European stability: What would happen if a recession struck today?

Six full years have passed since the onset of the last financial crisis.

Six years later, I wonder is the Eurozone ready for the next recession?

Public debt has plateaued at a record high (95% of GDP, compared to 70% of GDP pre-crash) and investors and Financial Institutions are holding bonds with extremely tight risk premia (i.e. low spreads against German bonds). If Eurozone sovereigns & banks' bond prices fell, European fianancial institutions could face wipe-out, again.

The effect of Quantitative Easing on share prices and earnings expectations makes European stocks similarly vulnerable.

I find this mixture of high public debt and extremely low risk levels weirdly reminiscent of the mid-noughties. Talk of increased asset prices (including Irish property) just adds fuel to that, despite the fact that Irish asset prices have not yet recovered to mid-noughties levels.

Is Europe ready for the next recession?

Rightwing

A Tyrant Named Miltiades! wrote: »

Six full years have passed since the onset of the last financial crisis.

Six years later, I wonder is the Eurozone ready for the next recession?

Public debt has plateaued at a record high (95% of GDP, compared to 70% of GDP pre-crash) and investors and Financial Institutions are holding bonds with extremely tight risk premia (i.e. low spreads against German bonds). If Eurozone sovereigns & banks' bond prices fell, European fianancial institutions could face wipe-out, again.

The effect of Quantitative Easing on share prices and earnings expectations makes European stocks similarly vulnerable.

I find this mixture of high public debt and extremely low risk levels weirdly reminiscent of the mid-noughties. Talk of increased asset prices (including Irish property) just adds fuel to that, despite the fact that Irish asset prices have not yet recovered to mid-noughties levels.

Is Europe ready for the next recession?

Short answer: No.

But what about Japan and the US? Compare and Contrasting the 3 would make for very interesting reading.

It would be fairly predictable. The Euro Area is a sort of parasite on the world economy, even if only a symbiotic parasite. The US, in particular, takes a far more affirmative approach to recessions, just as they seem do do in everything, from macroeconomics to dentistry.

If the American dream is achieving perfection of man, the European dream is doing our best with the hand we are seemingly dealt by Miserable Fate.

Thing is, we're so busy recovering from that hand we're not even thinking about the future.

Rightwing

The world economy in some worrying respects is in a worse place than in 08.

The central banks have effectively used up all of their bullets. Debt is much higher. Worst of all is Japan, that's a serious accident waiting to happen.

When and what will spark the crisis? I would say it will happen in 2016, and it will be in the bond market. There is a hint of illiquidity there already, which will lead to sharp to severe price movements.

realitykeeper

Usually when a recession comes along, central banks lower interest rates. If a recession came today, interest rates could not be lowered because they are already at or close to zero. The central bank could impose negative interest rates in which case money would be taken from savers accounts but of course that would lead to a run on the banks so it could only happen if the banks shut their doors and limited withdrawal from cash points in order to facilitate their ongoing theft from savers accounts. That would lead to riots, mass closures of small businesses a freeze on inward investment, the hoarding of goods and so on.

Negative interest rates would see unemployment spiral alarmingly out of control, shortages of food and everything else, queues for whatever was left to be sold, queues for the dole, government rations, etc.

An alternative to negative interest rates would be a currency collapse which would almost certainly be accompanied by a stock market collapse. This would lead to a frenzy of purchasing big ticket items in order to get value from the currency while it is still worth something. The Euro might not collapse as much as the dollar because the Euro QE program has only just started and the cost of QE is likely to be borne by the pigs, and Ireland is chief pig. Greece will not be able to avail of QE so that is one bullet they will dodge.

Once the currency collapses, the costs of everything (especially imports) would become prohibitively expensive. Ireland would almost certainly default and given the scale of the crisis, it is highly unlikely the EU or IMF could or would attempt to help. In a desperate bid to regain the ability to borrow, the Irish state would impose many new taxes, increase existing taxes, seize wealth under a guise of legality by rushing through emergency legislation and impose martial law to counter the violent resistance.

