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Wake up Europe!

by Aaron McCormack on July 15, 2011

"The European Bank Stress test results are like declaring the Hindenberg a perfectly safe mode of transport as long as there are no naked flames"

“If we are going to turn our eyes to the future for Europe and its constituent countries, we need to begin by clearing the decks of the debt crisis – nothing else will matter if we allow our institutions to continue to fudge and obfuscate on the core finances of our sovereigns and our major banks.”





I wonder if the political and financial leaders of Europe believe their own bullshit?   At their summits, and in their private conversations, do they seriously think that the current approach to the debt crisis has a chance of working?  Or are they fudging the issue?  “Kicking the can down the road”?  Engaged in a game of “extend and pretend”?

Or to put it more bluntly, are they lying to us?

What has happened in Europe is pretty simple.  Most governments have spent way beyond their means.  Not in a cyclical, temporary way.  But in a fashion that must have required them to suspend normal belief in the rules of financial markets and economics.  An abundance of cheap money from Europe’s banks (mainly German and French) aided and abetted this.  As others have said, people confused a lack of currency risk for a lack of risk, full stop.

Governments found a way to avoid the painful national debates that need to be had (like that currently ongoing in the USA) and borrowed to make the numbers work.  Private banks, through greed or stupidity or naivety or all three, were happy to lend to these countries.  Now, hamstrung by Euro membership, countries lack the freedom to solve their own mess as Iceland has done so well.

Along with the simple act of countries spending money they could not afford, people have also been lulled into a false sense of where we really are in terms of prosperity.  The added challenge of a debt bubble is that it  forces us eventually to change our definition of “normal”.

And it gets worse.  This has all happened at a time when Europe, with perhaps the exception of Germany, is struggling with its basic competitiveness and needs to make significant investments in education and R&D to enable new value-creating jobs for our people.

So, when we can least afford it, we are incapable of making the right down-payments on our future – investments that China, India, Brazil and others are happy to make.

So much for framing the problems, which are legion.  What do we do about them?  If we are going to turn our eyes to the future for Europe and its constituent countries, we need to begin by clearing the decks of the debt crisis – nothing else will matter if we allow our institutions to continue to fudge and obfuscate on the core finances of our sovereigns and our major banks.

Solving any problem usually starts with being brutally honest about the situation we find ourselves in.  This is all the more important when the problem space is complex and the consequences of action are high.

European leaders are consistently misleading their people about what has happened to Europe’s finances, and what needs to be done to fix the problems.

Let’s consider two examples from this week – the IMF/EU/ECB review of progress in the Irish bailout and the results of today’s European Banking Stress Tests, where eight banks failed.

The “troika” as they are known commended Ireland on progress against the tasks laid out by the bailout package.  A “pat on the back” if you will pardon the pun.  Taken at face value, this could be seen to support that narrative that Ireland is taking the prescribed medicine and healing nicely.  The problem is that the bailout construct is a fiction and assumes Ireland’s economy (and tax revenues) will grow at unrealistic rates.  It is a matter of arithmetic that Ireland will be broke once again in two years.  But, with Greece dominating the headlines and the political focus, the Irish situation is left on the back-burner for now – or, worse still, being touted as an example of how the EU strategy is working!

And as even more severe doses of economic chemotherapy are applied to Greece, the bank stress tests revealed today failed to test these institutions for a circumstance where Greece is forced to default (never mind Ireland, Portugal or Spain).  It’s like declaring the Hindenburg a perfectly safe form of transport as long as there are no naked flames.

The problem with debt, is that it always has to be paid.  It is an immutable fact.  Someone, somewhere has to foot the bill.  That trail of money leads back to large French and German institutions.  A narrative where the people of the European periphery (who are not blameless by the way) are seeing their countries destroyed to pay, in full, the gambling debts of French and German banks is not from the pages of the conspiracy-theory bloggers.

The real question is why do smart people (politicians, civil servants, bankers, journalists and others) not see this for what it is?  Why do these experts avoid the tough but necessary insights and decisions?  How do they allow us to stumble on through the crisis, and into deeper trouble?

It is possible that they genuinely believe that the continent can just hunker down and wait until turbulent times pass.  That the pain inflicted on citizens (particularly in Ireland, Portugal and Greece) is an acceptable price to pay (and, in most cases, deserved).  Irish and Greek politicians may lack the imagination or the courage or the execution skills to see what is really happening and may believe that the most important job the can do is to work with France and Germany to save the Euro.

More likely Europe’s key leaders are too invested in their Euro project to agree that the periphery cannot live within that construct any more (bizarrely so, since a Euro without the periphery would be a stronger currency).  And the domestic political concerns of French and German leaders means that they cannot enact a solution  – such as European Debt federalisation (see, or giving the Franco-German banks the haircut they deserve – without suffering significant electoral damage next time around.

So we are getting the worst of all worlds.  Lack of transparency and authoritative communication on the real situation, and a series of botched half-measures that are throwing good money after bad before the endgame finally plays out.

Unless European debt is federalised, countries like Ireland, Greece and Portugal will have to leave the Euro and default.  The debts will have to be paid.  The question is how much will be paid by citizens in the periphery countries, how much by the banks that made the bad loans and how much by the citizens of France and Germany if their banks need the bailout.

The people of Europe need to wake up to the seriousness of what is happening.  As someone said to me this week, Europe already faces the prospect of  becoming moribund for decades to come.  The longer we wait to fix this debt crisis properly, the worse the real crisis of competitiveness and prosperity will become.

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