The lockdown of Italy isn’t a temporary thing. Oh, the suspension of free movement is temporary, but it portends something far bigger.
It’s the beginning of the real political balkanization that’s coming to the European Union over the next few years. Old enmities and prejudices have not been stamped out under the boot heel of oppressive legislation coming from a bunch of disconnected technocrats in Brussels.
They have only been suppressed.
Because when there are existential threats, there’s no time or desire to virtue signal about how we’re all one big happy dysfunctional family.
For decades, Germany refused to lighten up on its fiscal inflexibility believing, rightly, that it shouldn’t subsidize profligacy in places like Italy, Spain and Greece if it didn’t want to.
At the same time, however, Germany transmitted those rules to the single currency regime of the euro. That was the price they forced on the rest of Europe.
This ensured that eventually they would have to do exactly that, subsidize or bailout debts, as the mis-pricing of labor and capital efficiency inherent in the any single currency applied over multiple economies drove capital to Germany and out from those countries.
Now Germans face the existential threat of COVID-19 imported into Europe mostly through Wuhan textile workers in Milan’s leather shops. Their leaders will force them to accept looser spending rules.
And do you think this will engender an outpouring of love and affection towards Italians?
If you do, you might be delusional or an open-borders libertarian… but I repeat myself.
Chancellor Angela Merkel has signaled for months she would spend more to satisfy the rising Greens on Germany’s political left.
Her finance minister, Olaf Scholz, has unleashed the full force of Germany’s sovereign wealth fund to offer unlimited support to German businesses facing troubles because of this virus.
This is as good a cover story for the gargantuan holes in the balance sheets of zombie German banks as they were likely ever going to get, folks.
ECB President Christine Lagarde was brought in to ram through the political changes needed to loosen Germany’s tie. She knew the only way the EU would survive the growing crisis within its non-functional sovereign debt market was to print money to the high heavens.
Or allow the union to break up. But, there is no Door #2 in Europe. All doors lead to Brussels.
Germany stood in the way of that, while at the same time Merkel ruthlessly enforced Schengen. She weakened the political center in Germany and inflamed memories of a Germany which rampaged across Europe militarily in the 20th century through enforced austerity hollowing out less-efficient euro-zone economies.
So in the midst of this mess comes COVID-19 and the uncoordinated and inept response to it from the political center of Europe to date. Only now are they coming to the conclusion they need to restrict travel, after sitting on their hands for a few weeks while Italians died by the hundreds.
And do you think that’s engendering waves of love and affection among Italians towards Germans?
If you do, then you don’t know Italians… at all.
And this is your signal that this is the beginning of the real crisis. Because while COVID-19 may have been the catalyst for the breakdown of capital markets, capital markets were simply waiting for that spark to occur.
Any other type of spark, a bank failure from a run of bad loans, could have been handled and absorbed. There was no Credit Anstalt the central planners weren’t prepared for.
They’ve been able to keep Deutsche Bank operational for the past few years, for pity’s sake, they could have handled any other single bank failure.
But with COVID-19 being the ultimate form of exogenous shock to the global economy, there is no containing the financial contagion. And that’s why we saw a strong unwind of U.S. equities and a sharp rise in both the Japanese yen and the euro when this thing began.
Part of what had been pushing U.S. equities higher was the capital flow from Europe and Japan into the U.S. That reversed for a short time as the eurodollar markets seized up and the demand for cash locally rose sharply.
It’s no different than what is happening here.
I went to my bank yesterday to grab some cash and finish our self-quarantine prep (we’d bought extra toilet paper weeks ago). The teller told me she’d moved out a lot more cash than normal, and it wasn’t even the end of lunch hour.
Then I told her the bank run on corporate credit began earlier in the week as companies like Boeing maxed their credit revolvers to front run the bank pulling it.
That got her attention.
The same thing on a larger scale was happening in Europe until Lagarde told the world that she wasn’t done blackmailing Germany into loosening its stance on fiscal rules at her presser on Thursday.
And the rally in the euro, which was already sick, died.
What we saw to end this week was an epic reversal of that capital outflow as the USDX and U.S. equities rallied while the euro crashed back to $1.11. And now that it’s started, I don’t expect it to stop.
The Fed fired major blanks at the dollar-funding crisis in the credit markets this week. What is the ECB going to do to stop rates from rising in Europe as money flees their incompetence?
Fairy dust springs to mind, honestly. But, more likely there will be a very quick move to close the banks and cancel the use of cash while new rules are adopted and Lagarde turns to the IMF to bailout the ECB, which can very easily go bankrupt here.
The weakest banking system in Europe serves a country on lockdown over this virus.
So, it doesn’t matter now that Germany has acquiesced, pledging its own savings and lifting fiscal restraints of euro-zone members. All the printing will do is feed the vortex of unpayable debt that is far bigger than their prodigious piggy bank.
The next stage of the crisis is here with the focus finally turning to Europe. The U.S., for all of its faults, is one nation with a unified debt market and an executive who can, and has, exercised powers necessary to keep the wheels from completely falling off the U.S. economy.
Will Trump spend money he doesn’t actually have? Yes. So what?
That money will go into a logistical pipeline that far outstrips Europe’s to combat a disease over a smaller population spread across larger distances. That limits the damage to the U.S. It ensures political stability that the EU cannot hope to compete with for the trust of spooked capital.
Add the global economy grinding to a halt. We’ll see the crisis emerge in Europe to feed a widening gyre of debt servicing that will look like a global bank run on dollar liquidity.
It will force fundamental reform of the euro and the ECB. They are necessary for the EU to survive this crisis in anything close to its current form.
I’m not laying odds that will work. Instead, I expect Schengen’s suspension to hold and more countries go the way of the Brits by exiting the EU itself.
While this crisis is tailor-made to shove the federalization of Europe down the throats of what’s left of the German middle class, I don’t think it succeeds.
Until Germany is willing to bail out Italian banks, there is no solution to this.
And while I think Merkel is willing to fall on her sword to get this done, it may still not work.
How convenient it is that Merkel’s CDU just cancelled their April 22nd leadership vote because of this crisis. This forestalls any possibility of Merkel losing control of her party until after Germany begins its EU Commission Presidency.
Whatever she has planned, she has to do soon. Her political capital is just about spent.
There will be no change of leadership during a crisis like this. She’s almost done completing the sell out of Germany to the EU begun by Helmut Kohl.
Just in time for the whole experiment to come crashing down.
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