. Their rise is cutting deeply into support for Greece’s two mainstream parties — the conservative New Democracy party and the center-left Socialists, known as Pasok — that share power in a fractious coalition government.

Given the utter train wreck that the Greek economy is, it is shocking that these figures are not significantly higher. In the recent first round of the French Presidential election, the far left and far right polled over 30%, a post-WW2 high.

All over Europe, the unemployed and dispossessed are becoming increasingly frustrated with the status quo.

From Bloomberg:

Europe’s front against austerity has expanded in recent weeks after Spain struggled to meet European Union-imposed deficit targets, election campaigns in Greece faced anti- austerity rumblings and a revolt against extra spending cuts in the traditionally budget-conscious Netherlands propelled Prime Minister Mark Rutte’s coalition toward an early breakup.

Europe has been here before. Hitler came to power, lest we forget, on the back of a devastating period of German austerity.

As I noted in November:

After just two years of “austerity” measures, Germany’s economy had completely collapsed: unemployment doubled from 15 percent in 1930 to 30 percent in 1932, protests spread, and Bruning was finally forced out. Just two years of austerity, and Germany was willing to be ruled by anyone or anything except for the kinds of democratic politicians that administered “austerity” pain. In Germany’s 1932 elections, the Nazis and the Communists came out on top — and by early 1933, with Hitler in charge, Germany’s fledgling democracy was shut down for good.

It’s the same story; more austerity means more misery, means more political and social rumbling, means a greater support for radical political parties. We haven’t gotten anywhere near the scope or magnitude of the 1930s (yet), but the present European contraction has not dampened the technocratic fervour for deeper and faster cuts and tax hikes (which, quite obviously lead to bigger deficits, which trigger more austerity, ad infinitum). Could this at some point mean revolutions that put radicals into power? It becomes increasingly plausible.

And the initial problem in my view is excessive dependency on the state and centralisation. If the state makes up 50% of GDP, cutting spending in the interests of paying down debt will cause a severe contraction throughout the entire economy. If the state makes up 15% of GDP, less so. If the state is only a small fragment, austerity in the interests of paying down debt — even during a recession or depression — is feasible. If the state is a goliath, it will lead to a crippling economic contraction (and of course, the attendant realities of public fury and politcal extremism).

Centralised systems are always and by definition fragile to shocks and mismanagement, because the activities at the centre are transmitted throughout the entire system; poor decisions at the centre metastasise throughout the system. In a robust decentralised system, mismanagement only hurts at the local level, because there is less of a mechanism for the transmission of shocks.

The lesson sticks: anything the government gives you, the government can take away (sometimes deliberately, sometimes not). That could be healthcare, that could be security, that could be economic growth. If it’s delivered by central fiat, it’s fragile.

We’re All Doomers Now

How bad are things getting in the Eurozone?

Paul Krugman is getting apocalyptic:

The big story: German bonds are now being priced as a risky asset — what the FT calls the “apocalypse trade“. The interest rate on bunds, at 2.21% as I write this, is still very low by historical standards. But it’s above the rate on UK bonds (2.17%) and way above the rate on US bonds (1.88%).

The way to see this is that the market is in effect pricing in a real possibility of eurozone collapse.

In particular, market expectations seem to assume that the ECB will remain utterly indifferent to its responsibilities. The German breakeven rate, an implicit forecast of inflation over the next 5 years, is just 1 percent. That’s a disaster level, implying severe deflation in the debtor nations — or, more likely, a euro breakup.

There is a cruel and almost Shakespearean irony to all of this: the Teutonic monetarists at the ECB, with their sole mandate of price stability, and deep hostility to inflation have had the horrors of the hyperinflation of the 1920s imprinted on their memories. Really, they should have been worried about the credit contraction and austerity of the Brüning years in the early 1930s. Unemplyment shot up, industrial production slouched, hunger was rife, and Germans were willing to vote for a charismatic Austrian anti-semite bent on consolidating Europe into one.

While I do not agree with much from Keynes, he did understand that monetary contractions in a system of fractional banking can totally destroy the productive economy. His response to that was that the answer was government-driven stabilisation. My response to that is interventionism and preservation eventually turns to zombification, and that the true answer to the problem of credit contractions is noticing that fractional banking is a fundamentally unstable and dangerous system, and abolishing or significantly reforming it. But that’s an argument for another day.

From Zero Hedge:

The only quote worth noting from the just delivered speech by ECB executive board member José Manuel González-Páramo is the following: “We cannot completely delegate governance to financial markets. The euro area is the world’s second largest monetary area. It cannot depend solely on the opinions of ratings agencies and markets. It needs economic governance arrangements that are preventive and linear. This underscores my central point that a much more comprehensive approach to economic governance is now the priority for the euro area. And this means more economic and financial integration for the euro area, with a significant transfer of sovereignty to the EMU level over fiscal, structural and financial policies.”

So the ECB has lost faith in markets and now believes that a form of central planning is a better economic model.

It’s a shame they haven’t lost faith in austerity — because it is those disastrous, divisive, technocratic and wrong-headed policies that will drive Europe to the stage of bank runs and systemic collapse far quicker than anything else.

Anyway, despite the technocratic coups d’état in Italy and Greece, a federalised Europe still seems politically and socially impossible. Bureaucrats will be punished for this folly. History always sees to that.