Die Another Day?

A consideration of the possible domino-effect of the EU’s debt structure, with reference to various initials, including TLTRO, TARGET, QE and EZ. We provide links to many related posts.

Debt 1There are many factors that could destroy the European Union – which we described in our review of Ian Kearns’ book ‘Collapse: Europe after the European Union‘ [Collapse: Europe After the European Union – Parts 1&2] – but here we will summarise the most immediate problem: debt. If a state is bankrupt its bonds aren’t safe, its credit will soon be cancelled and its companies will struggle to repay their loans. If one state fails then others whose financial institutions are intimately linked to it are in danger too.

The eurozone (EZ) forged such links and created the conditions that have bankrupted several of its members. Three disguised supports from the ECB are providing financial levitation but they cannot sustain the system indefinitely. At some point the troubled economies must grow fast enough to meet their obligations, or if they cannot they will have to throw off their burdens (default on their debts) and take back control of their currencies (so they can devalue to become competitive again). We have described the ECB’s methods in previous posts but here we explain their scary-looking titles briefly and simply with links to our fuller descriptions. The three ‘euro-props’ are: the Trans-European Automated Real-time Gross Settlement Express Transfer System (TARGET2), Quantitative Easing (QE) and Targeted Longer Term Refinancing Operation (TLTRO). Don’t Panic! Yet.

White credit card isolated pathTARGET2 is analogous to a credit card system that a country uses to buy imports from other EZ countries. However the accounts aren’t settled regularly, instead they are expected to balance out over time as import debts are matched by export credits – but that hasn’t happened. Instead an imbalance of €1trillion has built up, half of it is owed by Italy and half of it is owed to Germany. Much the same system, called the Transfer Rouble (TR), contributed to the fall of the Soviet Union, the accounts were never settled so lots of Russia’s exports became free to its satellite republics. Were it not for monetary union the weaker states would see their currencies devalue and their exports become competitive again but within the EZ that natural balancing process was abolished and the TARGET2 accounts reflect that fact. [Money, Money, Money (Funny Money)]

QE (quantitative easing) was initiated in 2015 by the European Central Bank under President Mario Draghi’s “whatever it takes” strategy to save the EZ’s banks. QE Cartoon 2The ECB electronically created €2.6 trillion to buy mainly government and some corporate debt, or ‘bonds’. The program ended nearly four years later in December 2018 at the insistence of the Bundesbank. These state bonds were decreed to be zero risk so banks loaded up on them to make their balance sheets appear safer. Italian banks in particular have large amounts of ‘non-performing’ loans, debts that are unlikely ever to be repaid, but their store of absolutely safe bonds keeps them technically solvent – as long as the market believes the government will repay its loans. In real terms (that is, allowing for inflation) the Italian economy has hardly grown over the past twenty years since the creation of the euro currency and is currently in recession; it could only pay its debts from the already half-empty pockets of its people rather than from newly-created wealth. Sooner or later the markets and the ratings agencies will confirm the actual risk and many banks will become factually insolvent. French banks are by far the most exposed to their Italian counterparts, about five time more than Germany’s and sixteen times more than the UK’s (mostly Barclays). [The Future of the Euro – 2]

Euro-tap 1TLTRO is another form of QE whereby the ECB gives free money to banks for them to lend on to businesses in order to stimulate an economy. The banks are financially rewarded provided they do lend the money as intended. QE1 had merely postponed bank failures and what is effectively QE2 had to be announced two months after the first version ended – embarrassing. [TLTRO Rugby]

The European Stability Mechanism (ESM) could also provide bailout funds if a state or its financial sector is under threat and this has already given support to Spain and Cyprus (Greece, Portugal and Ireland were bailed out under previous schemes). Its funds are limited to €500 billion, about enough to sustain Italy for a year in present circumstances, provided its ‘populist’ government succumbed to stringent reforms to restore stability (i.e. impose austerity on its already hard-up people). Unlike Greece, Italy is economically big enough to threaten destruction of the EU project, a strong negotiating factor, and it has a history of fascist dictatorship not entirely disliked by all its citizens.

The risky EZ venture, which was meant to accelerate convergence, has actually driven its member nations further apart economically with high unemployment, low growth and huge debts for some while others appear to be doing well. The appearance is deceptive; when citizens of the richer nations discover their savings will be forfeit – because the poorer ones can never repay what they owe – the consequences will be dire for both. Unfortunately contagion will affect others beyond the EZ and beyond the EU, including the UK whether or not it is still a member. French banks may be most exposed but British banks are exposed to their French confrères.

As Europe’s financial capital, London is especially vulnerable to EZ collapse. The Bank of England Governor, Mark Carney, has assured MPs that UK banks will survive, according to the results of its recent stress tests, their defences having been strengthened since the great crash of 2007 [1]. If bank bailouts are necessary the Cyprus solution will apply to the EU’s failing banks, whereby citizens’ money above €100,000 will be confiscated (if the UK follows suit that would be £85,000) [2].

The danger is imminent, if it’s third time lucky for May’s deal and the UK bails out of the EU this March perhaps there is more chance of avoiding a bail-in for its banks though it would trigger the £39 billion divorce payment. Therefore a dilemma faces eurosceptic MPs, whether to accept the Prime Minister’s ‘bad-deal’ or hold out for ‘no-deal’? An argument could be made to agree anything that puts more distance between the UK and EU in the expectation that the latter will collapse pretty soon. Would any of the remnants from a breakup inherit the deal or would it lapse because one party had effectively departed the scene? That’s a question for the legal eagles which cannot be addressed until the extent of the coming breakdown is clearer.

Germany itself is now in recession, its manufacturing exports having shrivelled. With low or negative growth, imaginary money and enormous debts everyone is going be unhappy. Political stability is threatened with extremist parties and possible riots across the EZ. The UK could look like a calm sea if it can minimise its involvement and end its Brexit divisions, its economy is relatively robust in comparison.

Links to previous posts (in reverse chronological order of posting):


Eventually the money lent has to be repaid so more debt is being piled up, which is fine if growth is stimulated enough to do it. That’s unlikely.

Money, Money, Money (Funny Money)

There are dangerous forces at large, such as neo-fascist AfD in Germany. If Germans end up footing the bill for the ECB’s management of the eurozone the party will get stronger.

The Death of the Euro

How the EZ may fragment, perhaps leaving a core Euro2 zone.

The Future of the Euro – 2

The example of the Transfer Rouble is described, it’s a close parallel of EMU. Also we show the warnings given before the euro was launched.

The Future of the Euro –1

We describe past failures of monetary unions in Europe.

The State of The Euro

Like most previous monetary unions the EZ has not achieved its objectives. It is likely to follow the majority of such unions into break up.

Italy Missing the Target

We describe TARGET2 and how the money flies to its safest nest.

Collapse: Europe After the European Union –2

Europhile Ian Kearns describes the financial dangers likely to lead to the collapse of the EU unless it changes course. We review his analysis.

Collapse: Europe After the European Union –1

Ian Kearns continues his description of other dangers threatening the future of the EU (immigration, military threats, etc.) which we again review.

[1] https://www.bloomberg.com/news/articles/2018-10-19/carney-says-brexit-stress-tests-for-banks-severe-but-plausible

[2] https://www.zerohedge.com/news/2015-10-28/weve-all-been-warned-cyprus-bail-model-coming-country-near-you



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