The Eurozone's Winter of Discontent Approaches Shakespearean Proportions

As if to spoil the relaxed tone of the elite gathering of Frankfurt bankers last week, Angela Merkel issued a stern warning on the future of the Eurozone. “There’s a rumour going around that states cannot go bankrupt,” said Chancellor Merkel. “That rumour is not true.” Since then, Germany’s financial institutions have been busy checking their exposure to Europe’s poorer nations, and the available data is pointing to a collapse of the 16-nation Eurozone by late this year, and to a possible disintegration, for all practical purposes, of the European Union itself at some point in 2010.

Angela Merkel’s Shakespearean flourish was perhaps necessary to get the world to realize that, if governments go too far in bailing out banks and corporations, they could face insolvency themselves. While her critics suggest that the “countries-going-bankrupt” scenario is influenced more by Ms. Merkel’s exposure to scientific (Marxist) socialism during her early years (she was educated at the University of Leipzig and the Berlin-Adlershof Academy of Sciences in the German Democratic Republic) than by any real grasp of international economics, the hard facts simply cannot be ignored.

Like her counterparts in Europe, Chancellor Merkel has expressed her displeasure at the manner in which Germany’s bailouts have unfolded. In particular, despite being provided with US$52.3 billion in guarantees, Munich’s Hypo Real Estate (HREHY.PK) remains a prime candidate for full and comprehensive nationalization. The fate of Commerzbank (CRZBY.PK), Germany’s second-largest consumer bank, continues to hang in the balance despite the government acquiring a 25% stake as part of a rescue package. But of even greater concern today is Deutsche Bank, (DB) whose fourth-quarter loss of $6.48 billion sent shock waves through the corridors of power in Berlin.

Quite obviously, Angela Merkel was drawing on her most-recent experiences with bailouts in Germany to point to the sorry state of affairs within the Eurozone. The sovereign debt matrix is self-explanatory: compared with German Bunds which are yielding around 3%, 10-year government bonds for Greece, Ireland and Spain are being priced at 5.75%, 5.25% and 4.20% respectively; credit default swap spreads are reflecting the same diversity in sovereign risks. Alarmed by the situation, Luxembourg’s finance minister, Jean-Claude Juncker, boldly suggested that the 16 Eurozone nations should issue “common debt securities”. Ms. Merkel responded by emphasizing that the need of the hour was for countries like Greece, Italy, Spain, Ireland and Portugal to implement drastic austerity measures and to severely curtail welfare spending. “This common Euro Bond is a non-starter,” a German finance ministry official told Der Spiegel earlier today.

The problem outside the Eurozone but within the EU is even more serious. And, in that respect, Chancellor Merkel possesses the unique perspective derived from first-hand knowledge of the circumstances surrounding the fall of the Berlin Wall in 1989. Very specifically, and albeit with the wisdom of 19-year hindsight, she is best positioned to conclude that the rush to draw former Soviet satellites into the EU orbit may well have been a blunder of true Shakespearean proportions, driven by political rather than economic considerations.

Fortunately, efforts to incorporate Ukraine into the European community have been shelved for the present. But the deep-rooted problems in the Baltics and in South-Eastern Europe only show that the objective of achieving a decisive end to the Cold War should not have been confused with booming growth prospects. In other words, democracy is no excuse for unbridled leverage. In their communism-to-free market transitions, virtually all the former Soviet satellites (with one or two exceptions) were supported by massive debt from western banks, without appropriate considerations for the size and capacity of individual economies (and consumers within those economies) to service loans.

Der Spiegel, in an analysis following Chancellor Merkel’s warnings on sovereign defaults, forecast that “some countries might have to leave the club.” That forecast relates to the Eurozone currency umbrella. What Europe has not started talking about publicly is the sheer complexity and magnitude of the challenges that 25% of the EU’s new members (in Eastern Europe) are bringing to the current crisis.

Disclosure: Short ADRE, GUR.

Comments

[SeekingTruth:]

Rakesh, What happens when Welfare states significantly curtail welfare spending when the vast number of welfare recipients are already suffering more than at any time in memory?
They have been conditioned for disproportionate assistance and like domesticated pets, have little or no ability (or opportunity) to fend for themselves.

Are we in the early stages of a certain late 18th century type episode experienced by the French, at least in some of the countries?

Feb 04 01:17 PM

[Gedankonomist:]

How is it that Deutsche Bank and Commerzbank are sinking and yet the blame is placed on the poorer EU states?

I'm surprised Merkel was from the DDR. Since she went to school there, she must have been a member of the Communist party (otherwise you don't go to school, you go work in the factory).

But Merkel is right about the idea of nations going bankrupt.

I'd say that's more of an "Austrian school" philosophy than a Marxist one. After all, Marx would favor EU expansion and a socialist world government. And that is exactly what the EU is a building block for.

Feb 04 02:29 PM

[Rakesh Saxena:]

Yes, numerous people have suggested that Angela Merkel's father (a pastor) must have had close communist links since the family was allowed to travel freely between East/West Germany. Ms. Merkel does not deny that she was a member of the communist-led Free German Youth movement.

On another note, I'm not sure if I agree with your view of the Marxist outlook for Europe. The works of Rosa Luxemburg and her contemporaries [pre-1920s] appear to express strong disagreements with European "socialist" parites with respect to control over the means of production. But this matter is certainly worth investigating further (particularly in today's context) and I will address this in a forthcoming article.

