Italian default scenarios

Cross-posted from Credit Writedowns

The most important debate of our lifetimes is now ongoing. For many, the answer will be existential. First, the question: Should the ECB “write the check’ for the euro area national governments? In thinking about the answer to this all-important question, I prefer to shift the focus by changing the verb “should” to “will”.

Answering this slightly different question is much more important than answering the first question for you as an investor, a business person and as a worker. If the ECB writes the check, the economic and market outcomes are vastly different than if they do not. Your personal outlook as an investor, business person or worker will change dramatically for decades to come based upon this one policy choice and how well-prepared for it you are. The right question to ask then is: Will the ECB “write the check’ for the euro area national governments?

To date, my answer to this question has been yes. See, for example, my thoughts on why questioning Italy’s solvency leads inevitably to monetisation and why Investors will buy Italian bonds after ECB monetisation. But what if the ECB doesn’t write the check? What if the ECB let’s Italy default, what then?

Here’s my thinking on that score.

Italian death spiral

Let me start off with what I have previously written from two posts from November 7th.

The euro zone periphery was a sideshow. This stuff with Italy is the real deal. With yields at 6.7% and rising, it’s game over for the euro zone. The extend and pretend stuff ain’t gonna work.

And if you are an investor, this is the moment of truth. Everything – every asset class – depends on how the euro zone performs in the Italian Job. There are only two outcomes, here. If Italy blows up, a Depression is upon us; banks would be insolvent, CDS triggers would implode the system, bank runs would begin, stock markets would crash, and you will would see sovereign debt yields go to unbelievable lows for nations with a lender of last resort. If Italy survives, I would expect a monster rally in periphery debt, stock markets, and bank shares and a selloff in CDS at the minimum. However, the euro zone is already in recession so that rally will not be sustained.

Forget about Berlusconi and austerity in Italy. That’s a sideshow too. Austerity is not going to bring Italian yields back down. These days are over, folks.

Here’s the real problem: Italy needs to run a primary budget surplus (excluding interest payments) of about 5 percent of GDP, merely to keep its debt ratio constant at present yields. That’s never going to happen. So the yields for Italian bonds must come down or Italy is insolvent. More than that, a stressed Italy means a stressed euro zone and a deepening recession with all of the attendant ills that means: Ireland would suddenly start missing deficit targets for example. Bank shares would be under stress, triggering more Dexia’s. So even if Italy limps along at 7 percent yields, we will see a nasty double dip recession and bank failures. And we know that yields will rise. Last November, we were discussing Ireland in the same way with its yields at these levels. Soon, the yield went to 9% and Ireland was forced into a bailout – one that Italy is to big to give.

So we are definitely facing a real financial Armageddon scenario here.

Italy! Italy! Italy!

Here’s what I am saying.

  1. Italy needs to run a primary budget surplus (excluding interest payments) of about 5 percent of GDP, merely to keep its debt ratio constant at present yields. It won’t ever be able to do so.
  2. Therefore, yields for Italian bonds must come down or Italy is insolvent as it must roll over 300 billion euros of debt in the next year alone.
  3. Austerity is not going to bring Italian yields back down. First, Italian solvency is now in question and weak hands will sell. Moreover, investors in all sovereign debt now fear that they are unhedged due to the Greek non-default plan worked out in Brussels last month. As Marshall Auerback told me, any money manager with fiduciary responsibility cannot buy Italian debt or any other euro member sovereign debt after this plan.

Conclusion: Italy will face a liquidity-induced insolvency without central bank intervention. Investors will sell Italian bonds and yields will rise as the liquidity crisis becomes a self-fulfilling spiral: higher yields begetting worsening macro fundamentals leading to higher default risk and therefore even higher yields.

Soft depression

I believe the global economy is in a cyclical upturn within a larger depression. Two years ago, I wrote:

… all countries which issue the vast majority of debt in their own currency (U.S, Eurozone, U.K., Switzerland, Japan) will inflate. They will print as much money as they can reasonably get away with. While the economy is in an upswing, this will create a false boom, predicated on asset price increases. This will be a huge bonus for hard assets like gold, platinum or silver. However, when the prop of government spending is taken away, the global economy will relapse into recession.

Credit Writedowns, Oct 2009

Last week I wrote that this is “a soft depression scenario where the countries with a true lender of last resort can backstop without problems.” The problem, however is that the ECB is not a true lender of last resort as we are now seeing.

Should the ECB go all-in or not? There aren’t a lot of options. No one is going to buy Italian bonds at a low yield without a backstop, irrespective of austerity now that the insolvency genie is out of the bottle. With a backstop, some people will. An Italian default equals the insolvency of the Italian banking system. An Italian default means massive losses for German and Dutch banks and beyond. Any scenario in which there is an Italian default leads to a Depression with a capital ‘D’. The question is a political one and, hence, unpredictable. The Germans (and Dutch) either allow the backstop or face Depression. It’s as simple as that.

Italy’s debt woes and Germany’s intransigence lead to Depression

Outlining the Armageddon scenario

This is the crucial piece in understanding how to protect yourself in the event the ECB decides to not act as a lender of last resort for the euro area national governments. This is a true Armageddon and Depression scenario.

The reason no real alternative to the ECB’s acting as a lender of last resort is offered by hawkish types is because the alternative is economic collapse – and recognising this is not politically palatable. We know that Italy will default without the central bank based on the analysis above. Italy’s default would trigger a cascade of interconnected bank runs default and Depression as did the insolvency of Creditanstalt in 1931. Could Italy unilaterally exit the euro zone and redominate euro debts at par into a new Lira currency to forestall the default? Perhaps. That is something to consider at a later date. For now, here’s what will happen if Italy defaults.

  1. Credit event: An Italian default would be a credit event, meaning it could not occur under the voluntary arrangement which the EU is trying to force through for Greece because Italy is simply too large for banks to willingly take the writedowns needed to deal with its insolvency. Doing so would render many financial institutions insolvent. Even in the Greek case, I doubt whether they will get enough participation from the private sector to meaningfully reduce the Greek sovereign debt load. So, an Italian default would be uncontrolled and immediately crystallise losses that must run through the balance sheets of everyone holding their bonds.
  2. Italian bank run: Once Italy defaults, Italian banks would be insolvent as a result of these losses since they are the largest holders of Italian sovereign debt. Given the 10 billion euro writedown at Unicredit just yesterday, we can see these banks are already weak. Therefore, we should anticipate wholesale bank runs in Italy beyond just the weakest banks.
  3. Spain and Slovenia insolvency: Other weaker sovereign creditors within the euro area without IMF funds would come under heavy selling pressure. This includes Spain and Slovenia first but would also include Belgium later and perhaps Austria due to its bank exposure to Eastern Europe. Spain’s yields have already crossed 6% and Slovenia’s have already crossed 7%. These governments would default as well then, cascading the losses onto their banking systems. Defaults here would lead to domestic bank insolvency and bank runs as in Italy. Countries like Ireland, Portugal and Greece would want to default in order to escape the suffocating strictures of austerity given the now untenable solvency path that a deep Depression would cause. Likely, these countries would default as well. Analysts like Sean Egan estimate eventual losses in Greece will be 90%. In the Italian default scenario, these losses would crystallise overnight.
  4. Contagion into Eastern Europe: Unicredit’s losses included significant writedowns in Eastern Europe and Central Asia (Ukraine and Kazakhstan). One area of contagion could be to other banks with exposure to weak economies elsewhere in Eastern Europe like Hungary and Slovenia. Greek, German and Austrian banks would be most vulnerable because of exposure to central Europe and the Balkans. Hungary, already under threat of a sovereign downgrade to junk, amidst a record decrease in the Forint/Euro exchange rate, would suffer contagion. the currency would come under heavy selling pressure. Other weaker sovereign debtors would be affected as well.
  5. Euro bank insolvency: Other debtors with significant exposure to Italy would suffer huge writedowns. Core bank exposure to Italian debt an order of magnitude larger than periphery combined. Financial institutions with exposure could be recapitalised by the state, however. The questions here for the likes of Germany, France and the Netherlands are a) how explicit a backstop will these banks get? would bond holders take losses; b) how would this affect the sovereign debt level and credit rating? c) how would this lack of capital affect credit availability and economic growth?
  6. Credit default swaps: As an Italian default would be a credit event, it would trigger credit default swaps, many of which were sold by American financial institutions. Would these institutions pay out? Could they? How would Italian losses affect their capital base? The same questions for euro countries become applicable here as well as American banks could be recapitalised by the state. (Will Americans allow another bailout?): a) how explicit a backstop will these banks get? would bond holders take losses; b) how would this affect American sovereign debt level and credit rating? c) how would this lack of capital affect credit availability and economic growth in the US?

