What happens when you attempt a cold shutdown of one of the biggest debt spirals that the world has ever seen? Well, we are about to find out. The politicians in Europe have decided that they are going to “take their medicine” and put strict limits on budget deficits. They have also decided that the European Central Bank is not going to engage in reckless money printing to “paper over” the debts of troubled nations. This may all sound wonderful to many of you, but the reality is that there is always a tremendous amount of pain whenever a massive debt spiral is interrupted. Just look at what happened to Greece. Greece was forced to raise taxes and implement brutal austerity measures. That caused the economy to slow down and tax revenues to decline and so government debt figures did not improve as much as anticipated. So Greece was forced to implement even more brutal austerity measures. Well, that caused the economy to slow down even more and tax revenues declined again. In Greece this cycle has been repeated several times and now Greece is experiencing a full-blown economic depression. 100,000 businesses have closed and a third of the population is living in poverty. But now Germany and France intend to impose the “Greek solution” on the rest of Europe. This is going to create the conditions needed for a “perfect storm” to develop and it means that the European financial system is heading for an implosion of historic proportions.
The easiest way to deal with a debt spiral is to let it keep going and going. That is what the United States has done. Sure, “kicking the can down the road” makes the crisis much worse in the long run, but bringing the pain into the present is not a lot of fun either.
Europe has decided to do something that is unprecedented in the post-World War II era. They have decided to put very strict limits on budget deficits and to impose tough sanctions on any nations that break the rules. They have also decided that they are not going to allow the European Central Bank to fund the debts of troubled nations with reckless money printing.
Without a doubt, this is a German solution for a German-dominated Europe. Germany does not want to pay for the debt mistakes of other EU nations, and so they are shoving bitter austerity down the throats of those that have gotten into too much debt.
But this solution is not going to be implemented without a massive amount of pain.
In fact, this solution is going to make a massive financial collapse much more likely. The following are 17 signs that the European financial system is heading for an implosion of historic proportions….
#1 As noted above, when you reduce government spending you also slow down the economy. We have already seen what brutal austerity has done to Greece – 100,000 businesses have shut down, a third of the population is living in poverty and there is rioting in the streets. Now that brand of brutal austerity is going to be imposed in almost every single nation in Europe.
#2 As the economy slows down in Europe, unemployment will rise. There are already 10 different European nations that have an “official” unemployment rate of over 10 percent and the next recession has not even officially started yet.
#3 Before it is all said and done, the EU nations that are drowning in debt will likely need trillions of euros in bailout money just to survive. But at this point Germany and the other wealthy nations of northern Europe are sick and tired of bailouts and do not plan to hand over trillions of euros.
#4 The European Central Bank could theoretically print up trillions of euros and buy up massive amounts of European sovereign debt, but this would go against existing treaties and most of the major politicians in Europe are steadfastly against this right now. But without such intervention it is hard to see how the ECB will be able to keep bond yields from absolutely skyrocketing for long. In fact, without massive ECB intervention it is hard to see how the eurozone is going to be able to stay together at all. Graeme Leach, the chief economist at the Institute of Directors, said the following recently….
“Unless the ECB begins to operate as a sovereign lender of last resort function, with massive purchases of eurozone public debt, the inexorable logic is that the eurozone will break up.”
#5 European leaders are hoping that the new treaty that was just agreed to will be ratified by the end of the summer. In reality, it will probably take much longer than that. German Chancellor Angela Merkel has made it clear that the solution to this debt crisis is going to take a long time to implement….
“It’s a process, and this process will take years.”
Unfortunately, Europe does not have years. Europe is rapidly running out of time. A massive financial crisis is steamrolling right at them and they need solutions right now.
#6 Sadly, the cold, hard reality of the matter is that none of the fundamental problems that Europe is facing were fixed by this recent “agreement” as Ambrose Evans-Pritchard recently noted in one of his columns….
There is no shared debt issuance, no fiscal transfers, no move to an EU Treasury, no banking licence for the ESM rescue fund, and no change in the mandate of the European Central Bank.
In short, there is no breakthrough of any kind that will convince Asian investors that this monetary union has viable governance or even a future.
Germany has kept the focus exclusively on fiscal deficits even though everybody must understand by now that this crisis was not caused by fiscal deficits (except in the case of Greece). Spain and Ireland were in surplus, and Italy had a primary surplus.
#7 Nobody wants to lend to European banks right now. Everyone knows that there are dozens of European banks in danger of failing, and nobody wants to throw any more money into those black holes. The U.S. Federal Reserve and the European Central Bank have been lending them money, but a lot of European banks are already starting to run out of “acceptable forms of collateral” for those loans as one Australian news source recently explained….
“If anyone thinks things are getting better, they simply don’t understand how severe the problems are,” a London executive at a global bank said. “A major bank could fail within weeks.”
Others said many continental banks, including French, Italian and Spanish lenders, were close to running out of the acceptable forms of collateral, such as US Treasury bonds, that could be used to finance short-term loans.
Some have been forced to lend out their gold reserves to maintain access to US dollar funding.
So will the U.S. Federal Reserve and the European Central Bank keep lending them money once they are out of acceptable collateral?
If not, we could start to see banks fail in rapid succession.
