Mario Draghi, the European Central Bank President, announced yesterday that he would do everything possible to save the Euro. But the real message seems to be that desperation is taking over and that therefore collapse is near. There are four powerful arguments why this interpretation of Draghi's statement is true.
First, we must make clear what is the problem of Europe: the problem is solvency of the southern countries, not liquidity. See detailed explanation here. The southern countries are going broke (as opposed to needing a temporary loan while they work out the problem, perhaps helped with a printing press). The countries are going broke as well as their national banking systems. A business goes broke when its revenues are less than expenses for an extended time. And this is true for the Southern European governments as well as their national banking systems. The southern countries' banks' and national governments' income is inadequate to cover the expenses necessary to maintain a desired level of services. Spain has tremendous unrealized real estate losses, much like the US in 2008. The commercial banks of Greece, Spain and Italy are full of their national government bonds that are not going to be paid. Both the Southern European banks and governments are in critical financial condition. This is a solvency, not a liquidity, issue. More loans do nothing to fix the problem. More loans are simply a way to avoid confronting the reality of the situation (kicking the can down the road) and make it worse because of the ongoing accrual of interest that cannot be paid.
Some readers will instantly say this is not true because the printing press can be used to print whatever money is necessary, even if it causes inflation. This is not true for several very important reasons. First, the bankrupt southern nations do not control the Euro printing presses. Simply printing more money must be done with the consent of the Northern nations. More importantly, since this a solvency issue, the northern European countries will only bankrupt themselves if they keep advancing more money to the bankrupt southern countries. The new loans to the southern European countries will be guaranteed pro rata by the Northern European countries. When the loans to the southern nations are written down by the northern countries for being non collectible, it is then that they will find they are bankrupting themselves. Given this is a solvency issue and not a liquidity issue, the whole argument of printing presses and inflation is simply not relevant to the question at hand.
Here is what is relevant. Enormous transfers of money are being made that vastly increased loans to nations that cannot pay them. Here is a summary of what happened in the last year, most of which the public does not know: Worried depositors in southern nations banks have withdrawn their deposits from the southern national banks and taken them elsewhere, particularly Germany. This left German banks with lots of money to lend, but they had such excesses that the German Central Bank deposited (lent) about 400 billion euros to the ECB last year. The ECB turned around and lent 275 billion euros to Italy, which previously did not have any debt with the ECB. Furthermore, the ECB lent 350 billion euros to Spain, which previously only owed 50 billion euros. When it is recognized the southern European nations cannot repay the ECB, the ECB is broke. When the ECB is broke, those who lent monies to the ECB are broke. While we cannot say when the ECB and the northern European countries will stop lending to the southern European nations, we can assure readers the northern nations will stop lending, be it this year or the next year or so. This is not a printing press issue without consequences. This is a solvency issue where each nation must protect its own financial survival.
The second critical point is that the European Monetary Union was doomed to fail from the start if they did not complete the integration (retirement policy, tax collections, labor policy, income and other taxes policy, etc). At this moment, there exists a completely impossible situation. The southern Europeans brazenly avoid paying their income taxes while the northern countries collect very effectively their income taxes. Greeks retire in the early 50s while Germans retire near 70. Corruption is rampant in all the southern countries, as compared with much less corruption in the northern countries. The southern countries have labor laws that make firing employees practically impossible while the northern countries have much more practical labor laws. As a result the northern countries export more and have better trade balances while the southern countries have non-workable levels of imports and exports. No amount of new loans can fix a monetary union that was never workable from day one and has now accumulated debt levels that are not payable by the southern countries. It is now far to late to complete the true integration of the countries and collapse is the only practical alternative.
The third issue is this remarkable statement by Mario Draghi. Various Bloomberg commentators said today that in almost all cases like Draghi´s statement today, his remarks would have inspired fear and caused the markets to crater. We had a market looking for favorable news and markets went up. Yet, the fact is that this was not the rational and professional economist saying we have a practical plan to fix the problem. In my days as a commercial banker, when I had a borrower resort to emotion, as opposed to logical plans, I always knew it was time to pull the plug on the borrower because things would only get worse.
A fourth issue is that we are now several years into the problem that permit us to predict the future based on past results. There are practical results for all to see. First, Southern European countries trying to cut their expenses only made worse the short fall in national income because government revenues decreased more than the cost cuts. Southern European countries that did not cut their expenses likewise saw the national deficits only increase. The simple truth is that there is no solution to the problem in Southern Europe at this time other than a profound downturn in these economies. Massive write-offs of outstanding credit will inevitably have to be made. However, this simple, historically provable fact is not broadly accepted. Even worse, the issue is described as liquidity that can be solved by a printing press, when it is in fact an issue of solvency where there is no outcome other than insolvency.
In conclusion, it should be noted that Draghi talked about saving the Eurozone, but did not elaborate what that means. Could Draghi say a year or so down the road that he say that he meant to protect the surviving members? Could he have meant a Eurozone without the Southern Eurozone counties still as members? Certainly Greece will be out and probably several other countries. The only thing certain is that Draghi´s optimism of yesterday will not be the reality of the coming year or so. This must negatively affect American financial markets, namely the SPY.