There are a lot of other potential areas where this could go like capital controls, civil unrest, eurozone breakup, government coups, etc, etc. All of that is speculation. But above are the six parts I see as a sure thing: credit event, Italian bank run, Spain and Slovenia insolvency, contagion into Eastern Europe, some euro bank insolvencies and credit default swap triggers. Clearly, this would mean an economic downturn of at least the magnitude of the Great Depression.

I also tend to think contagion will spread throughout the eurozone until it breaks apart – and we do see yields rising right across the euro zone, today in France, Austria and even the Netherlands:

This is a rolling crisis wave through the eurozone infecting more countries, closer and closer to the core. As Marshall wrote recently, this is a structural problem. All of the euro zone countries face liquidity constraints and all of them will eventually succumb to the rolling wave of yield spikes one by one until we get a systemic solution: full monetisation and union or break up.

Felix Zulauf on the inevitability of further crisis in Europe, July 2011

Protecting your wealth

Hedging against this outcome means preparing for black swan scenarios in stocks, government bonds, currencies, commodities and precious metals. This is a world of unpredictable policy paths that will certainly involve civil unrest, government repression and economic nationalism, but may also involve competitive currency devaluations, currency controls, and trade wars.

My view is that such a scenario will mean significant dead weight economic loss due to debt deflation dynamics. Economic output would decline significantly, as would stocks and high-yield debt. Commodity prices would also decline. But depending on the policy response of governments, bonds and precious metals are wildcards.

Governments like Norway’s are protected because of low debt and rich natural resources. On the other hand, governments like Australia’s and Canada’s are exposed because of significant household sector indebtedness and high property valuation. In essence, there is nowhere to hide in the sovereign bond area. As a foreign investor in sovereign debt, you want to know where the currency and the interest rate are going and neither is foreseeable in this train of events.

If governments try to inflate their way out, precious metals might be a good safe haven, although paper gold presents a problem of reliability and physical gold is subject to confiscation. On the farmland front, as Jim Grant testifies, yields are already very low, so you have to wonder how much upside there is to that trade. Obviously, in a world of financial repression and competitive currency depreciation, those investments won’t necessarily lose value.

Highly rated corporate bonds and high quality dividend paying stocks may well be the best safe havens.

Those are my thoughts on what an Italian default would mean. The overall thrust of the arguments here is that a default would be economically catastrophic and put into play a lot of outlier scenarios. The potential for large losses would be significant, and, therefore it pays to think about how to protect your wealth in such an environment, given that serious policy makers believe letting Italy default is a justifiable policy choice.

P.S. – after I wrote this post, I noticed a piece by David McWilliams, a well-known Irish economist, which ran through an Irish euro exit scenario like the one I had speculated about for Italy above. See my article highlighting McWilliams main points here.

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward


  1. James

    If the rich want a bailout, they’ll get a bailout. The “rolling crisis” is a pretext to get the political changes the rich want to enable their ongoing looting. The rich want austerity for you and luxury for them, and they’ll get what they want because they rule the world.

    1. Typing Monkey

      If the rich want a bailout, they’ll get a bailout

      Oh really? Who exactly will they get this money from?

        1. jake chase

          Everyone knows there will be a bailout; nobody knows how it will play out. My guess is that American banks are massively on the hook on Italian CDS. That means the Fed will enable the ECB; it may mean the Fed will support the market for Italian government bonds. To masters of the universe money is just blips on computer screens. There is nothing standing in the way of a bailout except words on paper which, like all words, are subject to interpretation. The creditor class ain’t folding its hand. Meanwhile, the fear mongering provides an excuse for austerity politics aimed at workers. The crisis talk is all corporate propaganda bullshit.

          1. mac

            So can we please define exactly just how to identify “the rich”, not “them” etc but real numbers of how much real wealth these “rich” have and in what form $$ land bonds etc!!

      1. wunsacon

        Nothing complicated here. The Fed will continue to pay inflated prices for the near-worthless financial paper held by the rich.

        IOW, the Fed will continue to expand its balance shiit.

      2. Jim

        Where does the money come from? From the German working class, to whom the ECB explicitly promised that it would never engage in what Edward Harrison is now proposing.

        It’s as if the German voter, the German constitution, has no say in the matter, when it should.

        If the NK community supports ECB wholesale buying of Italian debt, why are we even supporting OWS?

        Isn’t OWS protesting the bank bailouts? Well, the Bush administration said it had no choice, it had to save the world from a depression.

        So, what’s the difference between the Bush administration’s arguments and those of technocrats in Brussels?

        1. Jesse

          Germany’s trade warfare finally caught up with it and they’re all like, “OMG!” I’m going to love watching the cheating exporters (China, Japan, SK, Germany) cry when they get paid back at real interest rates of -50% on their reserves. When you guys don’t work toward mutually beneficial relationships, you shouldn’t expect anyone else to either.

      3. Maximilien

        @Typing Monkey

        The rich will get their bailout from everyone else alive today, as James points out. Then they’ll get it from taxpayers not even born yet, as their government flunkies eagerly mortgage the future as far as the eye can see.

        Then they’ll get it from the coming deflation, as savers are pounded into poverty by ZIRP while they buy bonds in rigged markets.

        Finally, they’ll get it in the coming hyper-inflation when the poor and the ignorant are robbed of their last savings while they (the rich) are profiting from the gold, the houses, the art they bought in rigged markets that had driven out everyone else.

        The collusion of governments and business has resulted in the perfect wealth extraction machine. It’s a machine DESIGNED for bailouts.

  2. chad

    Isn’t the question “CAN the ECB write the check” equally valid? Forgive my ignorance, but IIRC there are treaty and other legal issues standing in the way of the ECB monetizing the debt.

    1. Brett

      That’s true, but as I understand it, the ECB has already been buying government bonds (such as Italy’s, Spain’s, Greece’s) in the open market. So they have bought them from banks in an attempt to provide unlimited liquidity to stressed banks.

      So what’s the real difference between buying them through an intermediary, and buying them directly from the government?

      What would end this crisis is the ECB announcing that they will buy unlimited amounts of Eurozone debt to stop this crisis, even if that means they have to give up their inflation target. Yields would instantly shoot down for Italy and other stressed countries (France yields shot up yesterday).

