Best of the Week
Most Popular
1. Crude Oil Price Trend Forecast - Saudi's Want $100 for ARAMCO Stock IPO - Nadeem_Walayat
2.Gold Price Focusing on May Cycle Bottom - Jim_Curry
3.Silver, silver, and silver! There’s More Than Silver, People! - P_Radomski_CFA
4.Is the Malaysian Economy a Potemkin Village - Sam_Chee_Kong
5.Stock Market Study Shows Why You Shouldn’t “Sell in May and Go Away” - Troy_Bombardia
6.A Big Stock Market Shock is About to Start - Martin C
7.A Long Term Gold Very Unpopular View - Rambus_Chartology
8.Stock Market “Sell in May and go away” Study When Stocks Are Down YTD - Troy_Bombardia
9.Global Currency RESET Challenge: Ultimate Twist - Jim_Willie_CB
10.The Coming Silver Supply Crunch Is Worse Than You Know - Jeff Clark
Last 7 days
Trump Puts North Korea Nuclear WAR Back on Track as Plans for Nobel Peace Prize Evaporate - 25th May 18
Insane EU GDPR SCAM Triggers Mass Email Spam Attacks! - 24th May 18
Stock Market Higher Again, but Still No Breakout - 24th May 18
Study: Slowing Global Economic Growth IS NOT Bearish for U.S. Stocks - 24th May 18
What if This Week’s Rally in Gold is Already Over? - 24th May 18
EUR/USD – Reward for Bears - 24th May 18
5 Terrible Trading Mistakes That Rookie Investors Keep Making - 24th May 18
More Clarity for the Short Term for Bitcoin Price - 22nd May 18
Study: A Rising and Strong U.S. Dollar Isn’t Consistently Bearish for the Stock Market - 22nd May 18
Gold, Silver & US Dollar Updates with Review of Latest COTS - 22nd May 18
Upside DOW Stock Market Breakout May Be Just the Beginning - 22nd May 18
5 Reasons Why Forex Trading Is Becoming Such A Big Deal In SA - 22nd May 18
Fibonacci And Elliot Wave Predict Stock Market Breakout Highs - 21st May 18
Stock Market Ideal Cycle Low Near - 21st May 18
5 Effects Of Currency Fluctuations On The Economy - 21st May 18
Financial Conditions are Still too Easy for the Stocks Bull Market to End - 21st May 18
US Stock Market Elliott Wave Predictions for 2018 and Beyond - 20th May 18
Are You Still Fearful of Cryptos? - 20th May 18
US Stocks - Why I am Short-term Bearish, Medium-term Bullish - 20th May 18
Looking for a Turn in Gold Price - 20th May 18
GDX Gold Mining Stock Fundamentals 2018 - 19th May 18
Semiconductor Stock Market Canaries: Chirp, Warble… Soon a Croak and Silence? - 19th May 18
Three Drivers of Gold Price - 18th May 18
Gold Market in First Tertile of 2018 - 18th May 18
What Happens Next When Small Cap (Russell) Leads the Stock Market - 17th May 18
Negative Signs for EUR/USD? AUD/USD - Battle - 17th May 18
DOW Jones and CRUDE Oil on a Cliff Edge, Waiting for a Nudge! - 17th May 18
Gold Price No More Subtleness – It’s Show Time! - 17th May 18
VIX Cycles Point to Stock Market Correction - 17th May 18

Market Oracle FREE Newsletter

Trading Lessons

Italy Is the Mother of All Systemic Threats

Stock-Markets / Eurozone Debt Crisis Sep 16, 2016 - 11:44 AM GMT

By: John_Mauldin

Stock-Markets

BY GEORGE FRIEDMAN : Italy has been in a crisis for at least eight months, though mainstream media did not recognize it until July. This crisis has nothing to do with Brexit, although opponents of Brexit will claim it does. Even if Britain had voted to stay in the EU, the Italian crisis would still have been gathering speed.

The high level of non-performing loans (NPLs) has been a problem since before Brexit. It is clear that there is nothing in the Italian economy that can reduce them. Only a dramatic improvement in the economy would make it possible to repay these loans. And Europe’s economy cannot improve drastically enough to help. We have been in crisis for quite a while.


Banks were simply carrying loans as non-performing that were actually in default and discounting the NPLs rather than writing them off. But that only hid the obvious. As much as 17 percent of Italy’s loans will not be repaid. This will crush Italian banks' balance sheets. And this will not only be in Italy.

Italian loans are packaged and resold, and Italian banks take loans from other European banks. These banks in turn have borrowed against Italian debt. Since Italy is the fourth largest economy in Europe, this is the mother of all systemic threats.