Social order would break down, people would barricade themselves in their houses against rampaging hoards of starving youths and eviction squads. Dumps would become scavenging grounds for the hungry and people would set up stalls to flog their belongings in the hope of making enough to eat.

In short, I think it would not be good. Here is an interesting video by Peter Schiff: https://www.youtube.com/watch?v=C3LEajyL6oA

realitykeeper

realitykeeper wrote: »

Social order would break down, people would barricade themselves in their houses against rampaging hoards of starving youths and eviction squads. Dumps would become scavenging grounds for the hungry and people would set up stalls to flog their belongings in the hope of making enough to eat.

In short, I think it would not be good. Here is an interesting video by Peter Schiff: https://www.youtube.com/watch?v=C3LEajyL6oA

Some bright young graduate student should write a thesis on the links between right-wing politics and apocalyptic fetishism.

Also, right-wing politics and youtube videos. Beware anyone getting an economics education from youtube.

Sand

realitykeeper wrote: »

In a desperate bid to regain the ability to borrow, the Irish state would impose many new taxes, increase existing taxes, seize wealth under a guise of legality by rushing through emergency legislation and impose martial law to counter the violent resistance.

Social order would break down, people would barricade themselves in their houses against rampaging hoards of starving youths and eviction squads. Dumps would become scavenging grounds for the hungry and people would set up stalls to flog their belongings in the hope of making enough to eat.

They did all of the above a few years ago and there was no resistance, let alone violent resistance. The rest of the post genuinely made me chuckle. Exaggerate much?

realitykeeper

Sand wrote: »

They did all of the above a few years ago and there was no resistance, let alone violent resistance.

You probably also think they imposed "austerity" while in truth they were borrowing tens of billions of euro.

The gap between peoples perception of their entitlements and their optimistic notions about the economy have never been further from reality. That is saying something given the long history of this island since humans first arrived.

When the next recession does come, people will learn what austerity is really about.

Sand

realitykeeper wrote: »

You probably also think they imposed "austerity" while in truth they were borrowing tens of billions of euro.

The gap between peoples perception of their entitlements and their optimistic notions about the economy have never been further from reality. That is saying something given the long history of this island since humans first arrived.

When the next recession does come, people will learn what austerity is really about.

That doesn't really address the point though. Unless you think that the government did not "impose many new taxes, increase existing taxes, seize wealth under a guise of legality by rushing through emergency legislation" already, then you have to acknowledge the point that this dreadful day has already happened without martial law (seriously - with maybe 7,500 in the army how would that even work? The British couldn't even secure the city of Basra with more troops and more equipment and essentially unlimited support of the US) and without Irish society devolving into a The Walking Dead spinoff series.

For the record, I think the "austerity" was avoided for as long as possible, led as poorly as possible, carried out as incompetently as possible, and was as unfair as possible.

realitykeeper

Sand wrote: »

That doesn't really address the point though. Unless you think that the government did not "impose many new taxes, increase existing taxes, seize wealth under a guise of legality by rushing through emergency legislation" already, then you have to acknowledge the point that this dreadful day has already happened without martial law (seriously - with maybe 7,500 in the army how would that even work? The British couldn't even secure the city of Basra with more troops and more equipment and essentially unlimited support of the US) and without Irish society devolving into a The Walking Dead spinoff series.

The measures the government has taken were all hopelessly inadequate and the fact that they were borrowing to spend proves that the Irish people are getting a lot of stuff they did not earn.

If martial law cannot be imposed, anarchy may prevail instead but either way, the consequences of a severe depression are unavoidable.

andrew

A Tyrant Named Miltiades! wrote: »

Six full years have passed since the onset of the last financial crisis.

Six years later, I wonder is the Eurozone ready for the next recession?