      But the public statements so far from the ECB have not been helpful at all. They all keep saying that the Eurozone is on it’s own, and they must impose austerity to solve their budget deficit problems. They don’t seem to understand (or are unwilling to admit) that austerity won’t solve these problems and as the yield creep up the surpluses the governments need to run to balance their budget (taking in the interest costs of the debt) become unrealistically high. The ECB doesn’t understand that they are the only institution with the ability to solve this crisis. They are abdicating their responsibility over a psychotic desire to maintain the 2% inflation target (even if the result is destruction of the Euro).

      1. James

        Another take on this is that the ECB is allowing financial stress to build in order to extort each member in turn. Nothing like a crisis to force cuts.

        1. Howard L

          Exactly James!
          The Troika is trying to keep the Euro system going long enough to destroy as much of the social safety net as possible before the ECB becomes the lender of last resort.

          I would speculate that when a TBTF European bank collapses will be the sign to fully monetize the sovereign debts of the Eurozone.

      2. shtove

        ECB sovereign bond purchases are illegal under Art 123 of Lisbon. That treaty will need a referendum in Ireland if there is to be a change, but it’s doable.

        The biggie is Germany – if expansion of the ECB balance sheet involves permanent transfers from German taxpayers, there has to be a referendum in Germany. Their supreme court was crystal clear on that issue at the end of the summer.

        1. TC

          this is widely unrecognized in the press. Any more funding from Germany has to go through the policial process in Germany.

          Not only did this ruling make it difficult for Germany to increase their funding of the EFSF, it pointed a way for other countries to blow up europe. Just put it infront of a court – there must be dozen of ways to challenge any part of the process in the individual countries.

          The euro is doomed.

      3. Jim

        What happens if the ECB buys 300B of Italian debt, and Italy decides to leave the Eurozone.

        Who capitalizes the ECB?

        The German voter who was explicitly promised that the ECB would never monetize debt?

          1. Dob

            Seriuosly, ECB cannot print money now. Nothing like Helicopter Mario is going to happen without a complex revision of treaties. Even on the operational level, they don’t print currencies, they allow member states to do it. The only guide is stability of prices and foreign currency exchange.

  3. financial matters7

    We need civil unrest, economic nationalism, tarrifs and a reserve currency not based solely on one countries currency.

  4. Francois T

    Declare credit default swaps null and void. Force issuers to repay buyers at par.

    Make them illegal; who the hell ever came out with the idea of insurance without rules?

    1. Hellga

      Like all brilliant things, your idea is simple and effective.

      Yes: make all forms and variants of credit default swaps illegal.

        1. Maximilien

          Better question: Who in his right mind would SELL insurance on euro-debt? Unless, (a) he had no intention of paying out, or (b) he knew he was backstopped by gov?

  5. babaganush

    Whether the ECB writes the check or not there will be considerable pain associated. If they write the check us EU tax payers are on the hook for trillions while a sick systems keeps limping on with empty promises of reform. In addition the banks will probably avoid much needed restructuring and downsizing and still have us by the short hairs.

    Without exceptional euro area growth, can all the debt of even realistically be repaid over the longer run? If not, then we should just end it now, write it off, purge system, take the pain.

    In band-aid parlance, do you rip the band-aid off with great momentary pain or do accept prolonged discomfort as you tease it off? I say rip it.

    1. PQuincy

      Considerable economic distress is pre-programmed by past stupidity, the success of regulatory capture by the financial industry, the creation of the naked CDS, and various other past events. Economic pain is a given.

      The less of macroeconomic and history, however, is that we have some control over how severe the pain is, and how it is distributed, because the strong positive-feedback loops of macroeconomics will, without action to prevent it, cause pain an order of magnitude greater than the ‘objective’ data contain. Preventing bank runs is almost always a good idea, because a bank run by definition not only harms weak assets, it destroys strong assets as well.

      In the end, what happens in the next year (and really, much of what has happened over the last year or two) are matters not of economics, but of political economics. Normally economic activity operates with some autonomy from political affairs (there are always entanglements, but they are not normally at the structural level), but now the structure of the situation makes outcomes almost entirely a matter of politics, broadly taken. Sovereign states have unlimited power to change financial rules (that’s what it means to be sovereign), after all (not ‘economic rules’, but financial ones), and we should expect non-linear increases in political pressure as developments unfold. If we’re lucky, politics might take the shape of mobilized voter anger that forces action by political forces hitherto beholden to the financial industry (directly or through ideological affinities and blinders). If we’re less lucky, violence and war both domestically and internationally are very real possibilities, as even a cursory glance at the period 1925-1940 suggests.

      Let’s hope we’re lucky.

    2. Yearning To Learn

      In band-aid parlance, do you rip the band-aid off with great momentary pain or do accept prolonged discomfort as you tease it off? I say rip it.

      The problem is that we don’t have a bandaid on a tiny wound, that can be just ripped off.

      Instead, what if we have a cut to our carotid artery, and we’re holding the bandage on that? If we rip the bandaid off we bleed to death.
      If we hold it there for a while then the carotid artery may clot up and we live.

      we see this all the time in medicine. All treatments have side effects. Sometimes the side effects of the treatment are worse than the disease process

      If a disease process is really bad, then we use terrible medicines… but it’s our only choice.

      My favorite analogy is lung cancer. The answer to lung cancer for most people is to never smoke. Once you get lung cancer, your options are grim. We must poison you very slowly (using surgery/chemo/radiation) hoping that the poison kills the tumor before it kills you.
      But some tumors are “inoperable” and “untreatable”. thus, we comfort you until you die.

      IMO this is more like our situation. Our global economy has a horrific lung cancer. It is unclear if it is a fatal case. All treatment options will be horrific. Some of them may kill us themselves.

      I think that we did need to do a great “muddle through” to buy us time. Unfortunately, instead of using the “muddle through” in order to better the structure/laws of our economy, they chose to reward speculation, fraud, and crime. It’s like doing chemo so that you can start smoking heroin.

  6. dictateursanguinaire

    @babaganush —

    I know less about this than you, I’m sure, but it seems that part of the problem is that either political pressure from banks is keeping elected officials from seeing things so clearly or that elected officials simply have imbibed too much austerity-theology and think that, even with ‘the default genie out of the bottle’ as EH sez, that Pinocheting the population will lower bond yields. I think there are too many smart bondholders who understand that that will not lead to growth or magically make Italy solvent. Because I totally agree — when you put it that way, it’s hard to see why you’d want to slowly tear it off, especially when ripping it off quick is far more ethically acceptable (hey, I thought capitalism was about risk-taking, eh??; banks basically already get a free lunch anyways in the boom times, why shouldn’t they accept the risk they took, all entrepreneur-like??; dunno if the euro banks’ behavior was quite as abhorrent as American banks’ but rather screw them over than public sector workers in the periphery who, as Yanis Varoufakis points out, really do not make that much aside from isolated incidents that the biz press circles vulture-like.)

  7. PQuincy

    At this point, I’m simply baffled by the ECB’s ongoing refusal to be a central bank. ECB statements and policy clearly threaten direct harm not just to the Euro and thus to the ECB itself, but to every government and every economy in Europe and the world. The evidence that we face, in the short term, a run on quasi-sovereign debt within the Eurozone is overwhelming, and growing daily, yet we keep hearing these bizarrely unreal ukases from the ECB and the Bundesbank that no, they will absolutely not provide water to put out the fire that is burning their own building down, because that would be wrong.