Finally, the failure of the German banks cannot be blamed on the poorer EU states; on the contrary, my view is that the German banks thought they saw a unique opportunity to lend at above-average rates and collect huge fees, and now they are paying the price. Many thanks - Rakesh


On Feb 04 02:29 PM R Jensen wrote:

> How is it that Deutsche Bank and Commerzbank are sinking and yet
> the blame is placed on the poorer EU states?
>
> I'm surprised Merkel was from the DDR. Since she went to school there,
> she must have been a member of the Communist party (otherwise you
> don't go to school, you go work in the factory).
>
> But Merkel is right about the idea of nations going bankrupt. <br/>
>
> I'd say that's more of an "Austrian school" philosophy than a Marxist
> one. After all, Marx would favor EU expansion and a socialist world
> government. And that is exactly what the EU is a building block for.

Feb 04 10:59 PM

[Rakesh Saxena:]

Seeking Truth: One consequence of curtailing welfare spending will be street demonstrations, and other forms of popular unrest. We are already seeing this phenomenon take shape, in traditional Europe and in the former Soviet satellites. Immigration is another very touchy issue now. Yes, a bit like late-18th century France but more like Europe in the 1920s--another very touch issue, but I guess we must deal with it, sooner rather than later. Many thanks - Rakesh


On Feb 04 01:17 PM SeekingTruth wrote:

> Rakesh, What happens when Welfare states significantly curtail welfare
> spending when the vast number of welfare recipients are already suffering
> more than at any time in memory?
> They have been conditioned for disproportionate assistance and like
> domesticated pets, have little or no ability (or opportunity) to
> fend for themselves.
>
> Are we in the early stages of a certain late 18th century type episode
> experienced by the French, at least in some of the countries?

Feb 04 11:06 PM

[Mad Hedge F...:]

Uh BBg While American banks have their subprime crisis, European banks are being dragged under by their lending to emerging economies in Eastern Europe. Ledd by UniCredit in Italy, Austria’s Erste Group Bank and Raiffeisen International, France’s Societe Generale, Belgium’s KBC, and Hungary’s OTP, banks have lent $1.6 trillion to companies in these formerly communist countries at cheap rates, with minimal documentation, and few questions asked. The easily available credit caused local money supplies to explode, and sparked bull markets in both stocks and currencies. Emerging Europe grew at rates double and triple rates in the West, as local companies pumped up on steroids became the master of leverage. Now $400-$600 billion is due for rollovers this year from nonexistent credit markets, and the chickens….make that vultures have come home to roost. Economic growth has fallen off a cliff, with Poland’s seasonally adjusted industrial output down in December a precipitous 7.4% YOY. The Polish stock market fell 48% last year, and the zloty of off 40% again the dollar from its June peak. The Central European Equity Fund (CEE) has crashed 80% in eight months. The crisis is so severe, it may postpone Poland’s entry into the Euro block, which had been scheduled for 2011. Home mortgage borrowers are in especially bad shape. Up to 50% of their loans were denominated in Swiss francs, so the collapsing Polish currency has caused a near doubling of borrowers’ monthly payments and principals since last year. Austria really has its knickers in a twist, as these heavily syndicated loans account for 80% of GDP. A 10% default rate could wipe out the entire banking system there. Germany has the smallest loan exposure, but has the most to lose, with 25% of its exports headed east. It is now in negotiation with its partners in the EC to cobble together a bailout with the help of the IMF to provide bridge financing for these loans, and hopefully ward off a further economic collapse. It looks like the headlines in Europe are about to get uncharacteristically sensational.

Mar 01 11:11 PM

[Rakesh Saxena:]

You are correct Sir. The East European situation wil get even more messy as we move along. - Rakesh


On Mar 01 11:11 PM The Mad Hedge Fund Trader wrote:

> Uh BBg While American banks have their subprime crisis, European
> banks are being dragged under by their lending to emerging economies
> in Eastern Europe. Ledd by UniCredit in Italy, Austria’s Erste Group
> Bank and Raiffeisen International, France’s Societe Generale, Belgium’s
> KBC, and Hungary’s OTP, banks have lent $1.6 trillion to companies
> in these formerly communist countries at cheap rates, with minimal
> documentation, and few questions asked. The easily available credit
> caused local money supplies to explode, and sparked bull markets
> in both stocks and currencies. Emerging Europe grew at rates double
> and triple rates in the West, as local companies pumped up on steroids
> became the master of leverage. Now $400-$600 billion is due for rollovers
> this year from nonexistent credit markets, and the chickens….make
> that vultures have come home to roost. Economic growth has fallen
> off a cliff, with Poland’s seasonally adjusted industrial output
> down in December a precipitous 7.4% YOY. The Polish stock market
> fell 48% last year, and the zloty of off 40% again the dollar from
> its June peak. The Central European Equity Fund (seekingalpha.com/symbo...)
> has crashed 80% in eight months. The crisis is so severe, it may
> postpone Poland’s entry into the Euro block, which had been scheduled
> for 2011. Home mortgage borrowers are in especially bad shape. Up
> to 50% of their loans were denominated in Swiss francs, so the collapsing
> Polish currency has caused a near doubling of borrowers’ monthly
> payments and principals since last year. Austria really has its knickers
> in a twist, as these heavily syndicated loans account for 80% of
> GDP. A 10% default rate could wipe out the entire banking system
> there. Germany has the smallest loan exposure, but has the most to
> lose, with 25% of its exports headed east. It is now in negotiation
> with its partners in the EC to cobble together a bailout with the
> help of the IMF to provide bridge financing for these loans, and
> hopefully ward off a further economic collapse. It looks like the
> headlines in Europe are about to get uncharacteristically sensational.

Mar 02 02:36 PM