Center Can't Hold

Italy seems to have gone too far. Its 10-year bonds yields are back over 7%. It is “the beginning of the end” say analysts.

But the end of what?

When the going is good people have little patience for questions. They are too busy, earning and spending, buying and selling, and getting where they are going. But then comes a major turnaround, all of a sudden, and they develop the deep torments of a retarded poet in an unhappy marriage.

‘What really matters?’ they ask themselves. ‘And what the hell am I doing here?’

In the US, the “War Between the States” settled the matter. “We will agree to have a single, centralized state,” said Abraham Lincoln, or words to that effect, “or we will kill you.” Later, the federal income tax, the direct election of senators (which ended individual states’ participation in the federal government), interminable meddling, and numerous Supreme Court decisions further enlarged the power of the central government at the expense of “states’ rights.”

In Europe, several times, centralization was attempted. In his article in The Financial Times, on Wednesday, Martin Wolf called it “the dream of centuries.” It took big dreamers to think they could put together so many different tribes. Caesar…Bonaparte… Hitler. (For some reason, perhaps it was a slip of memory, Wolfe doesn’t mention Adolf.) But the most recent centralization cycle was agreed voluntarily. Europeans saw it as a way to prevent war and stimulate their economies. They appeared to be right on both points, for a while. Europe’s economies boomed during the “30 glorious years” following WWII. Then, when America turned to private debt, Europe financed further lifestyle enhancements with public debt, financed at low German rates. The periphery states flourished by borrowing and spending. Germany flourished by selling them things.

Now, they all must cut back. The rest is detail…and denial. Total un-payable debt may be in the trillions. Someone is going to suffer it. Whether it is the taxpayers or the lenders hardly matters, not the way the two are twined together. If the lenders are forced to take large haircuts, many collapse…and bring down Europe’s sovereign bonds…and its economies. If the burden of loss is put directly onto the general public, the result is much the same. Whether the austerity is voluntary, or forced, it is inescapable.

The authorities struggle to remain on course — towards a more powerful, more centralized, more bountiful state. But they may be fighting the tides of history as well as economics. The last 300 years have been marked by further and further centralization, first, consolidating the kingdoms, duchies, and principalities of Western Europe in the 18th century. Then, building the nation states of the 19th century. Finally forming the European Union in the 20th. All over the world, local dialects, local money, local customs, and local military power gave way. By 2007, most of the major states of Europe — and quite a few minor ones — used the same currency (the euro)…paid the same interest rates (low)…worshipped the same god (mammon)…and spoke a common commercial and diplomatic language (mid-Atlantic English). Almost the entire world embraced modern credit-enhanced capitalism as taught in the leading business schools. Mario Draghi went to MIT and worked for Goldman Sachs. Mario Monti went to Yale and worked for Goldman Sachs. Lucas Papademos went to MIT and worked at the Federal Reserve Bank of Boston. They are interchangeable parts of the same machine.

What caused such homogenization? Was it the availability of modern communications, which made centralization easy and convenient? Was it merely a further elaboration of the division of labor, where each region could do what it did best and depend on the others for what it lacked? Was it the invention of modern artillery? No castle walls were strong enough to protect a local fiefdom. Some thought that modern, democratic government — combined with guided capitalism — was simply a better, more productive system, an evolutionary improvement on all that had gone before. We don’t know.

But we know something. The worries that brought Europe together after WWII now pull it apart. Greek (and other) debtors can’t pay. German (and other) creditors can’t collect. The Germans call the Greeks layabouts and chiselers. The Greeks call the Germans ‘nazis.’

And the centrifugal forces don’t stop at the borders. Belgium has been without a central government for 16 months, and prospers. Thoughtful Italians of the North must resent Garibaldi as much as Monnet. And if the Germans of Hamburg are not willing to support the Greeks of Larisa, why would they want to support the Germans of Dresden?

Developed countries can’t continue to pay for lifestyle enhancements with debt. Total debt-to-GDP ratios already exceed 250% for almost all of them. Britain and Japan are near 500%. At 5% interest, it would cost 25% of total output just to pay for past spending — hamburgers eaten years ago…salaries paid in 1997…and bridges that already need repair! At Italy’s current yields, nearly a third of GDP would be required. As the cost of this past increases, there is less and less money available for voters in the here and now. The center cannot hold. It doesn’t even want to.


Bill Bonner,
for The Daily Reckoning

The Daily Reckoning