    At this point, I can’t even see a tactical game behind the ECB’s stubbornness. Their credibility as an inflation fighter is not at stake in any way, by now, is it? Even if it were, preserving that credibility will have no conceivable value going forward if the soverign debt run accelerates. Similarly, being resistant and reluctant and whiny about doing what a central bank does doesn’t increase the effectiveness of any action they might take: on the contrary, it specifically undermines their own ability to forestall the crisis. As shown in the ECB sovereign bond purchases so far, the noisy reluctance that the ECB has demonstrated has made such purchases less effective, and simultaneously cost the ECB real money by raising the cost and risk involved.

    I suppose some double-backwards jujitsu could be invented to explain why the ECB is ‘keeping its powder dry’, but the very complexity of such explanations or tactics means they are not likely to be either true, or effective if they were true.

    The ECB people are clearly not stupid: that can’t be the explanation either. By now, what is happening is not that complicated. Moreover, no matter how ideologically blinkered or historically confused (“we MUST prevent the hyperinflation of the 1920s which is just around the corner, really!”), the ECB has too many people specifically trained to examine evidence for me to believe that their choices follow from confident ideological conviction.

    Therefore, by Sherlock Holmes’ law (when all other explanations are eliminated, what remains must be true), I am driven to conclude that ECB policy is to allow , nay, to encourage, a sovereign debt crisis. But I’m too ignorant to see what interests both favor such an policy and are powerful enough to make the ECB follow this policy through.

  8. Brian

    The only question is, when does the death spiral begin in earnest. The bailout is pretend money, as has been most for the last 10 years. It doesn’t exist except in the dreams of avarice. It will be taking the very last from those that have the very least.
    You demand a bailout, you demand war.
    You demand restructure, you have a chance at restructuring without the parasisitic class that caused the collapse and who will be the only parties benefitting from the bailout.
    You can pretend, or you can get real. You can lower expectations going forward due to the lack of growth, or you can kvetch about it.
    But I wonder how all the people are going to react to the next trillion dollar giveaway to the banks that will be laid on their backs without their consent.
    Reality bites hard.

  9. don

    We who read Harrison’s thought provoking analysis know also that for him the “will” is also the “should”. He lumps together investor, business, and worker, yet only addresses the investor here. As far as I’m concerned, the investor’s and the worker’s interest are NOT the same.

    How is it that ECB buying not also simply extend and pretend? How is it that this really isn’t just an extension of the ‘we got to save finance or the world will blow up’? Are we really limited to nothing other than this, that there isn’t anything more radical and an alternative to what really is just the same thing as what we have been witnessing for the last few years? Are we really limited to either ECB buying or the end of the world? Why does NC support this line of thinking when it also stands behind OWS?

    1. Yearning To Learn

      I’m not sure that Edward’s argument and OWS ideals are incompatible.

      One can understand that practically speaking the ECB will likley eventually buy Italian debt, and maybe even supporting this idea, IF at the same time other efforts are made to address the problems in our system.

      For instance:
      what if the ECB bought the debt, and at the same time the world financial regulators banned all CDS products, and also instituted a world Glass Steagal? I’d say that is a step in the right direction.

      the problem is that the central bank bails out the creditor class WHILE AT THE SAME TIME continuing failed laissez faire and deregulatory neoliberal policies

    2. Brett

      I think in this case, it’s a little different from simply a bailout for the bankers. This is a bailout for countries, most of which were responsible with their budgets prior to the 2008 downturn (and housing bubble crash) that left many of them running large deficits. For example, Spain (who is also dealing with rising yields) ran large budget surpluses prior to the crash.

      The structure of the Euro is flawed, as we all now can recognize (and many people recognized while it was being debated and agreed to). The requirement for being a part of the Euro is that you could run budget deficits no more than 3% in any one year. In return, you’d be a part of a common currency zone that was supposed to be more efficient and less costly to do trade amongst the members (instead of many different currencies, and with them the need to hedge currency risk when doing any sort of business with another country that doesn’t have your currency, you’d now have a common currency).

      The flaw of the Euro is that if there was an economic downturn, revenues would drop (because of rising unemployment) and spending would rise (because of increased welfare benefits). This led to substantially larger deficits than the required 3% under Eurozone rules.

      The 3% requirement was there as mandate to keep those countries participating solvent. Part of being in the Eurozone is you give up your ability to create money by fiat (and you can’t devalue your currency to increase your competitiveness). Because the creators of the Eurozone somewhat understood that this could be problematic, they simply mandated that all countries keep budget deficits to 3% of GDP or less and preferably they wanted to run surpluses.

      So flash forward to today: we are basically dealing with solvent countries (except for Greece) who will be pushed to insolvency because of the whims of the market. As yields creep up, in order to maintain the same debt to GDP ratio (i.e. to remain solvent) these governments will have to continually run larger and larger surpluses just to tread water. How do you run larger surpluses? Well since they can’t devalue their currency to become more competitive (given they are in the common currency Euro), they must reduce govt spending. This creates job losses and works as a headwind toward any progress.

      The workings of austerity take a long time to see any results (if there are indeed any gains in this strategy rather than simply widespread pain for the population and the unemployed). Meanwhile, the markets can push the stressed governments into insolvency much faster than austerity or fiscal tricks and solve any problems.

      Central banks are built exactly to deal with a problem like this. This is why they exist — to be the lender of last resort and to mitigate crises. This Eurozone debt crisis is an existential event, that as Harrison writes, could lead to a Great Depression given how interconnected the financial system of the Eurozone is to the rest of the world. The ECB solving this crisis by standing behind the member’s debt is just what must be done to stop it and to prevent a massive catastrophe, not just for those countries but for the world-wide system. The losses would be staggering if the Euro unravels (thanks to financial products like CDS).

      If you save the country, you are indirectly saving the banks who hold that countries debt. They would be benefactors, but so would millions of people who can retain their jobs because their companies don’t go out of business because of all the failed banks.

      It’s not extend and pretend given that Italy and France and Spain have manageable debt to GDP ratios currently. This is just a confidence crisis in the markets. They see contagion spreading and they doubt that the ECB is willing to step in and do the job that must be done. Greece is another matter entirely, debt will have to be written off for Greece, but the country is rather small in the grand scheme of things. Those writedowns won’t bring the world financial system a halt, but Italy would.

      1. Eric

        ”The flaw of the Euro is that if there was an economic downturn, revenues would drop (because of rising unemployment) and spending would rise (because of increased welfare benefits). This led to substantially larger deficits than the required 3% under Eurozone rules”

        this is not the issue, the issue is that the countries that are now in trouble, Italy and Greece, entered the eurozone with debt at already more than 100% of GDP, violating the entry criteria, and did not bring down the debts in good times.
        In fact, Italian debt (now 120%) and Greece debt (now 180%) did only increase.
        If Italy and Greece would have had sustainable debt levels of much lower than 100% they would have had the option of spending rising during a crisis without the current outcome.
        Your claims about central banks always preventing default are also untrue. Simply look at the Iceland and Argentina defaults. The fact that our financial system is not able to cope with an Italian debt restructuring basically says our financial system is a house of cards, too big to save and too big to fail. This kind of system should never have existed in the first place Who’s fault is this?

        1. Brett

          You know, come to think of it, I’ve never read a long-form investigative article that details who specifically was pushing for the Euro back in 1999. I just googled it a bit but couldn’t find anything really informative.

          There are definitely specific economists and politicians responsible for it, but I couldn’t name them off the top of my head. But I do know Britain has Gordon Brown to thank for keeping them out of the Euro — today they don’t have the debt problems that the Eurozone countries face.

