We are accustomed to looking at Europe’s woes in a purely financial
context. This is a mistake, because it misses the real reasons why the EU
will fail and not survive the next financial crisis.
We normally survive financial crises, thanks to the successful actions of
central banks as lenders of last resort. However, the origins and
construction of both the the euro and the EU itself could ensure the next
financial crisis commences in the coming months, and will exceed the
capabilities of the ECB to save the system.
It should be remembered that the European Union was originally a creation
of US post-war foreign policy. The priority was to ensure there was a buffer
against the march of Soviet communism, and to that end three elements of the
policy towards Europe were established. First, there was the Marshall Plan,
which from 1948 provided funds to help rebuild Europe’s infrastructure. This
was followed by the establishment of NATO in 1949, which ensured American and
British troops had permanent bases in Germany. And lastly, a CIA sponsored
organisation, the American Committee on United Europe was established to
covertly promote European political union.
It was therefore in no way a natural European development. But in the
post-war years the concept of political union, initially the European Coal
and Steel Community, became fact in the Treaty of Paris in 1951 with six
founding members: France, West Germany, Belgium, Luxembourg and Italy. The
ECSC evolved into the EU of today, with an additional twenty-one member
states, not including the UK which has now decided to leave.
With the original founders retaining their national characteristics, the
EU resembles a political portmanteau, a piece of assembled furniture, each
component retaining its original characteristics. After sixty-five years, a
Frenchman is still a staunch French nationalist. Germans are
characteristically German, and the Italians remain delightfully Italian.
Belgium is often referred to as a non-country, and is still riven between
Walloons and the Flemish. As an organisation, the EU lacks national identity
and therefore political cohesion.
This is why the European Commission in Brussels has to go to great lengths
to assert itself. But it has an insurmountable problem, and that is it has no
democratic authority. The EU parliament was set up to be toothless, which is
why it fools only the ignorant. With power still residing in a small cabal of
nation states, national powerbrokers pay little more than lip-service to the
Brussels bureaucracy.
The relationship between national leaders and the European Commission has
been deliberately long-term, in the sense that loss of sovereignty is used to
gradually subordinate other EU members into the Franco-German line. The
driving logic has been to make the European region a protected trade area in
Franco-German joint interests, and to protect them from free markets. It was
not easy to find the necessary compromise. Since the Second World War, France
has been strongly protectionist over her own culture, insisting that the
French only buy French goods. Germany’s success was rooted in savings, which
encouraged industrial investment, leading to strong exports. These two
nations with a common border had, and still have, very different values, but
they managed to conceive and set up the European Central Bank and the euro.
In Germany, the sound-money men in the Bundesbank lost out to industrial
interests, which sought to profit from a weaker currency. This was actually
in line with her political preferences, and it was the political class that
controlled the relationship with France. In France the integrationists,
politicians again, defeated the industrialists, who sought to insulate their
home markets from German competition.
When a common currency was first mooted, two future problems were ignored.
The first was how would the other states joining the euro adapt to the loss
of their national currencies, and the second was how would the UK, with her
Anglo-Saxon market-based culture adapt to a more European model. It wasn’t
long before the latter issue was met head-on, with the withdrawal of sterling
from the Exchange Rate Mechanism, the forerunner of the euro, in September
1992.
The euro was eventually born at the turn of the century. The Franco-German
compromise led to the appointment of a Frenchman, Jean-Claude Trichet, as the
ECB’s second president. All was well, because the abandonment of national
currencies and the gradual acceptance of the euro meant that states in the
Eurozone were able to borrow more cheaply in euros than they ever could in
their own national currencies.
Bond risk was measured against German bunds, traditionally the lowest
yielding bonds in Europe. It was not long before the spread between bunds and
other Eurozone debt was commonly seen as a profitable opportunity, instead of
a reflection of relative risk. European banks, insurance companies and
pension funds all benefited from the substantial rise in the prices of bonds
issued by peripheral EU members, and invested accordingly. In turn, these
borrowers were only too willing to supply this demand by issuing enormous
quantities of debt, in contravention of the Maastricht Treaty. Bank credit
expanded as well, leaving the banking system highly geared.
