For the first time in my career, I see the international establishment, sometimes called the New World Order, facing a crisis so large that its very survival is at stake. For the first time, these people are scared.
There are not many of them. In his book, Superclass, author David Rothkopf estimates that there are only about 6000 people at the top of the pyramid of world power and influence. They are mostly males, and at least a third of them have attended America’s most prestigious universities. Most of the others have attended comparable universities in Europe.
The crisis in Europe is clearly beyond anything that this generation of establishment leaders has ever seen. The last time that anything like this faced the European establishment, it led to World War II.
During the entire postwar period, the United States has been the dominant force in the West. The United States government through the Marshall Plan wrote the checks to keep the European governments afloat, and it funded most of NATO, the mutual defense system that was set up to constrain the expansion of the Soviet Union.
The United States is no longer in a position to bail out anybody. It is running a massive trade deficit, and is running a massive federal deficit. Europe realizes now that, from an economic standpoint, it is on its own. If there are solutions to the European economic crisis, these solutions are going to have to be generated inside the eurozone.
BANKS AT RISK
Today, the entire banking system of Europe is at risk. The banks are highly leveraged, and they have made enormous investments at low-interest rates in bonds issued by governments that are technically insolvent. There is no possibility that any of these bonds will ever be repaid. They were never designed to be repaid. They were designed to keep the taxpayers of all European countries in permanent bondage to the banking system.
Now, in a complete reversal of fortune, the banks are increasingly dependent on the governments. The governments are now the lenders of next-to-last resort to the commercial banks. The central bank, of course, is the lender of last resort. But today, the European Central Bank has moved into neutral. It does not want to take action to bail out Greece, Spain, or Italy.
The PIIGS governments that wrote the IOUs to the banks in northern Europe are technically insolvent. When Greece defaults, which it will, there will be enormous losses sustained by some northern European banks. When Spain defaults, which it will, these losses will get far worse. When Italy defaults, which it will, the entire banking system of Europe will be busted.
The only things that can save European banking system today are the European Central Bank, which has the power to create money out of nothing, and the taxpayers of Germany, whose national leaders are relentless in their desire to expand the power of the eurozone over all of Europe. These politicians are willing to write IOUs on behalf of German taxpayers in order to extend this consolidation.
A DAISY CHAIN OF DEBT
The problem is, the Northern European governments do not have any money to serve as lenders to Greece, Spain, or Italy. They are borrowing money at rates not seen before in peacetime Europe. These governments are expected to intervene and lend money to the Greek government. But every northern European government is now faced with the additional responsibility of being the lender of next-to-last resort to the large commercial banks inside its own borders.
Who is going to lend northern European governments enough money to bail out southern European governments? Which lenders think this is a good idea today? At today’s rate of interest, not that many. That is why interest rates are going to rise. But when long-term interest rates rise, that will lower the present market value of all of the bonds in the portfolios of the lenders.
So, on the one hand, investors have to pony up the money to lend to the governments, and the governments need the money to recapitalize the banks in their own borders. This leads to the next problem: in order for the lenders to lend money to a government, they have to write checks on their bank accounts. What happens if their banks should go under? Who will lend money to the governments?
In this daisy chain of fiat money, credit, and debt, the European Central Bank is the lender of last resort. It is the lender of last resort because it has the legal authority to create money out of nothing. It can buy IOUs issued by governments, and it can lend money to banks, so that the banks can buy the IOUs of governments.
DAYS OF RECKONING
The entire political system that we know as the European Union is dependent upon a system of fractional reserve banking which has overextended itself, and now faces a day of reckoning. Actually, it faces two days of reckoning.
First, there is a day of reckoning in the PIIGS countries, when depositors withdraw funds. The second day of reckoning is going to be imposed by the insolvent governments who have been borrowing hundreds of billions of euros from the banks.
The arrival of a bank run threatens the ability of the Greek government to borrow money from anybody. The Greek government is dependent upon the Greek banking system to collect taxes. If the Greek banking system goes belly-up, the Greek government goes belly-up.
In this system, only the European Central Bank has the authority to bail out the system. Every other potential source of euros is dependent on the solvency of the European banking system. But that is exactly what is at risk today.
This is why all fractional reserve banking must ultimately rest on the monopoly granted by government to a central bank. The central bank, above all, is the guarantor of the solvency of the largest banks. The central bank is the economic agent of the owners of the largest commercial banks. These owners are now facing bankruptcy. They hold shares in multinational banks whose lending officers had no understanding of basic economics. They wrote checks to the PIIGS.
In this scenario, the only way to save the system is to risk destroying it. The only way to save the euro is to risk destroying it. This is because there are only two ways to save the largest commercial banks. The first way is by hyperinflation. This will enable the banks to keep their doors open, but the borrowers will be able to pay off their loans by selling a handful of hard assets, which will raise enough money to pay off the loans with worthless euros.
The second way to save the banks, which is what the European Central Bank is attempting to do, is to avoid hyperinflation, and to inflate the money supply only to the degree that the largest banks can be bailed out by making low-interest loans available to them. They in turn must lend out the money, if they can find solvent borrowers, and if those borrowers are willing to borrow.
If the European Central Bank adopts the second approach, this is going to lead to a depression. The bank has inflated. The commercial banks have lent money to insolvent governments. These governments are going to default if there is a recession, but by refusing to expand the money supply, the European Central Bank will produce a recession. The boom that it fostered in the Greenspan years has blown up on European banks, in the same way that the boom in the United States has blown up on America’s banks.
There is no equivalent of the FDIC in the European banking system. There is no single government that has the assets or the legal authority to lend to any and all of the other governments. There is no common fiscal system, which means that all the governments can run massive deficits. This means that the governments are in constant competition with each other to borrow enough money to fund their deficits.
So, the system is stretched to the limits. The few remaining lenders with capital who have enough money in their banks to write checks to insolvent governments are now refusing to write the checks. This is why Spain is paying over 7% to get lenders to fork over their money. Lenders who do this are going to wind up like the saps who loaned money to the Greek government prior to 2010. They are going to see the value of their investments collapse as interest rates go to double digits in Spain, which they are going to do unless the European Central Bank intervenes and makes fiat money loans to Spain’s government.
There is now at least one monthly emergency weekend meeting of the political authorities, accompanied by their bureaucrats from the ministries of finance. They come together on a Saturday to talk about how they can save the system. They issue a press release on Sunday. The press release is always short on specifics. Within a month, the crisis has escalated again, and there is another weekend summit meeting.
Every time there is a summit meeting, the investing public that has sufficient money to invest waits with bated breath to see if there is some solution offered on Sunday afternoon. There never is a solution offered, so the stock market drops for the first day or two after the meeting.
It is clear by now to everybody that there is no solution forthcoming. There is no agreement politically, especially between Germany and France, as to who is going to write the checks to bail out the next PIIGS government to hit the brick wall.