          1. William C


            The euro was really created by Mitterand and Kohl back in the very early nineties. Mitterand demanded it as the price for agreeing to the reunification of Germany which France could have blocked. The French were fed up with having to follow the lead of the Bundesbank in setting interest rates in Europe and saw the euro as a way of getting a French say in setting interest rates. Under the previous, fixed exchange rate regime, France always had to set interest rates in line with German ones. The Germans set their rates without consideration for the effect on the French.

    3. Edward Harrison Post author

      Don, sorry, I am not following you here. An economic depression is NOT in the workers’ interest. So clearly, we are all aligned in not wanting disaster. In your zeal to sharpen the differences between groups, you miss this important point.

      You write: “How is it that ECB buying not also simply extend and pretend?”

      The ECB’s providing LIQUIDITY to solvent entities is not the same as extend and pretend. What you fail to understand is that this is a liquidity crisis and you have to stop the panic first. That means providing liquidity to solvent entities and letting insolvent ones fail.

      The right thing to do, although I don’t say this, is to let Greece default massively and let Ireland’s banks default massively. And force German and French banks and holders of those bonds to eat the losses. On Italy, Ireland, Spain and Portugal, you can have an interest rate cap that is painfully high but allows them time to prove they are solvent or also follow Greece and the Irish banks into default.

      That is in the interest of workers and in the interest of European society. If you don’t get that, then you are basically standing behind policies that lead to Depression and unemployment.

      1. matt_us

        Ireland and Greece to default? And bond holders eat the losses? And then pretend everything else is going to be jsut fine? And you really believe anybody would finance Belgium or Portugal or Italy, for that matter.

        Also it would be hellishly unfair on hardworking hedge fund managers, who speculated all their money on naked CDS on Italy and Portugal, rather than Ireland or Greece.

        Of course this would lead to a massive recession – Greece and Ireland defaulting.

        If, however these countries need money, they could tax all outstanding CDS – both the owners of CDS and the sellers of CDS. How aboyut 100% tax on the nominal sum of CDS. It is a slightly higher rate than what is proposed as FTT at the moment, but taxing the gross CDS outstanding would allow us to collect 260 bn USD to rescue these two countries.

        Only from speculators who try to run these countries into the ground!

      2. Mike

        The distinction between worker and investor is much fuzzier than it used to be. I’m both a worker and investor. Like a lot of people these days, a large portion of my retirement funds, whether held by me in a 401(k) or through my employer-provided pension plan, are in stocks. At the present time the majority of my household income is wage income, but somewhere in the future that will change to me living off of my investments, pension, and whatever is left of Social Security.

        I don’t know what I can do to protect myself from being laid off, but I’m interested in the things I can do to protect my investments so I’m not living on the street in my old age.

        1. Sock Puppet

          Mike, same here. The 1% have coopted us by making us all “investors”, or grist for their mill. Invest in things that will reduce your costs going forward. Downsize, solar panels, smaller car, lower tax area, skills tha
          t will reduce your need to pay for repairs. Invest in local businesses, rentals, etc.
          The 4 or 5% risk free investment income that your 401k, pension plan, soc sec, life insurance needs was a lien on future gdp growth. Gone and never coming back in the usa. Best we’ll get is an illusion – 5% return and 5% inflation, forcing you out of cash but not giving a real return.

        2. Fiver

          One of the greatest betrayals of the public trust was to allow pension funds to be tied to markets in the first place. The whole notion of “permanent” 8% returns to fund pensions in a 2% annual GDP growth world was and is a fantasy. It is imperative, if we are ever going to get back control of the criminal class, for pension funds to be reclaimed by those for whom the money being there on retirement is vital.

      3. Cody Willard

        Ed, I can’t remember ever disagreeing with you and your principles before, but I’m 100% with Don on your glaring hypocrisy in statements like these:

        “Just to clarify, this is not about the banks, it is about the workers who lose their jobs by economy-killing austerity, default and depression.

        Here, it’s not about buying bonds off of banks either. If the ECB were to provide a universal cap to all sovereign debtors in the EU, those that were solvent would be able to withstand the pain of that cap being high, say 300 basis points over German yields. Those that could not would default. The ECB would not necessarily buy any bonds, but credibly guarantee them the way they and all central banks do for their policy rate.”

        Secondly, my biggest problem with your entire article is simply that you actually believe this, much less state it as some sort of FACT:
        “Any scenario in which there is an Italian default leads to a Depression with a capital ‘D’.”

        Let the people and banks and idiots who lent the money to Italy eat their losses and enforce the RULE OF LAW. Doing so wouldn’t lead to a Depression. IT WOULD LEAD TO IMMEDIATE and SUSTAINED PROSPERITY.

        I am at a total loss to understand how you can justify more bailouts whether in the form of more guarantees or any other form. Don’s also right that you’re betraying the entire premise of OWS with your embrace of more welfare for banks of any sort.

        1. Edward Harrison Post author

          This is about liquidity, not bailouts:

          “The right way to provide liquidity is at a rate that is painfully high but low enough that the solvent are not bankrupted by this. You can best achieve this via an interest rate cap. In this scenario (that I advocate), Greece would default massively and Ireland’s banks would default massively. German and French banks and other holders of those bonds would be forced to eat the losses and be recapitalised.”

      4. don

        Ed, you state:

        “Don, sorry, I am not following you here. An economic depression is NOT in the workers’ interest.”

        What I consider not in the interests of the working class is an economic system that is so crisis prone, that perpetuates and exacerbates class inequalities, in which the economic elite possesses such political power . . . etc., etc.

        Workers don’t benefit from depression . . . that it goes without saying. But at what point do we move away from a system for which catastrophe is now constantly in the background, and which is driving political decisions that are meant to perpetuate that system. ECB buying does nothing to change that. I am simply trying to expand the discourse to look past limiting ourselves to choosing between ECB intervention or accepting a depression, which is a false choice.

        You state:

        “That is in the interest of workers and in the interest of European society. If you don’t get that, then you are basically standing behind policies that lead to Depression and unemployment.”

        I do not believe myself to be advocating policies of accepting a depression and massive job losses. I am suggesting that we have options between bailing out the financial economy while also NOT accepting a silly Austrian ‘let it collapse’ and let creative destruction play out.

        I appreciate your analysis and regularly go to your web site. Thanks.

    4. Edward Harrison Post author

      Just to clarify, this is not about the banks, it is about the workers who lose their jobs by economy-killing austerity, default and depression.

      Here, it’s not about buying bonds off of banks either. If the ECB were to provide a universal cap to all sovereign debtors in the EU, those that were solvent would be able to withstand the pain of that cap being high, say 300 basis points over German yields. Those that could not would default. The ECB would not necessarily buy any bonds, but credibly guarantee them the way they and all central banks do for their policy rate.

      1. mg

        “…but credibly guarantee them the way they and all central banks do for their policy rate.”

        Isn’t that the problem, credibility? EFSF, leveraged SPIV seems to be an attempt at what you suggest. Yhe ECB isn’t your normal central banker. There is nothing to stop the citizens of any european country from electing someone that says no to austerity and threatens to leave the EMU either as a negotiating tool or because they’re serious. Who would buy that paper with that very real threat on the horizon?

      2. Howard L

        Mr Harrison,

        You are correct insofar that you have stated classical central bank theory a la Bagehot.

        I look forward to the day when powerful social institutions backstop the poor, the hungry, the sick. etc… and the financial oligarchy are left to experience austerity.

      3. TC

        It’s useful to point out the ECB has allowed this situation to get out of control.

        They could have done what you suggest at any point in the last 30 months and been done with it.

        It would have been better to punish the doubters early and severely – now there are questions about limits for the ECB.

        It’s a demon of their own design.

