EU Bail In Rules Ignored By Italy – Mother
Of All Systemic Threats and World War?
by George Friedman for Mauldin Economics via Forbes
Italy has been in a crisis for at least eight months, though mainstream
media did not recognize it until July. This crisis has nothing to do with
Brexit, although opponents of Brexit will claim it does. Even if Britain had
voted to stay in the EU, the Italian crisis would still have been gathering
speed.
The high level of non-performing loans (NPLs) has been a problem since
before Brexit. It is clear that there is nothing in the Italian economy that
can reduce them. Only a dramatic improvement in the economy would make it
possible to repay these loans. And Europe’s economy cannot improve
drastically enough to help. We have been in crisis for quite a while.
Banks were simply carrying loans as non-performing that were actually in
default and discounting the NPLs rather than writing them off. But that only
hid the obvious. As much as 17 percent of Italy’s loans will not be repaid.
This will crush Italian banks’ balance sheets. And this will not only be in
Italy.
Italian loans are packaged and resold, and Italian banks take loans from
other European banks. These banks in turn have borrowed against Italian debt.
Since Italy is the fourth largest economy in Europe, this is the mother of
all systemic threats.
Bail-Ins, Not Bail Outs
The only way to help is a government bailout. The problem is that Italy is
not only part of the EU, but part of the eurozone. As such, its ability to
print its way out of the crisis is limited. In addition, EU regulations make
it difficult for governments to bail out banks.
The EU has a concept called a bail-in, which means the depositors and
creditors to the bank will lose their money. This is what the EU imposed on
Cyprus. In Cyprus, deposits greater than 100,000 euros ($111,000) were seized
to cover Cypriot bank debts. While some was returned, most was not.
The bail-in
is a formula for bank runs. The money seized in Cyprus came from
retirement funds and payrolls. Rome wants to make sure depositors don’t lose
their deposits. A run on the banks would guarantee a meltdown. A meltdown
would topple the government and allow the Five Star Movement, a Euroskeptic
party, a good shot at governing.
The bail-in rule exists because Berlin doesn’t want to bail out banking
systems using German money. Anti-European sentiment in Germany is already
growing, with the rising popularity of the nationalist Alternative for
Germany party. The Germans feel that they are fiscally responsible, and they
resent paying for others’ irresponsibility.
Therefore, the German government’s hands are tied. It cannot accept a
Europe-wide deposit insurance system, as it would put German money at risk.
Nor can it permit overprinting of the euro. That would come out of the German
hide as well.
The Italians can only try to manage the problem by ignoring EU rules,
which is what they are doing.
Crisis Spreading
And another European economic crisis is brewing. Germany derives nearly
half of its GDP from exports. All the discipline and frugality of the Germans
can’t hide the fact that their prosperity depends on their ability to export.
The ability to export depends on the demand of their customers.
Germany exports heavily to the EU, and the Italian crisis could cause an
EU-wide banking crisis. That would cut deeply into German exports, slashing
GDP and driving up unemployment. Logically, the Germans should be desperately
trying to head off an Italian default. But Chancellor Angela Merkel is not
eager to announce to the German people that their economy depends on Italy’s
well-being.
Clearly, German businesses are aware of the danger. German production of
capital goods fell nearly 4 percent from last month. German production of
consumer goods rose only 0.5 percent.
German consumption can’t possibly make up for half of Germany’s GDP. In
addition, the IMF recently said Deutsche Bank is the single largest
contributor to systemic risk in the world. A rippling default through Europe
will hit Deutsche Bank.
The US Piece of the Puzzle
However, the real threat to Germany is a U.S. recession. Recessions are
normal, cyclical events that are necessary to maintain economic efficiency by
culling inefficient businesses. The U.S. has one on average once every six to
seven years. Substantial irrationality has crept into the economy. The yield
curve on interest rates is beginning to flatten. Normally, a major market
decline precedes a recession by three to six months. That would indicate that
it likely won’t happen in 2016, but it could in 2017.
Given the stagnation in Europe, Germany has been shifting its exports to
other countries, particularly the U.S. If the U.S. goes into recession,
demand for German goods, among others, will drop. But in the case of Germany,
a 1 percent drop in exports is nearly a half percent drop in GDP. With
Germany’s minimal growth rate, drops of a few points could drive it into
recession and high unemployment.
A U.S. recession would not only hit Germany, but the rest of Europe. Many
countries export to the U.S., either directly or through producing components
for German and British products. The U.S. is somewhat exposed to foreign debt
defaults, but not enough to bring down the American system. The United
States, with relatively low export percentages and low exposure, can
withstand its cycle. It is not clear that Europe can.
The Big Picture
The EU must address Italy’s and Germany’s problems, but its regulations
make finding solutions very difficult. This all was put in motion in 2008,
but it is not a 2008 crisis. This is most of all a political and
administrative crisis. The European system was created to administer peace
and prosperity, not to manage the complex gyrations of an economy.
The argument from those who are against internationalism is simple. Sometimes
the major international systems fail. The less entangled you are with these
systems, the less damage you suffer. And since such systemic failures
historically leads to political conflict and crisis, the case for nationalism
increases – assuming you aren’t already trapped in the systemic crisis. In
any event, increasing nationalism follows systemic failure like night follows
day.
Italy’s contagious crisis is part of a storm of instability engulfing a
region that’s home to 5 billion of the planet’s 7 billion people.
In this provocative documentary from Mauldin Economics and Geopolitical
Futures, George Friedman uncovers the crises convulsing Europe, the Middle
East and Asia … and reveals the geopolitical chess moves that could trigger
global conflict.
Watch George Friedman’s Ground-breaking Documentary ‘Crisis &
Chaos: Are We Moving Toward World War III?’ and access
the Forbes article here
Editors Note: The U.S. will not be unscathed from
the collapse of the EU banking and political system, from a new global
financial crisis or indeed a new world war. Indeed, we believe the U.S.,
being the largest debtor nation the world has ever seen, would have plenty of
its own financial, economic and geo-political challenges. Financial and economic
contagion is the likely outcome. We agree with the substantive point made in
the article and believe that an important way to protect investments and
savings in the coming years is to be diversified and have a healthy
allocation to physical gold – both in one’s possession and in secure storage,
in the safest vaults in the world.
Download
Bail-In Guide
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