Last week, a parade of events have set the stage for what may become one of the most volatile economic periods of the 21st century. On Wednesday, Germany, the linchpin nation of the European Union, had a disastrous bond auction, raising only $5.2 billion of the $8.1 billion it expected to raise. On Thursday, Portugal's debt was reduced to junk status. On Friday, Italy's borrowing costs soared again, reaching their highest levels since joining the EU. Belgium, which has been unable to form a government for 18 months, had its credit rating lowered from AA+ to AA. Spain, where the People's Party will be forming a government in the coming weeks, may apply for international aid to maintain its solvency. In short, the EU is going to hell in a socialist hand basket.
Yet it is precisely the denial of that odious reality that prevents any real progress from taking place. It is a denial born of ideologically-inspired hubris, economic illiteracy, and an entitlement mentality that afflicts everyone from the top of the so-called economic food chain to the bottom. It began with the fantasy that nations with completely different cultural values could be yoked to a common currency, primarily for the purpose of preventing another World War. It was viewed as a way to prevent Germany from ever again becoming the dominant force in Europe.
It hasn't worked. It is Germany that has blocked the European Central Bank's (ECB) effort to make massive "eurobond" purchases from Europe's debtor nations. Last Thursday, Chancellor Angela Merkel reiterated that the ECB was only responsible for monetary policy. This stance sets her apart from the rest of the EU leaders. They want the ECB to do what Ben Bernanke and the U.S. Federal Reserve have been doing: "quantitatively ease" their way out from under, by financing debt with more debt. This is the socialist-inspired "too big to fail" scheme that keeps the banks and markets afloat while they look for a soft landing. A soft landing that ostensibly gives debtor nations time to get their acts together, lower their debt-to-GDP ratios, and regain some measure of solvency.
Such a scheme brings us to the other end of the fiscal food chain. This is the end, in countries like Portugal, Ireland, Italy, Greece and Spain, affectionately known as the PIIGS of Europe, where the bottom end of the chain, aka the "little people," will be forced to endure years of austerity in order to realize such a transformation.
It's a transformation that has engendered chaos. In Italy, riots broke out earlier this month when the new government, led by technocrat Mario Monte, outlined reforms to dig that country out from under $2.6 trillion of national debt. In Greece, the latest of many riots occurred last Thursday when workers at the country's largest power company, PPC, clashed with police. They don't want to be tasked with collecting property taxes via electricity bills, in a country notorious for tax evasion. Yet Greece needs $10.7 billion by Christmas, or the country will run out of money. Furthermore, their newly-formed government has yet to agree on terms for a far larger bailout of $174 billion, necessary to maintain national solvency.
On the same day in Portugal, a major strike engineered by the nation's two largest trade unions took place, due to public outrage over austerity measures there. Portugal needs $104 billion of bailout funds. In Spain on Saturday, thousands of demonstrators massed in Barcelona to participate in a planned anti-globalization rally. As a result, border controls made unnecessary by integration into the EU were reinstated to prevent outside agitators from entering the country. And in Britain, a public sector union strike is also scheduled for this coming Thursday, because the government is proposing to raise the retirement age and increase employee contributions to their pensions.
While the peoples' anger seems justifiable, there is something missing. It is their inability to recognize that they are every bit as responsible for the current crisis as those they seek to blame for it. Ironically, both ends of the fiscal food chain have enabled each other's demise. It was the massive amounts of credit issued by lending institutions at the top, who made billions of dollars by making easy credit available to the bottom end of the chain. It was the easy credit that enabled the socialist government spending sprees that quickly, but artificially, raised the living standards of people who were more than happy to live the good life, even if it was built on a mountain of accumulating debt. It is that debt that has now become unsustainable, putting both ends of the food chain on the brink of insolvency in the process.
All of it could be coming to a head this week. In simple terms, investors want higher interest rates to underwrite what they perceive as riskier debt. The higher a country's borrowing costs, the more necessary it becomes to impose greater austerity measures. Austerity measures make it difficult, if not impossible, for a country's economy to grow. Without growth, paying higher interest rates becomes unsustainable. The possibility of unsustainability, aka default, pushes interest rates even higher, and the cycle becomes self-reinforcing.
Where is it leading? On Sunday, it was announced that France and Germany are attempting to put together a Stability Pact, with a treaty outlining strict deficit rules and control rights for national budgets in the hopes that it will persuade the ECB (which cannot directly finance governments) to increase government bond purchases. If it comes together, it may be implemented at the beginning of next year. In addition, Germany is pushing to change the EU treaty. They want the ability to sue in the European Court of Justice any countries that break EU budget rules. All of this is a follow up to a proposal made by the European Commission last Wednesday. They want the power to approve EU zone national budgets--before they are submitted to the national parliaments.
What does it mean? At the very least it means that economic decisions made by national parliaments will be rendered meaningless. They either get it "right," or they get sued. It likely means that Angela Merkel, the one politician with the guts to prevent the same currency-debasing quantitative easing that is ruining the dollar, has seemingly lost that battle. It may even mean that a "two-tier EU" will emerge, in which countries either abide by supra-national rules of finance, or they will be on the outside looking in.
That may be the entire point of this latest exercise. Certain nations (read Greece and Italy at the present time) may be faced with a "lesser of two evils" choice: an effective loss of national sovereignty, but the ability to continue borrowing from the ECB, or independence--and national bankruptcy.
No matter how this latest development plays out, one reality remains unalterable: the entire EU is "running out of other people's money to spend." And the so-called little people, long used to a level of salaries, benefits, services and entitlements which are mathematically unsustainable, are immersed in the same kind of denial that afflicts the bankers and politicians who engineered the debacle in the first place.
Furthermore, the dirtiest little secret of socialism has been revealed. In short, there are no heroes. At the top of the food chain, there are those suffused with a breathtaking arrogance rooted in the belief that a handful of the "right" people can out-think millions of ordinary Europeans acting in their own best interests, and create a utopian paradise. They further believe that the historically documented wreckage produced by such ideology has only occurred because the "wrong people were in charge."
At the bottom of the food chain are people who believe they are entitled to a "fair share," irrespective of their own effort, ambition or talent. They also believe that any economic disparity between them and their fellow man is de facto evidence of injustice, and that economics itself is a zero-sum affair: they are only "down" because someone else is "up."
All of it is reaching critical mass. Moreover, Americans should pay close attention. What is happening in Europe is a precursor of where America is inexorably headed if the electorate refuses to make the hard choices in 2012.
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