        1. Edward Harrison Post author

          Agree 100%. They have let the dominos fall and now there will be serious dead weight loss. The best solutions are ones that allow the clearly bankrupt to fail and for their creditors to eat the losses while allowing the solvent to continue on.

          It’s getting the middle group: the Spains, the Italys and the Irelands that create the problem. Once things spiral out of control, you get dead weight economic loss from the cascade of bankruptcy and that’s where we are now. Frankly, there is no palatable solution here. The ECB steps in or the whole house of cards tumbles down.

          Instead of people making morality plays about who deserves to feel the pain, it would nice if people realise there are better and worse economic outcomes here and the ECB is the difference.

          1. Eric

            If you don’t want to leave it to the markets, and you think it’s the job of the ECB to step in, than you should ask for a complete redesign of the euro system: eurobonds, central oversight over government budgets and fiscal transfers to soften imbalances. Without this, confidence will not come back.
            The Northern countries are not going to accept that just the ECB stepping in will force countries like Italy to do structural reforms. Italy probably won’t bring down their governent debt. It was assumed that the markets would keep Italy’s debt under control when they entered the euro, the markets didn’t, and now the Northern countries are forced to bail them (and the banks) out? This is not right.

      4. JTFaraday

        “Just to clarify, this is not about the banks, it is about the workers who lose their jobs by economy-killing austerity, default and depression.”

        I think that what people suspect is that “backing/bailing out the countries” is actually, in fact, code for “backing/bailing out the banks while finding an excuse to institute austerity anyway.”

        We have some semblance of this in the US right now.

        1. Edward Harrison Post author

          Agreed. It’s hard to to disagree with that statement. I just don’t know how you get around the need for liquidity to prevent this widening panic. I say you do it at a penalty rate, but there aren’t a lot of other options here.

      5. don

        Ed, you say:

        “Just to clarify, this is not about the banks . . ”

        Were the ECB not do as you recommend, would there be serious consequences for banks holding the sovereign debt? I suspect so. So is it not an indirect bailout? Am I missing something here?

    5. No Know

      I find the analogy of an aircraft in flight that is frequently used to describe the situation to be quite apt. The global economy has reached stall speed. The theoretical answer is simple, accelerate the aircraft. Unfortunately that is easier said than done. The correct maneuver is counter intuitive, you don’t just pull back on the stick and hit the gas, you must force the nose down and let gravity assist. Unfortunately, the aircraft must be at sufficient altitude in order to make the correct maneuver. This is the dilemma in my opinion. The worlds’ economies are at stall speed and are way too close to the ground. You can hit the gas (print tons of money), or make the correct maneuver of pushing the nose down (austerity, etc.), but in either case the outcome is the same. The only questions are do we have either an inflationary or deflationary depression, and how do we hold our societies together and work our way through it? Stated another way, folks, consult the information in the seat pocket and prepare for a crash landing (and let’s hope Captain Sully is on the flight deck!).

  10. mg

    If the ECB prints/monetizes debt, when does it stop? After monetizing France’s debt? Wouldn’t the euro at parity or below to the US dollar achieve similar ends?

    1. Yearning To Learn

      it might, but how to do that?
      all major currencies are at a race to the bottom (EUR, USD, pound, Yen, etc).

      Bringing the Euro to Parity with the USD would increase US unemployment which would of course lead to stress on its banking system which of course would lead the Fed to print as well.

      This is a race that nobody can or will win.

      1. mg

        Since they can’t print, Greece, Spain, Italy and soon France has to devalue internally by lowering labor costs amid further austerity. Might be hard to keep the peace. A greatly weakened euro seems to be the least painful option and one all could agree with. I can’t see why Germany would be upset by this. Could create further opportunities w/China, increased trade, China gaining inroads into europe manuf. and maybe banking.

        How to devalue the euro greatly would be to continue on the same path they’re on now,keep the pot boiling at the right temperature

        1. Yearning To Learn

          How to devalue the euro greatly would be to continue on the same path they’re on now,keep the pot boiling at the right temperature

          but again mg, this only works in a vacuum.

          The Euro HAS been devalued significantly these last 2 years. However, it just hasn’t devalued as much vs the Yen, Yuan, and Dollar as it has versus other assets such as Gold. there is a reason for this.

          If the Euro fell to dollar parity you would see a significant drop off in American exports not to mention a massive increase in American unemployment. This would cause further defaults on the already over-indebted American, which would strain the American Banking System.

          The Fed would clearly step in to shore up the American Banks, in part by devaluing the dollar vs the Euro. So the Euro rises again.

          As for China: China is the biggest mercantilist nation on Earth, even moreso than the Japanese. What do you think China and Japan will do if the Euro weakens vs the Yuan and the Yen? Do you think that China will decide to suddenly consume and go into trade deficit with the EU? Do you think the Japanese will do the same?

          Thus: it’s easy to say “all we need is a weaker Euro”. It’s a lot harder to achieve it when everybody else (Pound, Yen, Dollar, Yuan) also wants to be weaker.

          up until now the American consumer has been the consumer of most of the World’s products. That consumer was torpedoed by the financial crisis. Thus, we “need” someone else to step in and be the consumer now. But all countries are enacting policies of austerity and all are seeking trade surplus status, INCLUDING those nations that already have massive trade surpluses (like Germany, Japan, and China).

          we all can’t have weak currencies relative to one another.
          we all can’t run a surplus.
          at least not at the same time.

          So for your plan to work: the EU must find a counterparty willing to have a strong currency AND run a deficit with the EU.

          1. TC

            This is a very good point. China will do what it can to keep the euro above 1.2500.

            Their 12th 5 year plan involves diversification away from 60% USD reserves to more closely match the SDRs.

            If you ever wonder why the yen just seems so gosh darn strong, well, think about China.

          2. Fiver

            But isn’t that exactly what the Fed, BoE and Wall Street, Mr. Harrison and NC in general all SAY they want, i.e., for everyone to print money or engage in “fiscal stimulus” which means monetizing the debt in any case for the US, Japan, UK and most of Europe?

  11. Brick

    I would not really disagree with the scenario painted here with what happens with an Italian default. There are a number of steps which would happen first including the IMF being called in. Once the IMF is called in then you will see the bank runs. It all rather makes it seem as if the ECB choice should be simple, so lets consider the alternative that the ECB prints the money to solve the european debt problem.
    Firstly by my rough calculations you should see an aproximate decline in the Euro of about 30 percent. The immediate effect of this will be two fold, you will get imported inflation on goods which can not be substituted within the Euro Area and where it can you will see a drop of in import trade. My rough napkin calculations suggest a drop in exports to the Euro area from china of about 12 percent, which would be enough to have negative growth in China for the first time in a very long time. I would expect Chinese banks would need a bail out by the state on the back of this. In terms of the US I think you should expect a 5 percent drop in exports and 5 percent increase in imports due to trade changes with Europe along with a corresponding drop in exports to china. The net effect would be stagflation for Europe with eventual collapse due to world trade dropping, China going into a significant recession, US unemployment accellerating with deficits increassing and the bond vigilantes taking a close look.
    The obvious answer is for every central bank to print, to keep currencies stable. The question of whether the ECB acts or not might be rather moot because you end up at the same disasterous scenario anyway. This is just an exploration of the theme and my numbers are guess work but it would be nice to see some proper anlysis of the consequences of the other options, not just assuming it would all be beneficial.

