A few more comments on Italy. Italian GDP is around $2 trillion. At today’s exchange rate, Italy’s nonperforming bank loans total roughly 25% of GDP. Compare Italy to the US, where nonperforming loans amount to only 1.2% of GDP, or $128 billion. If nonperforming loans in the US were 25% of US GDP, they would amount to an astronomical $4.5 trillion.
In reality, €190 billion is a Band-Aid over a major gash, one that is still bleeding and getting bigger. But that Band-Aid will get Renzi through the next election, and he (along with institutional Europe) hopes that he gets the mandates he needs to start the long-past-due reforms that Italy will require to pull itself back from the brink. If he doesn’t and the Five Star Movement maintains the momentum it has achieved in the regional elections, the ball game will change. Or at least there will be new players on the field, contending with the same problems.
The reality is that much of the assets against those nonperforming loans will end up being like the homes that were pledged against subprime loans. Once the cascade starts, the underlying value of the assets plunges and the number of nonperforming loans swells, perhaps dramatically. I’ve written about this domino effect before and used a colorful map to visually demonstrate that the large majority of the nonperforming loans are in Southern Italy. Italy is one good global recession away from a major crisis. But now that the ECB has decided that it can use the funding mechanisms created in the last crisis, it will be able to print the money, piling the resulting debt on the back of all of Europe. Then, of course, there will be Spain or Portugal or whichever domino falls next.
That brings us to one of the most dangerous parts of Europe’s minefield: France.
The French Gambit
Last week my friend Ben Hunt of Salient Partners made a fascinating and scary point on his firm’s Brexit conference call. Ben thinks Brexit is comparable to the Bear Stearns collapse in March 2008.
At the time, Bear was thought to be the main culprit in the subprime mortgage meltdown. After months of drama, the firm’s big hedge fund clients started withdrawing money – enough to render Bear illiquid. The Fed stepped in, essentially executed Bear Stearns, and handed the corpse to JPMorgan Chase.
Everyone then breathed a huge sigh of relief, thinking the Fed had done its job and the crisis was over. Markets recovered somewhat, and all seemed well. Six months later the second shoe dropped when Lehman Brothers was allowed to collapse, and then AIG and Merrill Lynch all got “resolved” at enormous cost.
If Brexit is like Bear Stearns, then we can expect a calmer period just ahead – followed by another, bigger calamity. Ben thinks it will happen in France. Opinion surveys show the French are at least as unhappy with the EU as the British are, and possibly more so. They will have a chance to express their discontent in their presidential election next April. So, the interval before the next shoe drops may be longer than six months, but Europe is always slower.
Socialist President François Hollande has not yet said whether he will stand for re-election (he wouldn’t even make it into the runoff), but we know Marine Le Pen of the National Front is running. She has a fair shot at winning, too. If she does, a National Front victory would be a thunderbolt at least as serious as Brexit.
Le Pen congratulated the Brexit voters in a New York Times op-ed last week, at the end of which she summarized her own manifesto. I’ll quote her at length because what she says is so important. In particular, pay attention to what she says about Merkel and Germany.
Brexit may not have been the first cry of hope, but it may be the people’s first real victory. The British have presented the union with a dilemma it will have a hard time getting out of. Either it allows Britain to sail away quietly and thus runs the risk of setting a precedent: The political and economic success of a country that left the European Union would be clear evidence of the union’s noxiousness. Or, like a sore loser, the union makes the British pay for their departure by every means possible and thus exposes the tyrannical nature of its power. Common sense points toward the former option. I have a feeling Brussels will choose the latter.
One thing is certain: Britain’s departure from the European Union will not make the union more democratic. The hierarchical structure of its supranational institutions will want to reinforce itself: Like all dying ideologies, the union knows only how to forge blindly ahead. The roles are already cast — Germany will lead the way, and France will obligingly tag along.
Here is a sign: President François Hollande of France, Prime Minister Matteo Renzi of Italy and acting Prime Minister Mariano Rajoy of Spain take their lead directly from Chancellor Angela Merkel of Germany, without running through Brussels. A quip attributed to Henry Kissinger, “Who do I call if I want to call Europe?” now has a clear answer: Call Berlin.
So the people of Europe have but one alternative left: to remain bound hand-and-foot to a union that betrays national interests and popular sovereignty and that throws our countries wide open to massive immigration and arrogant finance, or to reclaim their freedom by voting.
Calls for referendums are ringing throughout the Continent. I myself have suggested to Mr. Hollande that one such public consultation be held in France. He did not fail to turn me down. More and more, the destiny of the European Union resembles the destiny of the Soviet Union, which died from its own contradictions.
The People’s Spring is now inevitable! The only question left to ask is whether Europe is ready to rid itself of its illusions, or if the return to reason will come with suffering. I made my decision a long time ago: I chose France. I chose sovereign nations. I chose freedom.
That does not sound like someone who is going to be all that compromising with Brussels and the EU. There is the real possibility that Sarkozy will be in the runoff with Le Pen, and like Bernie Sanders moved Hillary Clinton to the left, Le Pen will force Sarkozy’s politics even further to the right. The Financial Times reports that Marine Le Pen “has already promised a straight ‘in-out’ vote on France’s EU membership if she is elected next year, convinced it will tap the same well of dissatisfaction that propelled the Brexit campaign.”