The control mechanism for this explosion in borrowing was meant to be the
Exchange Stability and Growth Pact, agreed in Maastricht in 1993. This laid
down five rules, of which two concern us. Member states were bound to keep
their national budget deficits to a maximum of 3% of GDP, and national
government debt was limited to 60% of GDP. Neither Germany nor France
qualified on the debt criteria, without rigging their national accounts, and
the only reason that deficits came within the Pact was a mixture of dodgy
accounting and fortuitous timing of the economic cycle. The control mechanism
was never enforced.
So from the outset, no nation had any sense of responsibility towards the
new currency. The rules were ignored and the euro became a gravy-chain for
all member governments, spectacularly brought to public attention by the
failure of Greece.
The Eurozone’s banking system, incorporating the national central banks
and the ECB, bound together in a bizarre settlement system called TARGET,
became the means for member nations to buy German goods on credit. Very good
for Germany, you may say, but the problem was that the credit was supplied by
Germany herself. It is the same as lending money to the buyer of your
business in a rigged transaction. This flaw in the system’s construction is
now a rumbling volcano ready to blow at any moment.
The Germans want their money back, or at least don’t want to write it off.
The debtors cannot pay, and need to borrow more money just to survive.
Neither side wishes to face reality. It started with Ireland, then Cyprus,
followed by Greece and Portugal. These are the smaller creditors, which
Germany, led by its Finance Minister Wolfgang Schäuble, managed to crush into
debtor submission and are now economic zombies. The real problem comes with
Italy, which is also failing and has a debt-to-GDP ratio estimated to be over
133% and rising. If Italy goes, it will be followed by Spain and France. Herr
Schäuble cannot force these major creditors into line so easily, because at
this stage the whole Eurozone banking system will be in deep trouble, as will
the German government itself. German savers are also becoming acutely aware
that they will pick up the bill.
The first line of defence, as always, will be for the ECB as lender of
last resort to keep the banks afloat. The only way it can do this is to
accelerate the printing of euros and to monopolise Eurozone debt markets.
Whether or not the ECB can hold the currency with all these liabilities on
board its own balance sheet, and for how long, remains to be seen.
For the moment, the euro stands there like a Goliath, seemingly
invincible. It represents the anti-free-market European establishment, which
no one has dared to challenge. This surely is the underlying reason the ECB
can impose negative interest rates and get away with it. But serious cracks
are appearing. First we had Brexit, likely to be followed by other small
states wanting out. The Italian banking crisis is almost certain to come to a
head soon, and an Italian referendum on the constitution next month is also
an important hurdle to be overcome. The politicians are in panic mode,
reassuring everyone there is nothing wrong more integration and a new army
won’t cure.
The market effect, besides being a severe shock to all markets, is likely
to be two-fold. Firstly, international flows will sell down the euro in
favour of the dollar. Given the euro’s weighting in the dollar index, this
will be a major disruption for all currency markets. Secondly, Eurozone
residents with bank deposits are likely to increasingly seek refuge in
physical gold, as signs of their currency’s impending collapse emerge,
because there is nowhere else for them to go.
Whichever way one looks at it, it is increasingly difficult to accept any
other outcome than a complete collapse of this ill-found political
construction, originally promoted in US interests by a CIA-sponsored
organisation. The euro, being dependant on political cohesion instead of
original market demand, will simply cease to be money, somewhat rapidly.
The views and opinions expressed in this article are those of the
author(s) and do not reflect those of Goldmoney, unless expressly stated. The
article is for general information purposes only and does not constitute
either Goldmoney or the author(s) providing you with legal, financial, tax,
investment, or accounting advice. You should not act or rely on any
information contained in the article without first seeking independent
professional advice. Care has been taken to ensure that the information in
the article is reliable; however, Goldmoney does not represent that it is
accurate, complete, up-to-date and/or to be taken as an indication of future
results and it should not be relied upon as such. Goldmoney will not be held
responsible for any claim, loss, damage, or inconvenience caused as a result
of any information or opinion contained in this article and any action taken
as a result of the opinions and information contained in this article is at
your own risk.