Charles Wyplosz, a professor of international economics at Geneva’s Graduate Institute, is absolutely certain that we are going to see some major European banks collapse….
“Banks will collapse, including possibly a number of French banks that are very exposed to Greece, Portugal, Italy and Spain.”
#8 Not only does nobody want to lend money to them, major banks all over Europe are also dramatically cutting back on lending to consumers and businesses as they attempt to meet new capital-adequacy requirements by next June.
According to renowned financial journalist Ambrose Evans-Pritchard, European banks need to reduce the amount of lending on their books by about 7 trillion dollars in order to get down to safe levels….
Europe’s banks face a $7 trillion lending contraction to bring their balance sheets in line with the US and Japan, threatening to trap the region in a credit crunch and chronic depression for a decade.
When nobody wants to lend to the banks, and when the banks severely cut back on lending to others, that is called a “credit crunch”. In such an environment, it is incredibly difficult to avoid a major recession.
#9 European banks are absolutely overloaded with “toxic assets” that they are desperate to get rid of. Just as we saw with U.S. banks back in 2008, major European banks are busy trying to unload mountains of worthless assets that have a book value of trillions of euros. Unfortunately for the banks, virtually nobody wants to buy them.
#10 European bond yields are still incredibly high even though the European Central Bank has spent over 274 billion dollars buying up European government bonds.
Up until now, the European Central Bank has been taking money out of the system (by taking deposits or by selling assets for example) whenever it injects new money into the system by buying bonds. That makes this different from the quantitative easing that the U.S. Federal Reserve has done. But at some point the European Central Bank is going to run out of ways to take money out of the system, and when that happens either the Germans will have to allow the ECB to print money out of thin air to buy bonds with or we will finally see the market determine the true value of European government bonds.
#11 Bond yields are going to become even more important in 2012, because huge mountains of European sovereign debt are scheduled to be rolled over next year. For example, Italy must roll over approximately 20 percent of its entire sovereign debt during 2012.
#12 Once the new treaty is ratified, eurozone governments will lose the power to respond to a major recession by dramatically increasing government spending. So if the governments of Europe cannot spend more money in response to the coming financial crisis, and if the ECB cannot print more money in response to the coming financial crisis, then what is going to keep the coming recession from turning into a full-blown depression?
#13 Credit rating agencies are warning that more credit downgrades may be coming in Europe. For example, Moody’s recently stated the following….
“While our central scenario remains that the euro area will be preserved without further widespread defaults, shocks likely to materialise even under this ‘positive’ scenario carry negative credit and rating implications in the coming months. And the longer the incremental approach to policy persists, the greater the likelihood of more severe scenarios, including those involving multiple defaults by euro area countries and those additionally involving exits from the euro area.”
#14 S&P has put 15 members of the eurozone (including Germany) on review for a possible credit downgrade.
#15 The stock prices of many major European banks are in the process of collapsing. If you doubt this, just check out the charts in this article.
#16 Bank runs have begun in some parts of Europe. For example, a recent article posted on Yahoo News described what has been going on in Latvia….
Latvia’s largest bank scrambled Monday to head off a run among depositors who were gripped by rumours of the bank’s imminent ruin.
Weekend rumours that Swedbank was facing legal and liquidity problems in Estonia and Sweden sent thousands of Latvians to bank machines on Sunday, with some lines reaching as many as 50 people.
The Greek banking system is literally on the verge of collapse. According to a recent Der Spiegel article, the run on Greek banks is rapidly accelerating….
He means that the outflow of funds from Greek bank accounts has been accelerating rapidly. At the start of 2010, savings and time deposits held by private households in Greece totalled €237.7 billion — by the end of 2011, they had fallen by €49 billion. Since then, the decline has been gaining momentum. Savings fell by a further €5.4 billion in September and by an estimated €8.5 billion in October — the biggest monthly outflow of funds since the start of the debt crisis in late 2009.
#17 There are already signs that European economic activisty (as well as global economic activity) is really starting to slow down. Just consider the following statistics from a recent article by Stephen Lendman….
In November, French business confidence fell for the eighth consecutive month. In October, Japanese machinery orders dropped 6.9%, following an 8.2% plunge in September.
South Africa just reported a 5.6% drop in manufacturing activity. Britain recorded a 0.7% decline. China’s October exports fell 1.7% after dropping 3.8% in September.
Korea’s exports are down three consecutive months. Singapore’s were off in September and October. Indonesia’s plunged 8.5% in October after slipping 2% in September. India’s imploded 18.3% after being flat in September.
Are you starting to get the picture?
Europe is in a massive amount of trouble.
The equation is simple….
Brutal austerity + toxic levels of government debt + rising bond yields + a lack of confidence in the financial system + banks that are massively overleveraged + a massive credit crunch = A financial implosion of historic proportions
Unless something truly dramatic happens, the economy of Europe is a dead duck.
There is no way that Europe is going to be able to substantially reduce the flow of money coming from national governments and substantially reduce the flow of money coming from the banks and still be able to avoid a major recession.
Look, I want it to be very clear that I am in no way advocating government debt in this article. It is just that under the debt-based monetary paradigm that we are all operating under, there is no way that you can dramatically reduce government spending without experiencing a whole lot of pain.
An economic “perfect storm” is developing in Europe. All of the things that need to happen for a major recession to occur are falling into place.