In particular I want to show you how the financial problems building in the European banking system will morph into a political crisis that could strike a mortal blow to the entire European project. If these problems continue to escalate… there won’t be a Europe for Britain to negotiate with in two years’ time!
First off, our meeting with Greenspan was private. There were no representatives of the mainstream press (most of whom were down the road from us in Washington, preparing for Donald Trump’s inauguration). With that in mind it’s worth us looking at precisely what he said concerning Europe since… well… you won’t find it anywhere else but here.
Here’s what he said, with added emphasis from me.
There’s one thing that bothers me considerably, which nobody makes any mention of. There is in the European Central Bank a mechanism as it exists of necessity where the European Central Bank is made up of the central banks of the European, euro area and there’s a thing called TARGET2, do you know what TARGET2 is?
TARGET2 at this particular stage is turning out to be an extraordinary large transfer from Bundesbank to essentially Italy and Spain, and most recently the European central bank. That means the Bundesbank is lending money to the European central bank and the question is – it’s big numbers. We’re talking 7, 800 billion euro.
This can’t go on indefinitely because at some point somebody’s going to have the courage to move Greece out. Greece is in the ECB by accident. They came in under false pretenses and the government, immediately following the government that got Greece fraudulently into the ECB, said the numbers were all wrong and if they were actually the numbers used they would not have been in, but nonetheless they let them stay. That was a terrible mistake. The Greek personal savings rate right now is -20%. You cannot run an economy at -20% savings rate.
Something is going to happen there. My view is it’s either going to be Greece – it conceivably could be Italy. The funny part of it is that the second largest contributor to the net flow in lending to Spain and Italy is Luxembourg. They’ve got some steel and they’ve got a few other things and they’ve got some banks, but it is extraordinary what is going on in this system while the total assets of [the] European Central Bank continue to go straight up. What would happen if there was a default of the euro?
In the United States, if there were a default on the dollar the US treasury could always [step in]. For example, if the federal reserve went into default the US treasury would bail it out but what do [European banks do?] There is no comparable vehicle to help the system.
I’m very worried. Mario Draghi, whom I know and he’s a very good guy, is just talking like we’ll do whatever is required. Well at some point somebody’s going to say, “I don’t want to accept euros.”
A detailed analysis of the TARGET2 system is beyond the remit of today’s letter. Look out for it later in the week.
But let’s dig into what else Greenspan said. There’s a whole sordid history of central and commercial banking subterfuge hidden between the lines. Take, for instance, the fact that Greenspan is direct about the fact Greece should never have been allowed into the euro to begin with. He even uses the word “fraudulent” to describe its admission.
But then, it’s ironic that he outlines what a good guy ECB chief Mario Draghi is in the very next breath. Why?
Because it was Goldman Sachs that helped Greece cook its books in such a way that it could enter the euro to begin with. The head of the GS international division for large parts of that process was… who?
You guessed it! Mario Draghi!
Never underestimate the ability of the Deep State and the global financial establishment to look after one another. The risks of cutting anyone loose or showing any genuine critical thinking about their actions would be highly dangerous to the system. Whether Draghi is a good guy or not is beside the point, but we certainly can’t take Greenspan’s word for it.
How Europe’s financial crises become political nightmares
It is worth considering why Greenspan is so concerned though. He highlights Greece and Italy as potential flashpoints in the next European crisis. Clearly he believes the endgame is a crisis in which the ECB becomes powerless due to the fact that people won’t accept euros any longer.
That crisis would have to be both financial and political in nature in order for something that drastic to happen.
How precisely would it blow up?
We’d need to see a renewed flare up in the “periphery” nations. Except this time the contagion wouldn’t just be financial, but political too – we’d likely see not just a spike in bond yields, but in support at the polls for anti-establishment, anti-euro parties.
2017 certainly has the potential to be the moment that happens. Perhaps it’ll be the endgame for the European project.
In short, Europe has always been a political movement. It’s held together by political commitment. Logic dictates it’ll take a political disaster for it to end. But financial forces will create the conditions to make it possible.
Exactly what could that bring that about? Well, we’ve covered Greece. It shouldn’t even be a part of the eurozone. But then, it’s already knee-deep in a depression that’s bleeding the nation white. It hasn’t cracked yet.
