Martin Wolf of the Financial Times is Scaring the Heck Out of Us on Europe

If He Keeps It Up, We Will Stop Reading Him

One of the preeminent observers of current economic conditions in the world is Martin Wolf of the Financial Times.  Recently he has headlined his comment on the condition of the European economies as follows.

Fear and Loathing in the Eurozone

The problem:

It is contained in two sentences: “Nearly half of the €6,500bn stock of government debt issued by euro area governments is showing signs of heightened credit risk”; and, “As a result, banks that have substantial amounts of more risky and volatile sovereign debt have faced considerable strains in markets.”

Ok, what does this mean. It basically means that unlike any period in post World War II Europe, the debt issued by countries is not the most credit worthy of debt, and that by holding this debt the banks of Europe face considerable risk.  Since banking is the linchpin of economic activity, this means that the economies of Europe faces considerable risk, not of a slowdown but of a total collapse.

This should not be the case.  Bank lending to sovereign governments should be less risky than lending to private companies and individuals.  This low amount of risk for sovereign debt is why lenders have flocked to U. S., German and British government debt, bidding up the prices of government bonds and lowering the interest rates to record post war levels.  But the debt of European countries other than Germany is not so good.

The emergence of doubt about the ability of sovereigns to manage their debt undermines the perceived soundness of the banks, both directly, because the latter hold much of the debt of the former, and indirectly, via the dwindling value of the sovereign insurance.

Do we know what happens when the banking system fails?  Yes, you can look it up.  Look under the topic “The Great Depression”.

The solution, according to Mr. Wolf is this.

The answer is twofold: a recapitalisation of weak banking institutions, on a credible scale, and sufficient liquidity to prevent the panic from ending up in the collapse of banks and vulnerable sovereigns

And in case it is not clear what he means, it can be summed up in two words: 

MASSIVE BAILOUTS

In closing, Mr. Wolf sounds what he probably thinks is a positive note.

The eurozone has still to decide what it will be when it grows up. But first it needs to reach that stage. The costs of a meltdown would be too grave to contemplate. The members simply have to prevent that. They have no sane alternative.

But anyone who has ever followed politics and economics knows full well that when there is no sane alternative to a policy, more often than not the insane alternative is selected.