  12. Matt

    One question I’ve never been clear on: who exactly is all this debt at risk of default OWED to? Last I checked, the sovereigns have armed forces, and the debt holders aren’t bulletproof – not that it should come to that, but the fact is that the only way the financial sector can blow up the world is if we LET IT…

    1. Brick

      The debt holders are a mixture of Banks, Pension funds, Other governments, municipal investors, hedge funds, insurance companies. With the exception of hedge funds and possible questionable exception of banks, ultimately its the average person who is the debt holder in one form or another.
      An Italian default means you need to put more into your pension, you need to pay more local tax, your insurance goes up, you need to pay more tax to central government.

      1. chris murphy

        “ultimately its the average person who is the debt holder in one form or another.”

        This is not true. In fact the vast majority of financial assets, including sovereign debt, is held by a very small % of the population. For example, according to a 2007 Federal Reserve study 1% of the US population owns 50% of financial assets and the bottom 50% of the population owns only 1% of financial assets.
        This misconception that ownership of financial assets is widely dispersed is quite dangerous and is used by the plutocracy to push policiesthat benefit them at the expense of the working and middle classes.

  13. Eric

    this article is based upon false circular reasoning, that goes like this:

    Italy’s debt is unsustainable at current interest levels, only the ECB can bring back confidence and bring down rates by buying bonds, or we will see Italy default.

    where is the proof for the ”only ECB can bring back confidence” claim?

    1. Edward Harrison Post author

      You misuse the word circular because one argument does not lead to the other and back again. I am making a simple assumption that you have identified correctly as being “The ECB is the only credible agent that can reduce yields enough to give the euro zone the breathing space to help solvent sovereigns make fiscal adjustments.”

      Could the assumption be wrong? Sure. But the alternative at this point now is a worsening panic. I see this leading eventually to economic collapse.

  14. larry darnell

    The most important debate of our lifetimes is now ongoing. For many, the answer will be existential.

    true dat

    Italian death spiral = milton friedman shock doctrine baloney

  15. William LeGro

    I’m reading the headlines every day looking to see if the ECB is going to step up, or not. Like Harrison says, it’s hard to believe it won’t, given the alternative.

    What I don’t get is this: Harrison predicts worldwide depression if Italy starts the dominoes falling. But then he says the best thing investors could do would be to put their money in “highly rated corporate bonds and high quality dividend paying stocks…”

    Well, if the economies of the world are crashing, how would even those be “safe havens”? Why not just be ready to get out of the market altogether and stash your cash?

    As a small investor whose life savings are basically the market and home, and who’s already been badly damaged by the last couple of crashes, this is a vital question for me.

    1. Timothy I

      Buying corporate bonds of solid companies at the beginning of the Great Depression would have made you rich. I think the same will be true this time around. Well-run companies are sitting on huge cash reserves and have cut expenses to the bone. Demand doesn’t drop to zero, and what’s left will just be spread among the fewer remaining companies.

      Just gotta be brave enough to buy when the blood is really running in the streets (and what we’ve seen so far is just a dress rehearsal).

      1. gg

        So in this scenario even U.S. Treasuries are a risk? How is that possible? Is Harrison saying that if Italy defaults eventually the U.S. Government will default?

  16. James

    How did investors lose confidence in their confidence game? The big ones know full well that they are the masters of the known universe. Some of them are politicians with direct access to the administrative and policy mechanisms that determine the outcome. Did they wake up one day in confusion, wondering whether they would bail themselves out at everyone else’s expense?


  17. mg

    I’m not a WW I scholar but the argument that Europe has to or will do something because if they don’t the results will be dire was the prevelant mindset before war broke out. Of course, no land war this time but a neo-liberal war on nations debt and currencies

  18. Bam_Man

    Edward remarked that Gold is likely to perform well in his Armageddon scenario, but that “physical gold is subject to confiscation”.

    I think that in such an “Armageddon” scenario, that ANY form of physical wealth will be subject to government confiscation. The question is, with the Government at that point having been revealed as totally bankrupt in every sense – will people readily comply? And if you consider yourself likely to be among those who will not, then Gold is still the asset of choice for obvious reasons.

    1. Walrus

      Gold will not be “confiscated”. You will be required to surrender it in exchange for legal tender because Gold will become the only medium of exchange for international trade if the current system fails.

      In effect that takes us right back to the gold standard. Governments will be required to settle trade imbalances in Gold.

  19. frank

    The Germans are not only playing a very strong handed game of chicken with the club med countries, but are forcing the British and Americans to the table.

    The Germans want a transaction tax on stock, bond and currency trades. England and America refuses to go along. Although neither a member of the Euro, both have much too lose if the markets crash.

    The transaction tax would be the revenue to pay back the ECB/ESFS or IMF or what ever bond was created to fund the sovereign and bank recapitalization losses. The transaction tax can only be implemented if ALL countries agree, so that the finanical transactions don’t go to the lone dissenters.

    The ECB is manipulating the sovereign bond rates to induce fear and has successfully induced austerity and regime change.

    I am in the camp of monetization. The ECB has seen it work in America and elsewhere. It is the easier choice. I would suggest that as for an investment criteria putting cash in small community banks below $250,000. These banks have no exposure to CDS swaps or have an investment banking arm. I also belive that holding cash buried in the backyard is an alternative at zero interest. When the crisis does explode we will definitely have a market holiday and may also have a bank holiday. Please recall when 9/11 hit the markets shut down.

    Lastly there is much to be learned from the recent MF/Corzine failure. Seperated accounts weren’t seperate and the SPIC is not keeping their promise. We also have learned from AIG and now Greece that CDS pose a counterparty risk that is unacceptable.

    1. BarbaraNH

      “I would suggest that as for an investment criteria putting cash in small community banks below $250,000…. I also belive that holding cash buried in the backyard is an alternative at zero interest.”

      What’s wrong with good ole U.S. Treasuries?

      1. Bam_Man

        The MF Global fiasco has shown that your trusted “fiduciary” could be using your US Treasuries to meet its margin calls.

        This is the first clear sign that NOTHING in this thoroughly corrupt system is safe unless it is physically in your possession.

    2. William C

      I think I agree with Frank: monetisation by the ECB is still the most likely outcome but only when they have extracted every concession they can from the debtor countries. They see a need to do this to placate German public opinion. It is of course highly debateable whether this is the best route from an economic point of view but the politics is pushing this way.

      I suspect some good lawyers could find a way round any legal difficulties: if the ECB is limited in its lending to states but can lend to banks then they can lend to the banks to lend to the states?

      Of course things could go awry so I am not going to bet the ranch on this.

  20. Fiver

    My argument all along has been that this is an orchestrated attack on sovereignty of nations in order to asset-strip Europe to feed to the ultimate “winners” of this financial war, i.e., the US-based banking/corporate empire.

    Italy has fully succumbed. Monti’s new government consists of bankers, businessmen and career bureaucrats – not ONE elected representative. Who do you suppose these clowns answer to if not the very Visible Hands of “markets” that have, from the moment the crisis began in 2007, been used as WMD by banksters, the strongest hedge funds and private equity firms, with the full participation of the Fed? One need only consider the fact I cited the other day here on NC – the quintupling of Blackrock’s assets to $3.5 TRILLION over the course of the crisis to provide a sense of the enormity of the wealth transfer underway.

