OK, that’s my headline. Krugman’s is much more uplifting:
Euro Zone Death Trip
This is not good at all, folks, and it’s not just a Europe story. As Joe Stiglitz told John and Chris last month, the U.S. is exposed to a European collapse via its banks (what did they loan? what derivatives do they hold?) and also via its consumer exports.
For example, here’s Ben Bernanke saying that U.S. banks hold about $200 billion in European credit default swaps (CDS’s). Are U.S. banks on the right side of those bets? And even if they are, what is the risk that the other side will actually pay off (something called “counter-party risk”)?
Note also that if U.S. banks lost a good chunk of their $200bn, French and German banks would lose more, and that would ripple to our shores as well. I think this just scratches the surface.
Back to Krugman. He’s been ringing this bell for a while, and now he thinks things have become inevitable — not because the situation in most countries can’t be saved, mind you; but because the Europeans won’t do what’s needed to save it.
There are several segments to this column. It deserves a full read. Here’s the part on where-we-are-now:
The introduction of the euro in 1999 led to a vast boom in lending to Europe’s peripheral economies, because investors believed (wrongly) that the shared currency made Greek or Spanish debt just as safe as German debt. Contrary to what you often hear, this lending boom wasn’t mostly financing profligate government spending — Spain and Ireland actually ran budget surpluses on the eve of the crisis, and had low levels of debt. Instead, the inflows of money mainly fueled huge booms in private spending, especially on housing.
But when the lending boom abruptly ended, the result was both an economic and a fiscal crisis. Savage recessions drove down tax receipts, pushing budgets deep into the red; meanwhile, the cost of bank bailouts led to a sudden increase in public debt. And one result was a collapse of investor confidence in the peripheral nations’ bonds.
Many of those CDS’s mentioned above are against those bonds.
According to Krugman, Greece, Ireland, and Portugal — each for different reasons — are unsalvageable. But Spain and Italy could survive, given a “favorable external environment — specifically, a strong overall European economy with moderate inflation.”
Will Europe get that climate? In a word, No.
Krugman closes by dissing Europe’s (and America’s) favorite bête noir, the hyper-inflation of the Weimar Republic. But that’s not what they (and we) should be looking at, he says:
Yet they almost never talk about a much more relevant example: the policies of Heinrich Brüning, Germany’s chancellor from 1930 to 1932, whose insistence on balancing budgets and preserving the gold standard made the Great Depression even worse in Germany than in the rest of Europe — setting the stage for you-know-what.
He doesn’t expect a result as bad as “you-know-what”. But he sees no reason for optimism.