In July of 1994, a comet named Shoemaker-Levy 9 crashed into Jupiter—it was quite a sight.
According to astronomers, Shoemaker-Levy was a comet that was captured by Jupiter’s gravity twenty or thirty years before it was discovered. As the comet circled Jupiter, at one point it passed the Roche limit—the line around a large mass where its gravity will rip apart a smaller mass by way of tidal forces.
By the time Shoemaker-Levy crashed into Jupiter, tidal forces had had their way with the comet. As the picture shows, it was no longer a single comet—it was a string of small lumps of rock and ice.
Tidal forces are pulling the European Union apart.
On one end, European governments have taken on debt and liabilities—both public and private—which they cannot possibly meet. These debts and liabilities are near-term enough that there is only one way to characterize many of the smaller European states: They are insolvent.
On the other end, Europe is unwilling to carry out sovereign default of any one of its member nations. Indeed, there is a sense that—constant drumbeat of the Germans aside—Brussels is unwilling to even contemplate the very notion of sovereign default and debt restructuring. Brussels and the European Central Bank believes in bailouts, not default, because they believe that the entire European project rests on the non-default status of all the EU members. They believe that all EU debt is backed by the entire EU, no matter how irresponsible the EU country that issued the EU debt.
As we watch Europe get closer and closer to the Global Depression, we are seeing as these two opposing forces—insurmountable debt vs. unwillingness to default and restructure—pull the continent apart as surely and relentlessly as tidal forces.
Let’s first look at the debts and responsibilities the Europeans have taken on, which they cannot fulfill.
American wags claim that its been the socialist policies of the Europeans that insure that the countries will be insolvent—and while the commitments required to fund the European social safety nets are indeed huge, this isn’t even half the story.
Certainly the member states of the Eurozone are over-committed as to pension and medical coverage, especially as the demographic bulge of the post-War baby boom starts to retire en masse, grow old, and require more and more health-care. Countries with demographic time-bombs, like Italy and Spain, are sure to suffer most.
But more than their social programs, it was really the European governments’ willingness to back-stop the private sector banks which did in European sovereign balance sheets.
I’m with the journalist Wolfgang Münchau, who very accurately pinpoints the moment when the Irish government decided to fully back its banks—September 30, 2008—as “the most catastrophic political decision taken in post-War Europe.” As Münchau points out, it wasn’t that just the Irish decided to fully back their insolvent banks—their decision obliged all the European governments to back their insolvent banks too.
Like their American counterparts, the Eurozone bureaucrats lacked the political will to implement the Sweden ‘92 solution: Nationalize the insolvent banks, liquidate the shareholders, give buzzcuts to all the bank bondholders, and clean up the banks’ balance sheets of all the crap debt, before sending them back out into the world, smaller but healthier.
Instead—for perverse political reasons and blinkered short-term-ism—the Irish and then the rest of the Eurozone governments took up as their own the burden of the insolvent European banks.
Take the Irish case: It was bad enough that they went and allowed Allied Irish Bank and Bank of Ireland to grow to be as big as they did—at year’s end 2008, AIB had total liabilities of €172 billion and Bank of Ireland total liabilities of €181 billion, while the total GDP of the Republic of Ireland was €164 billion.
But when the Global Financial Crisis happened in 2008, what did the Irish government go and do? They nationalized the banks’ losses! Prime Minister Brian Cowen in September of ‘08 went and threw a blanket-protection over the Irish banks—banks whose liabilities were twice the gross domestic product of Ireland! Cowen went and guaranteed the private debts of the Irish banks—effectively socializing the bank losses.
And not just the Irish—just about every European government basically did the same thing: All the teetering banks have all been back-stopped by their respective governments.
So what in 2008 was a banking insolvency issue was turned into a sovereign insolvency issue because of terrible decision-making.
Now, two years later, Europe is feeling the pain—should anyone be surprised that European sovereign liabilities are greater than any of them can comfortably pay? Or pay at all?
The UK is the only European nation doing anything serious about the issue of over-indebtedness by really and truly trying to slash spending and raise taxes—but then again, the UK is not in the Eurozone.
The rest of Europe? Slashing spending? Raising taxes? Hardly. They’re all making noises in that direction, but in truth, the rest of Europe is counting on the ECB to bail them out—with good reason.
As I write this (Thursday, 11/11/10), 10-year Irish bond spreads over German bunds are at 7.20%—up from 6.47% this morning, and 5.72% yesterday (Wednesday): A crash of Irish debt is imminent.
However, what is Brussels going to do? Why, it’s practically been announced: The ECB is going to save the Irish with “liquidity”—that is, propping up Irish debt by buying it.
First it was Greece last spring, now it’s Ireland. If we go by the spreads over the German bunds, up next is Portugal, then Spain, then Italy—is the European Central Bank going to save all of them with additional bursts of liquidity?
In a word, yes—and herein lies the problem, the basic contradiction of these tidal forces:
The weaker European nations are insolvent—but rather than have these countries default, and then restructure their debt, Jean-Claude Trichet and the European Central Bank want to expand liquidity: A dose of Quantitative Easing, European-style, is what they see as the only way to save all these insolvent countries—
—but the Germans won’t go for this.