  21. Foppe

    Apropos of nothing, but I’ll put it out here just to emphasize that the world is a really strange place:

    Eurogruppen-Chef Jean-Claude Juncker hat der Politik in Deutschland vorgeworfen, so zu tun, als wäre das Land schuldenfrei. “Ich halte die Höhe der deutschen Schulden für besorgniserregend”, sagte Juncker in einem Interview des Bonner General-Anzeigers und fügte hinzu, “Deutschland hat höhere Schulden als Spanien. Nur will das hier keiner wissen.” Der luxemburgische Ministerpräsident zeigte angesichts der Finanzkrise Verständnis für Ängste in Deutschland. “Hier mussten die Menschen zweimal machtlos der Totalzerstörung des gesamten Volksvermögens zusehen.”
    Er sehe derzeit aber weder eine Inflationsgefahr noch die Gefahr des Zusammenbrechens der Währungszone. “Es gibt keinen Grund zu denken, dass das Ersparte in die Gefahrenzone geriete”. Juncker sieht Griechenland bei der Haushaltskonsolidierung auf einem guten Weg. “Ich würde diesen Weg aber als nicht so gradlinig bezeichnen, dass er es jetzt schon erlaubte, Licht am Ende des Tunnels zu sehen.” Einen Austritt Griechenlands aus dem Euroraum bezeichnete Juncker als “theoretisch”. Weil das Land seine Schulden weiter in Euro bezahlen müsste, die neue Drachme aber 60 Prozent an Wert verlöre, drohte bei einem Austritt ein “katastrophales Szenario”. Juncker glaubt, dass die britische Regierung nicht mehr lange Widerstand gegen eine wirkungsvolle Finanzmarktregulierung auf europäischer Ebene leisten wird. “Auf Dauer wird es für Großbritannien keine Sonderwege geben.” Die Europäer dürften nicht “zum Spielball der Finanzmärkte werden”. Zurückhaltend zeigte sich Juncker bei der Frage, ob es mit der neuen Regierung in Italien jetzt wieder aufwärts geht. “Die Italiener müssen sich jetzt gemeinsam auf den Reformweg machen”, sagte Juncker.

    So, Ed (or anyone else): are you also really worried about the German debt levels? This really is bizarre..

    1. Foppe

      (Juncker’s choice to give this interview now, that is. But perhaps our friend Juncker really is tiring of extorting the Greeks, and he’s going after bigger targets now.)

    2. Edward Harrison Post author

      Germany is in violation of the Maastricht Treaty, as are the Netherlands and France. The sovereign debt levels are high right through the core of the euro area. If Italy fails, it will severely impact Germany and they will lose AAA status.

  22. the buckaroo

    …Nostradamus must have this one called. Cultural differences doom all economic unions…apparently such little things as self interest block all attempts at forging one.

    The Mediterranean effect is too powerful to be overcome by northern disciplines, verdad? Only a common language can break this rule…& though money has a voice, it cannot speak for itself nor ignore cultural boundaries. Political boundary realignment is it’s specialty.

    This obsession with rearranging the deck chairs must be viewed with suspicion & alarm knowing all along that a new boat is necessary. When did the rentier class obtain the power to enforce their interest…oil, black gold, Texas Tea comes to mind. This allows the ability to reach out & touch someone, literally.

    We must question a few fundamental concepts…is the air we breathe a shared resource & proceed from there. Is oil a shared evil beneficial to only the business class?

  23. Gallam

    There are a lot of radical solutions to the Italian debt problem here, but are they necessary?

    Italy is a very wealthy country. Why not just impose a wealth tax equal to about EUR20,000 per taxpayer, per year for a few years. It could be done as a function of property prices.

  24. Cynthia

    The Euro contagion is here

    All hope will be trampled by fear

    Get your gold, guns, and lead

    Lots of water and bread

    Then sit back and relax with a beer

    H/T: The Limerick King

  25. craazyman

    I Frankly Don’t Understand Any of This

    Economics is hard for me to fathom. Here’s data on the Italian economy from Bloomberg:

    Total 2010 GDP = 1.42 Trillion

    Household Consumption = 0.851 trillion
    Public Consumption = 0.303 trillion
    Total investment = 0.275 trillion
    Exports = 0.385 trillion
    Imports = 0.400 trillion

    I’m guessing “Public Consumption” is government spending, but I’m not sure.

    So let’s say austerity hits government spending so it stagnates or falls, and let’s say Italy has to pay uncomfortably high interest rates.

    Presumably, it’s paying these yields largely to Italian banks (i.e. “to itself”, as they say). And let’s say, somehow, they can boost investment by back room deals, a weaker euro (if that happens) boosts net exports. Investment did actually grow 2.4% in 2010, according to the data.

    It seems that Italy could muddle through, based on sort of a back of the napkin analysis. Government spending is only 0.3/1.4 = about 21% of GDP. So if the gods are with Italy and a weaker euro helps boost exports somehow and investment grows, I don’t know about all the doom and gloom. Not that it couldn’t happen, but it might not. It seems the Fates are in control more than any sort of logic.

    It could well be I’m missing something. As I said, I don’t understand this very well.

  26. Fiver

    I see no essential difference between Mr. Harrison’s analysis and that of, say, Ben Bernanke or Tim Geithner or Krugman, or the Wall Street Journal in that it repeatedly comes down to “Do this or it’s Armegeddon” followed by the truly absurd mantra of “We’re all in this together”.

    We are NOT all in this one together. Tell me this:

    How many of our best minds in government, corporations, or any other institutions have been directed to resolving this in a way that visits the brunt of the pain on the whole class of those who created this entire serial systemic extortion-by-threat-of-default-domino mess? To contemplate viable solutions that do NOT leave the existing, culpable criminal class in an actually ENHANCED position at game’s end ?

    I’d venture to say not 1. Not even two second bananas in one office. You may believe there is no possible way out other than just cave into this Mob if you wish, but I rather expect that if you had the best minds around the table AND they were explicitly directed to come up with the best solution for the public good in the true sense of that phrase, it would not entail “suck it up, hit the print button, and wait for a trickle down that never arrives for ever larger pools of workers. Meanwhile, wise investors will….”

  27. George Phillies

    They have some choices
    Kick the can down the road. Is it full of nitro this time?
    Haircut their bonds and stay in the Euro.
    Sovereign default on their bonds and restore the Lira
    Sovereign default on their bonds, and *stay in* the Euro system

    As part of any of the above, announce they are issuing their banks new bonds to keep the banks from croaking. The new bonds are in one, five, twenty, and one hundred Euro values. They pay no interest, and the term is ‘repayable when we feel like it’.

    However, they are legally valid for all tax payments, and are printed “This BOND — see, it’s a bond, not a piece of money, it says so right on the bond — is legal tender for all debts, public and private”.

  28. Flyng Kiwi

    Protecting my wealth?

    Here in New zealand I’m debt free and have an all-year vege garden, grow more apples, stone fruit, avocado, citrus and grapes than it’s sensible to eat, have two house-cows supplying 2 gallons of milk per day and 400lb of beef per year, 120 sheep on a 60 acre lawn out front and a bay full of fish and shellfish at the bottom of the road.

    I have 3,000 sunshine hours annually, an endless stream of clean water with a 150′ head from the mountain behind me and more trees for the stove than its possible to count within a 10-minute drive.

    I know all the 30-or-so people who live within 5 miles of my place and we whinge if the temperature gets down to 0’c any winter.

    Anyone know where I can get a Lifestyle Default Swap?

  29. Hugh

    Came late to this. But I recall seeing text of the EU treaties that suggested that what the ECB could and could not do in emergency circumstances were a lot vaguer than the absolute statements on its limits that I see here.

    Just to reiterate another point I make in these discussions, monetization of the national euro debts must be accompanied by fundamental reform and restructuring of Europe’s trade patterns, banking, politics, fiscal and debt policies, and wealth distribution. Monetization by itself solves nothing.

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