Public debt has plateaued at a record high (95% of GDP, compared to 70% of GDP pre-crash) and investors and Financial Institutions are holding bonds with extremely tight risk premia (i.e. low spreads against German bonds). If Eurozone sovereigns & banks' bond prices fell, European fianancial institutions could face wipe-out, again.

The effect of Quantitative Easing on share prices and earnings expectations makes European stocks similarly vulnerable.

I find this mixture of high public debt and extremely low risk levels weirdly reminiscent of the mid-noughties. Talk of increased asset prices (including Irish property) just adds fuel to that, despite the fact that Irish asset prices have not yet recovered to mid-noughties levels.

Is Europe ready for the next recession?

So, to bring this thread back to some level of sanity:

Re. bond prices: isn't this something that the various stress tests would've looked at? It'd be insane for any firm to think that bond prices will remain this high, so surely they're not so thinly capitalised that it matters?

Anyway, an interesting thing I read recently (on March 3rd) (via https://www.eurointelligence.com/) in relation to the Austrian/German Banking systems:

While everybody has been looking at Greece, another drama is unfolding right at the core of the eurozone - in Austria and Bavaria - where we are witnessing the failure of a large bank, and the possibility of a large sub-sovereign default - of the Austrian state of Carinthia.
For those not familiar with the tale of Hypo Alpe Adria and its bad bank, Heta, here is a short and incomplete summary of what happened (for German speakers there is an excellent, very entertaining video from two journalists of Der Stardard in Vienna, explaining what happened in great detail). This is our summary:

Hypo Alpe Adria was based in the Austrian state of Carinthia, and took a big gamble in eastern Europe last decade, but unlike other Austrian banks Hypo was a little more than reckless in its expansion policies and the choice of its business partners - gun dealers among them. The bank was also used by the former Carinthian prime minister Jorg Haider to fund various political activities, including an oil deal with Libya. Losses started to build up since 2006. In 2007, Hypo was bought by Bayern LB, one of the German Landesbanken in 2007, and after large losses emerged in the financial crisis, the bank was subsequently nationalised in 2009. A bad bank by the name of Heta was created last year with €11bn debt, most of which is guaranteed by the state of Carinthia, which is, of course, not in a position to fulfil this guarantee

There are lots more technical details than what we can relay here, but here is a broader point. It took the Austrians almost ten years to begin resolving this bank, which started to run into trouble as early as 2006. If you want to know why this highly complex financial saga never ends, this is one of the main reasons. We don't resolve debt crises. We pretend and extend. In this process we hide massive losses. It remains our contention that a large part of the German and Austrian financial systems are insolvent, which is what happens when you run extremely large savings surpluses, and when you have a corporatist banking system with closely interwoven relationships between politics and finance.

My point being that there are all sorts of things that we don't even know we don't know about, which could end up blowing up when the next recession hits. Now we, well, more people, know about the issue I've quoted above, but what else isn't widely known?

andrew

andrew wrote: »

Re. bond prices: isn't this something that the various stress tests would've looked at? It'd be insane for any firm to think that bond prices will remain this high, so surely they're not so thinly capitalised that it matters?

Not usually, because of the use (some would say reliance) on models which allow regulators to allocate zero-risk weighting to sovereign debt, and of prudential filters during stress testing. Prudential filters are mechanisms employed by regulators which allow risks associated with sovereign exposure to be 'filtered out', usually where sovereign debt is classified as 'for sale'.

Application of these 'filters' is usually the prerogative of national regulators.

They also have wide discretion in allocating zero-risk weight to sovereign debt.

In fairness to the EBA and national regulators, there are assurances that these models and filters will be phased out. But to answer your question, the concept of sovereign risk is still widely overlooked in European banking. In fact, there is still no serious mechanism in place to protect the banks from sovereign risk. Unfortunately, that was never really the objective of banking union/ SSM, and represents a credible danger in respects of countries like Italy and Spain with their extremely tight risk premia, and a huge amount of domestic sovereign exposure in their respective banking systems.