Just as Germany dominates Europe, its bankers dominate European banking circles. The German central bankers do not think like Ben Bernanke, with his “Grapes of Wrath” nightmares of deflation and depression in the 1930s U.S. Instead, in their German dreams they see a Pandora’s Box stuffed with paper money, pouring out in ever-worthless cascades while they desperately try to close the lid.
No, they don’t fear littering, they fear inflation.
A very short history of Germany during the last 90+ years
When WW I broke out Germany suspended the conversion of its currency into gold, and then decided to fund the war by borrowing, rather than raising taxes. It lost the war, and had to make reparations payments to France and others. The German government printed money to pay its foreign and domestic debts. If you had shorted the Mark back then you would have made a fortune (hopefully not paid to you in DM), as the DM/USD exchange rate went from approximately 40 Marks to the dollar in June 1920 to 4,500,000,000 Marks to the dollar in January 1924.
During this period, in 1923, Hitler and his party attempted to seize control of the German government during the Munich Beer Hall Putsch. The Nazis eventually took power in 1933, and (along with Italy and Japan) started WW II, a war in which Germany lost 8 to 10% of its population. Losses in Poland, Russia and other countries were even greater. 60 to 80 million people are estimated to have died because of WWII, roughly 4% of the all the people then living on planet Earth. Roughly 2/3 of the casualties resulted from crimes against humanity and civilian deaths during military actions. This horror in the minds of many German bankers traces back to the German inflation of the 1920s.
Now we can understand why the Western and Northern Europeans, led by and influenced by the German bankers, do not feel like taking the Bernanke approach, and why they have not yet lowered interest rates to zero, why they have not swapped bonds with Southern European sovereigns, and why they have not engaged in quantitative easing to the extent other regions have.
They want to avoid at all costs, inflation. But if Germany wants to save the European Union in its present form, inflation will happen. Here’s why.
Many countries in Southern Europe (and Ireland) are bankrupt in a cash flow sense -- they do not have enough money to pay their governmental operations and bond interest payments, and they cannot borrow the money that they need. In order to prevent defaults someone would have to pay a portion of what is owed to the bond creditors. This will involve real money, paid to bond holders and not paid back by anyone.
Further, banks in Europe hold debt, including sovereign bonds, that has lost value and continues to lose value. Just like many of their sovereign borrowers, these banks are also insolvent in a cash flow sense, in that they do not have enough cash for day-to-day operations, and no other banks will loan them money. The recent operation by the world central banks to provide U.S. dollars to these banks solves their cash flow problem in the short run (no pun intended). However, these banks are also insolvent in the balance sheet sense as their liabilities exceed their assets. That is, they are worthless, bankrupt and kaput. No lending will save them. Eventually, all insolvent banks must go to bank heaven (or the other place). The local governments will have to nationalize them, sell the assets for a song, and pay out the obligations as best they can. This will also cost real money.
The unwinding of all of this debt will damage economies resulting in asset values dropping even more. This will also cost (more) real money.
Personally, I doubt that anyone, except possibly China, has enough money to pay off the European bond holders and re-capitalize the banks. If Germany wants to provide the funds to solve these problems, then it will have to borrow it, or in some sense print it.
I don’t think that they will do it in time, if at all..
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Disclosure: I am long EPV. I may increase or decrease my position in EPV in the next 72 hours, depending on market conditions.