Europe on the Brink

I haven't been blogging much about Europe because I felt like I was mostly repeating myself.  Europe is not an optimal currency zone.  It opted for monetary union without the fiscal or labor market integration that make America's sprawling  currency zone work. So far, the various governments have failed to mount a really credible coordinated response.  I don't see how the thing can hold together, except that Jesus, it will be hell if it all falls apart.

But it's probably worth interrupting your regularly scheduled unemployment-and-kitchen-blogging to point out that it all really seems to be coming to a head:

In an interview with IMF advisor Robert Shapiro, the bailout expert has pretty much said what, once again, is on everyone's mind: "If they can not address [the financial crisis] in a credible way I believe within perhaps 2 to 3 weeks we will have a meltdown in sovereign debt which will produce a meltdown across the European banking system. We are not just talking about a relatively small Belgian bank, we are talking about the largest banks in the world, the largest banks in Germany, the largest banks in France, that will spread to the United Kingdom, it will spread everywhere because the global financial system is so interconnected. All those banks are counterparties to every significant bank in the United States, and in Britain, and in Japan, and around the world. This would be a crisis that would be in my view more serrious than the crisis in 2008.... What we don't know the state of credit default swaps held by banks against sovereign debt and against European banks, nor do we know the state of CDS held by British banks, nor are we certain of how certain the exposure of British banks is to the Ireland sovereign debt problems."

One of my twitter followers asks: "on scale of 1 to 10 (10=buy ammo, stockpile water; 1=go buy a Birkin Bag on credit),how serious is Greek default situation?"

Well, it's never a good idea to buy expensive consumer goods on credit, unless you have terminal cancer and no scruples about stiffing your creditors.  And even then, the waiting list is going to erode most of your utility.

Quibbling aside, it's hard to know how big a deal this is.  Deutsche Bank CEO Josef Ackermann famously said that "It is an open secret that numerous European banks would not survive having to revalue sovereign debt held on the banking book at market levels."  Which is pretty freaky.  But how numerous?  What's the exposure of American banks?  I'm not sure anyone knows--and if they do, they're government regulators who aren't saying.  Which is in and of itself pretty scary, because if the news were good, you can be pretty sure that they'd share it.

Don't get me wrong: at best, it's a big deal.  But is it a "0.2% knocked off US GDP" kind of big deal, or a "Credit Anstalt and the second American banking crisis" sort of event?

The Great Depression was composed of two separate panics.  As you can see from contemporary accounts--and I highly recommend that anyone who is interested in the Great Depression read the archives of that blog along with Benjamin Roth's diary of the Great Depression--in 1930 people thought they'd seen the worst of things. 

Unfortunately, the economic conditions created by the first panic were now eating away at the foundations of financial institutions and governments, notably the failure of Creditanstalt in Austria.  The Austrian government, mired in its own problems, couldn't forestall bankruptcy; though the bank was ultimately bought by a Norwegian bank, the contagion had already spread.  To Germany.  Which was one of the reasons that the Nazis came to power.  It's also, ultimately, one of the reasons that we had our second banking crisis, which pushed America to the bottom of the Great Depression, and brought FDR to power here.

To paraphrase Oscar Levant, there is always a fine line between a banking panic, and a sovereign debt crisis--and Europe has erased that line.  Which is ultimately what happened with Creditanstalt.  Austria's inability to backstop the bank's losses turned into a continent-wide problem for both banks and sovereigns, particularly in Germany, which was of course laboring under ludicrously unpayable debts from WWI.

On the other hand, parallels are rarely perfect.  There is still the possibility that Europe will somehow pull this one out--or that the contagion will not be as bad as when we were on the gold standard.  Gold is an excellent conductor of both electricity, and financial panic.

So while I wouldn't invest in canned goods and ammunition, I wouldn't invest in Greek bonds, either.  The only way we're going to find out how bad this will get is to live through it.