Europe Continues Stumbling and Bumbling Towards a Major Financial Crisis

Not Implementing a Good Solution, Because There is No Good Solution

The Dismal Political Economist has been quiet on Europe recently, because the powers are in continuous negotiations trying to resolve the banking crisis (banks have too little capital and have too much sovereign debt of Greece, Portugal, Italy ect.) and trying to resolve the Greek debt crisis and trying to resolve Italy’s dysfunctional government crisis and trying to resolve several other crises that are too small to comment on next to the big crises.

The European Union has been meeting  and so far they have come up with, nothing. 

1. Germany has agreed to more than double the European bailout fund to $1.4 trillion.  This illustrates the severity and size of the problem.  Before anyone gets too excited over the size of the fund it should be noted that no European country has agreed on funding for the enlarged fund.

2. Italy is becoming an increasingly large concern.  A lot of this is over its government’s inability to govern.  Recently a fist fight broke out in the legislature over pension reductions.

On Wednesday, Northern League lawmakers shouted at Mr. Fini to resign over the remarks, stoking a raucous session in the lower house that climaxed with a brawl between Claudio Barbaro, a member of Mr. Fini's FLI party, and Fabio Ranieri of the Northern League.

3. European leaders still do not understand that austerity leads to economic expansion.

The Europeans also want Mr. Berlusconi to live up to his promises to do more to reduce Italy’s huge accumulated debt — about $2.65 trillion, or 120 percent of gross domestic product, among the highest in the developed world — and to promote economic growth in a largely stagnant economy. 

See cutting the debt means huge cuts in government spending and tax increases which will reduce economic activity, create higher deficits and cause more borrowing.  Really, how hard is this?

4. The European banks that loaned all that money to Greece, Italy, Portugal, Spain etc want to be bailed out.  This appears to be a characteristic of banking world wide.  Banks want no regulation, want to be totally left alone, want no government interference, unless they need to be bailed out by taxpayers from their idiotic decisions.  Then its ok, as long as they get the money and the governments go away afterwards.

The latest agreement is for the banks to take a 50% loss on their holdings of Greek debt, for Europe's bailout fund to guarantee new debt issued by Spain and Italy and for some sort of restructuring of Greece's economy (again).  Exactly how this will be done, and whether or not other European governments will go along with the guarantees is still up in the air.

The European banks are going to have to raise $150 billion in capital to maintain their current size.  Where's that money coming from?  A reasonable fear is that instead of raising new capital the banks will shrink their balance sheets (reducing lending to business) in order to increase their capital ratio.  This could put the precarious European economy back into a recession.

So, when Europe gets this all settled out The Dismal Political Economist will get back to everyone.  Don’t keep the light on, it may be a while.