Bail-Ins, Not Bail Outs

The only way to help is a government bailout. The problem is that Italy is not only part of the EU, but part of the eurozone. As such, its ability to print its way out of the crisis is limited. In addition, EU regulations make it difficult for governments to bail out banks.

The EU has a concept called a bail-in, which means the depositors and creditors to the bank will lose their money. This is what the EU imposed on Cyprus. In Cyprus, deposits greater than 100,000 euros ($111,000) were seized to cover Cypriot bank debts. While some was returned, most was not.

The bail-in is a formula for bank runs. The money seized in Cyprus came from retirement funds and payrolls. Rome wants to make sure depositors don’t lose their deposits. A run on the banks would guarantee a meltdown. A meltdown would topple the government and allow the Five Star Movement, a Euroskeptic party, a good shot at governing.

The bail-in rule exists because Berlin doesn't want to bail out banking systems using German money. Anti-European sentiment in Germany is already growing, with the rising popularity of the nationalist Alternative for Germany party. The Germans feel that they are fiscally responsible, and they resent paying for others' irresponsibility.

Therefore, the German government’s hands are tied. It cannot accept a Europe-wide deposit insurance system, as it would put German money at risk. Nor can it permit overprinting of the euro. That would come out of the German hide as well.

The Italians can only try to manage the problem by ignoring EU rules, which is what they are doing.

Crisis Spreading

And another European economic crisis is brewing. Germany derives nearly half of its GDP from exports. All the discipline and frugality of the Germans can’t hide the fact that their prosperity depends on their ability to export. The ability to export depends on the demand of their customers.

Germany exports heavily to the EU, and the Italian crisis could cause an EU-wide banking crisis. That would cut deeply into German exports, slashing GDP and driving up unemployment. Logically, the Germans should be desperately trying to head off an Italian default. But Chancellor Angela Merkel is not eager to announce to the German people that their economy depends on Italy’s well-being.

Clearly, German businesses are aware of the danger. German production of capital goods fell nearly 4 percent from last month. German production of consumer goods rose only 0.5 percent.

German consumption can’t possibly make up for half of Germany’s GDP. In addition, the IMF recently said Deutsche Bank is the single largest contributor to systemic risk in the world. A rippling default through Europe will hit Deutsche Bank.

The US Piece of the Puzzle

However, the real threat to Germany is a U.S. recession. Recessions are normal, cyclical events that are necessary to maintain economic efficiency by culling inefficient businesses. The U.S. has one on average once every six to seven years. Substantial irrationality has crept into the economy. The yield curve on interest rates is beginning to flatten. Normally, a major market decline precedes a recession by three to six months. That would indicate that it likely won’t happen in 2016, but it could in 2017.

Given the stagnation in Europe, Germany has been shifting its exports to other countries, particularly the U.S. If the U.S. goes into recession, demand for German goods, among others, will drop. But in the case of Germany, a 1 percent drop in exports is nearly a half percent drop in GDP. With Germany’s minimal growth rate, drops of a few points could drive it into recession and high unemployment.

A U.S. recession would not only hit Germany, but the rest of Europe. Many countries export to the U.S., either directly or through producing components for German and British products. The U.S. is somewhat exposed to foreign debt defaults, but not enough to bring down the American system. The United States, with relatively low export percentages and low exposure, can withstand its cycle. It is not clear that Europe can.

The Big Picture

The EU must address Italy’s and Germany’s problems, but its regulations make finding solutions very difficult. This all was put in motion in 2008, but it is not a 2008 crisis. This is most of all a political and administrative crisis. The European system was created to administer peace and prosperity, not to manage the complex gyrations of an economy.

The argument from those who are against internationalism is simple. Sometimes the major international systems fail. The less entangled you are with these systems, the less damage you suffer. And since such systemic failures historically leads to political conflict and crisis, the case for nationalism increases – assuming you aren’t already trapped in the systemic crisis. In any event, increasing nationalism follows systemic failure like night follows day.

Watch George Friedman's Ground-breaking Documentary ‘Crisis & Chaos: Are We Moving Toward World War III?’

Italy’s contagious crisis is part of a storm of instability engulfing a region that’s home to 5 billion of the planet’s 7 billion people.

In this provocative documentary from Mauldin Economics and Geopolitical Futures, George Friedman uncovers the crises convulsing Europe, the Middle East and Asia … and reveals the geopolitical chess moves that could trigger global conflict. Register for the online premiere now.

John Mauldin Archive

© 2005-2018 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules