By Alasdair Macleod
Despite the ECB's subsidy of the Eurozone's banking system, it remains in a sleepwalking state similar to the non-financial, non-crony-capitalist zombified economy. Gone are the heady days of investment banking. There is now a legacy of derivatives and regulators' fines. Technology has made the over-extended branch network, typical of a European retail bank, a costly white elephant. The market for emptying bank buildings in the towns and villages throughout Europe must be dire, a source of under-provisioned losses. On top of this, the ECB's interest rate policy has led to lending margins becoming paper-thin.
A negative deposit rate of 0.4% at the ECB has led to negative wholesale (Euribor) money market rates along the yield curve to at least 12 months. This has allowed French banks, for example, to fund Italian government bond positions, stripping out 33 basis points on a "riskless" one-year bond. It's the peak of collapsed lending margins when even the hare-brained can see the risk is greater than the reward, whatever the regulator says. The entire yield curve is considerably lower than Italian risk implies it should be, given its existing debt obligations, with 10-year Italian government bonds yielding only 2.55%. That's less than equivalent US Treasuries, the global risk-free standard.
Government bond yields have been and remain considerably reduced through the ECB's interest rate suppression and its bond-buying programs. The expansion of Eurozone government debt since the Lehman crisis has been about 50% to €9.69 trillion. This expansion, representing €3.1 trillion, compares with the expansion of the Eurosystem's own balance sheet of €2.8 trillion since 2009. In other words, the expansion of Eurozone government debt has been nearly matched by the ECB's monetary creation.
Bond prices, such as that of Italian 10-year debt yielding 2.55%, are therefore meaningless in the market sense. This has not been much of an issue so long as asset prices are rising and the global economy is expanding, because monetary inflation will keep the fiat bubble expanding. It is when a credit crisis materializes that the trouble starts. The fiat bubble develops leaks and eventually implodes.
Now that the global economy has stopped expanding and is on the brink of recession, under these changing conditions, the monetary, systemic and economic dangers facing the Eurozone are rapidly rising. This is a problem beyond the ability of the ECB to contain. Politicians and their institutions in Brussels seem unaware of the approaching storm, but when they do become aware, they will turn to group-think for protection. Like fish in a tightening bait-ball, their actions are set to accelerate their own demise.
The Start of EU Disintegration
There can be no doubt that the ECB has so far only managed to prevent a financial and systemic crisis materializing because of the background of a worldwide monetary and credit expansion inflating financial asset prices. A global background of rising asset values was necessary for the consequences of the Greek financial crisis to be absorbed without destabilizing the whole caboodle. If it had happened during a global credit crisis, the outcome would have been different.
Inevitably, at some stage the euro's purchasing power will begin to fall under the weight of accelerating monetary inflation and the demands from crony-capitalists for a competitive exchange rate. Rising bond yields will be the inevitable outcome, requiring yet more QE from the ECB. It takes little imagination to realize that in an environment of rising bond yields and falling asset values, the Italian government and its economy will be exposed to intractable difficulties. The difference from the on-going Greek crisis is Italy's economy is nearly ten times the size of that of Greece. So far, aided by inflating markets, there has not been a full-blown crisis. In a vicious bond bear market of the scale likely to accompany the next credit crisis, Italy alone could crash the whole Eurosystem.
That could happen by the end of this year, because when things go wrong, the pace of calamities usually accelerates. Today, the EU is threatened with Brexit, which at the time of writing is yet to be resolved. But there's a significant possibility Britain will leave the EU without a comprehensive trade deal and without paying all the money allegedly owed to the EU. The money will have to be made up by the other members, principally by Germany, France, Italy and Spain, being the largest remaining economies. Furthermore, the UK's economic policy is bound to focus on being a competitive regional entrepôt for global trade, enhancing her economic performance relative to a stultifying EU. Existing political tensions within the EU are certain to escalate as the EU falls behind, and Brussels, hooked on profligacy, for the first time faces budget cuts.
It is becoming increasingly obvious to independent observers that the EU supra-national socializing model is failing structurally, politically, economically and financially. The next credit crisis, which appears to be evolving from the seeds of today's events, looks set to end the European dream.
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