But what of Italy? What could put the Italians in such a position that it could bring the entire system down?
That’s something we’ve been covering in detail for 12 months now. Tim Price, in particular, has been tracking the problem that’s come to be known as “Le Sofferenze”. Here’s how Tim put it in a recently published warning on the fate of the European project.
“Le Sofferenze” is what the Italians are calling their banks’ bad loans.
It means “the suffering”.
These non-performing loans are now so big they are stifling any hope of a banking recovery.
It all comes down to the country’s failing economy, which is still 8% smaller than it was BEFORE the 2008 financial crisis.
The chart below reveals the scale of the problem. Le Sofferenze now account for 18% of all loans.
To put that in context, Britain’s banks’ “bad loans” amount to less than 1.5% of their total. The global average is 4.3%.
And the problem is getting worse at a frightening speed: in the last five years, the sum of non-performing loans has increased 85%. The total now stands at €360 billion.
Let me repeat that: Italian banks have taken on 85% more “bad debt” in the last five years alone.
They do not have capital reserves to cover anywhere near that amount should they default.
Now, you only need look to the last crisis to understand how devastating non-performing loans can be to the global economy.
The 2008 recession was triggered by the build-up of bad loans in the US housing sector.
But the percentage of bad loans made by US banks in 2008 was just 5%. The bad loans made by Italian banks are currently more than three times that level.
So imagine the financial chaos, social unrest and negative impact of the last crisis all over again – and perhaps even worse.
Then you have weakness across the rest of the eurozone, including inside systemically important banks right at the heart of the European project. As Tim puts it:
In June, the International Monetary Fund (IMF) labelled Deutsche Bank “the most important contributor to systemic risks among the global banks”.
That’s a diplomatic way of saying: if Deutsche Bank goes down, the global financial system might be severely impacted.
It’s not hard to see why: Deutsche has derivatives contracts (obligations to buy or sell assets) worth an estimated €46 trillion. According to the Bank for International Settlements, that’s approximately 12% of derivatives outstanding worldwide. The sum is also roughly 14 times more than Germany’s GDP.
Deutsche has been in disarray for years now.
Restructuring its business model and building up capital to deal with litigation after years of malpractice has proven highly damaging to the bank.
In September, the US Department of Justice (DOJ) proposed that the bank should pay a $14 billion fine – to settle claims Deutsche mis-sold mortgage-backed securities before the financial crisis. While this figure is not set in stone, the bank only has $5 billion to cover it. Should it fail to persuade the DOJ to reduce the fine, it will be required to raise more capital urgently.
Deutsche Bank is in such a bad state, billionaire fund manager George Soros actually made a €100 million bet against the bank right after Britain’s EU referendum, predicting it would crash.
Deutsche Bank has made a lot of loans to the Italian banking system, too. That’s part of what’s weighing it down. Like I said, they’re joined at the hip. I’ll come to Italy shortly, but the long and short of it is – it’s not likely to get all of that money back.
There are problems elsewhere, too.
Using the US stress test system, French banks BNP Paribas and Societe Generale – two of the six biggest in Europe – were found to have capital shortfalls (money required to survive a future crisis) of €10 and €13 billion respectively.
Only Deutsche Bank requires more (€19 billion). Another study concludes that France requires more money – in absolute and relative terms – than any other country to meet these requirements.
In May, Spain’s Banco Popular saw its share price drop 25% in one morningafter it admitted it needed to raise €2.5 billion – just one month after claiming it had “one of the best” savings reserves in Europe.
Remember the thesis we’re testing. The financial problems within the European banking system are going to morph into political problems that will pull the European project apart in 2017.
Bad debts, low growth, capital shortfalls, a business model slammed by negative rates… they’re the gunpowder.
What they need is a spark.
And that’s where politics comes in.
I believe I can show you, down to five dates you need to mark on your calendar, precisely when the whole thing will go up in flames.
Nick is the associate publisher at Southbank Investment Research. He covers hard subjects like the impending debt crisis, the currency wars in Europe, and the war on cash. He also heads the publication, Exponential Investor, which focuses on how technology can and will unlock incredible advancements for humankind in the near future.
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