[The best analysis of the global economic tsunami about to overtake us as you are likely to read.]
Author, ‘Planet Ponzi’
You can already check off the foreign affairs issues that are going to dominate this election cycle. Iran. Israel. North Korea. The rise of China. Pakistan. Afghanistan. Global jihad. Drug crime in Mexico. Oil security.
Don’t get me wrong. Those things are all important. If the frigid stand-off between Iran and its enemies flickers into outright conflict, the economic consequences — forget the strategic ones, for a moment — could throw the whole world into a much deeper and more savage recession.
But those issues I’ve listed have a kind of static quality. Even when things change, there’s a seen-it-before quality to the news headlines. And meantime, there’s a huge cataclysm unfolding in Europe. It’s a cataclysm in slo-mo, I’ll grant you, and it doesn’t involve oil, nukes or terrorism — yet it’s profoundly central to the future of American prosperity and the global economy. Indeed — and I’ll come to this later — it may also have implications for the long-term health of global democracy. It’s something our politicians need to be talking about.
But let’s start with the cataclysm. The European Central Bank (ECB) is, quite rightly, concerned about the health of the European banking sector, which is vastly over-exposed to weak sovereign borrowers and a property market which is wildly over-inflated in a number of countries. Many European banks don’t carry sufficient capital to cover their potential losses.
Indeed, Deutsche Bank’s Josef Ackermann has publicly stated that numerous European banks “would not survive having to revalue sovereign debt held on the banking book at market levels.” Given that market levels represent the best available estimate of the value of that debt, Ackermann is saying that a large number of European banks are effectively insolvent. Since the remaining banks have huge exposures to those failing banks, it’s not to much to say that the European banking sector is currently bankrupt. An entire continent is bust.
It gets worse. There are good, bad and terrible policy reactions to disaster. A good policy reaction would follow the Swedish model, following that country’s own experience of debt crisis in the early 1990s. Bad private sector debts were rapidly eliminated via default and bankruptcy. Lenders who made bad credit decisions lost money. If they made terrible lending decisions, they went out of business. Via these tough measures, private sector debt dropped rapidly. Although public sector debt rose in response to the crisis, fiscal discipline was rapidly restored and the need for austerity communicated effectively to the Swedes. There was broad political and popular acceptance for the measures necessary.
Europe, however, has ignored its own ‘Nordic model,’ preferring instead to pioneer its own uniquely awful road to collapse. In the Eurozone today, it’s become an inviolable rule of policy that stupid credit decisions must never be punished. Bad lenders must be allowed to remain in business, subsidized by the taxpayers . Sovereign borrowers cannot be allowed to default. This is moral hazard elevated to profound political principle.
So, for example, the ECB recently lent €489 billion (around $643 million) to the continent’s banks. The loans are priced at a stunningly attractive rate of just 1%. The collateral requirements imposed by the ECB have been deliberately weakened to the extent that they’ve become more or less meaningless. (I estimate that some 37,000 different securities are now acceptable as collateral.) Because banks have nowhere useful to put their money (even they’re not dumb enough to lend to each other now), they are increasingly willing to buy sovereign debt, no matter how huge and obvious the problems faced by those sovereign borrowers.
So there’s the carousel. The ECB lends cheap money against bad collateral to insolvent banks who use their cash to prop up mortally wounded sovereign borrowers. For all the (German) talk of austerity and responsibility, all that has actually happened in practice is that a massive bailout program is being handled by the ECB under the guise of ordinary lending activities. Germany, meanwhile, as the only strong nation in a fractured continent is calling the shots to an increasingly unhealthy degree.
No such carousel can last for ever. On the contrary, with every turn of the wheel, debt increases. Sovereign borrowers increase their liabilities. Banks increase their exposures to precisely those assets they should most avoid. The ECB’s own balance sheet is deteriorating all the time. Europe is staggering ever further into bankruptcy. When the meltdown comes — and meltdowns always arrive in the end — the impact will be on a vastly larger scale than the Lehman collapse. Bear in mind that Lehman failed with net debt of ‘only’ $129 billion. Italy’s outstanding debt is around twenty times that amount.
The United States is no more immune from that forthcoming tsunami than Europe was from the collapse of the US subprime market in 2008. Indeed, because the sums involved are so much larger today, the likely consequences will be substantially greater too.
Naturally, the US cannot direct European policy, and US election debates are only feebly heard in Europe. Nevertheless, American policy is at present woefully collusive. Take, for example, Bloomberg’s recent revelation that the Federal Reserve conspired to lend as much as $1.2 trillion to a variety of banks – many of them desperately weak European lenders — during the crisis of 2008. Those loans were not approved by Congress. Indeed, they were not even revealed to Congress.
The Fed has also been offering cheap currency swap lines to European central banks, with the deliberate aim of helping weak European banks from facing up to market realities. In effect, the Fed is doing all it can to assist European policy makers in their truth-avoidance strategy. If the euro fails, the Fed — or rather, the American taxpayer — will own a fine portfolio of defaulted bonds in a dying currency as a reward for its efforts.
Meantime, the Fed is printing money, thereby putting pressure on the ECB to do the same. And the federal government is borrowing money in seemingly limitless amounts, thereby giving some kind of cover to the Eurozone’s ludicrous plans for massively leveraging the (already excessive) bailout fund. Economists such as Paul Krugman lend academic respectability to this kind of nonsense by trying to cut-and-paste theoretical solutions from the Great Depression, some eighty years ago. Those solutions have never been tested in the real world and make no sense in the vastly different climate of today.
These things matter hugely. Over the next four years, no area of foreign policy will impact American prosperity more than these issues — and to date, every single major policy move has been profoundly wrong.
And democracy is at risk. Why was the Fed able to lend $1.2 trillion without informing the American people? Or place the US Taxpayer dollars at risk in the event of a Euro collapse? Why are there no elected politicians in the Italian government? Why is Angela Merkel, the German chancellor, planning to campaign on French President, Nicolas Sarkozy’s behalf? Why was George Papandreou removed from high office in Greece because he insisted on putting a euro-bailout package to a popular vote?
These things are all abuses of democracy — and they’re becoming more common. Iran, Israel and all those other policy challenges matter for sure, but they’ve long been on our policy radar and our options and dilemmas are well-known, well-discussed. The current problems in Europe are utterly new. They threaten economic catastrophe on a scale that the United States hasn’t known since 1929. And at the moment our solutions, all of them, are dangerously wrong.
Mitch Feierstein is the author of Planet Ponzi and blogs at www.PlanetPonzi.com.