Frustration Breaking Out All Over Europe
Austria came within a hair’s breadth of just electing what is, for Europe, a far right-wing party, which means it is something that would be familiar to many Republicans here in the US, with a few glaring exceptions. The two finalists in the recent election were from the Green Party and from the Freedom Party of Austria (FPO), the top finishers in the first round of elections. Both trounced the traditional parties. Even though the FPO was the clear leader in the first round, the entire establishment of Austria fled back to the Green Party, which eked out a very narrow victory at 50.3% to 49.7%. The FPO would have been the first such right-wing party to win in Europe. And now the Austrian Supreme Court has invalidated the election and has told the parties to go back and have another election. This is one to watch.
In Holland, Geert Wilders’ Party of Freedom is currently topping the polls, and in Germany the anti-Islamic Alternative for Deutschland (AfD) has caused Angela Merkel, the German chancellor, to warn of a return to nationalism.
Establishment politicians across Europe will look at a FPO victory in Austria, and many will be very afraid. They should be.
Final Thoughts
I began this letter by recalling the Great War between France and Germany. Geography and history have pitted the two nations against each other many times. And if it wasn’t Germany, then it was England or Spain or one empire or another going back for 1000 years. The EU’s greatest accomplishment was to break that cycle.
I am not at all suggesting that France and Germany will go to war. I see no chance of that. What I do see, though, is bad enough: Marine Le Pen portraying the EU as a threat to French liberty and prosperity, with Germany acting as the EU’s puppeteer, and a substantial part of the French population agreeing with Le Pen. The problem is, there is a ring of truth to what she says.
I have readers in every country in Europe; it’s not my place to take a side here. As an outside observer, I see a level of frustration and antagonism that is reflected in the US and certainly is evident in England. Unless this frustration is addressed, it will not help the post-Brexit EU rebuild itself into an alliance that can handle Europe’s many challenges more effectively.
We should not underestimate the EU’s ability to postpone the inevitable. They’ve done it far longer than I thought possible seven years ago. Maybe they will again paper over the unpleasant disagreements and buy a few more years. Yet I think hanging on is getting harder for them. We may in fact be near the big turn.
The minefield we’ve talked about has a very narrow path through to safety. Europe is just now taking the first hesitant steps on that path. Any misstep will have appalling consequences.
I actually view Brexit as potentially quite positive, as it offers the opportunity for a reset along lines that are more realistic. To see the EU Council move as rapidly as they have to acknowledge the problem – something they would not have done without the vote in the United Kingdom – actually sparks a little bit of hope.
For the last 17 years, the EU has tried to make the old agreement work when it clearly doesn’t. Now that EU member nations know what doesn’t work, maybe they can design something that looks more like a trade union, with some additional characteristics that don’t impinge too much upon national identity – and maybe they can acknowledge the problem with immigration and borders (don’t even ask me how that gets solved).
That would be an EU far different than we see today. Forging it will require a completely different vision of the future than what we have seen in both the founding and the running of the current EU. Brexit was a wake-up call. The first few steps of the EU Council have been in the right direction. Now they have to rework 10,000+ pages of agreements, with bureaucrats fighting every inch of the way, trying to maintain their control. The task is daunting, and it’s not altogether clear that they can pull it off.
We are told by every twelve-step program that the first step in solving a problem is to acknowledge the problem. Until two weeks ago, that had not happened in Europe. Now it has, so all we can really do is wait to see if there is the willingness for step two. As I said at the beginning, there will be no end of rumors and personality clashes and trial balloons.
Las Vegas, Maine, and New York
First, let me remind you that the offer to buy the audio replay and transcripts from my recent Strategic Investment Conference will go down in a few days, so if you have been meaning to get them, don’t procrastinate. You can find the link here.
I know, I said I wouldn’t leave Dallas until I finished my book; but Mark Skousen talked me into coming to his big libertarian blowout in Vegas, called FreedomFest. Since I’m not really doing a vacation this summer, I thought I could go and moderate a few panels with old friends like Steve Forbes and Rob Arnott. I have tons of friends coming to the conference, and I’ll also do a breakout speech that I’ve have been wanting to do for quite some time but that I know nobody will pay me to do, entitled “The Invisible Hand, Evolution, and Why I Am an Economic Atheist.” It will be a short speech on a topic I have thought about a great deal and am passionate about.
Shane and I will catch a few shows (I will once again see the Cirque du Soleil show called “Love,” featuring the music of the Beatles) and spend time with friends. I will even catch some of the other conference speeches and panels. You can see the lengthy list of speakers and topics by going to freedomfest.com. It happens July 13–16 at the Planet Hollywood casino. It is actually a fairly inexpensive conference and venue. I think there will be something like 2,000 attendees, representing all wings of the libertarian world. Trump spoke there last year, and I think Gary Johnson is speaking this year. If you are at the conference, my speech is on a Saturday afternoon, and I would appreciate your dropping by. And if you see me wandering around, walk over and say hello.
For the last 10 years, the first Friday of every August has found me and my youngest son, Trey, in Grand Lake Stream, Maine, for what is now affectionately known as Camp Kotok, after David Kotok, who founded the annual the event many years ago. It is a gathering of economists and financial types, along with their friends, who spend three days talking economics and politics, sharing stories, fishing, and drinking. I will leave from Maine on Sunday and spend the next few days in New York doing media and some meetings.
The last few weeks have been rather emotionally stressful for me, with family and business issues to work out. I often talk about countries that are left with no good decisions, but we all know that sometimes that happens in our personal lives as well. Yet you have to make a decision and move on. The reality is that very few people (and that includes me) would feel all that sorry for me, as my life is really quite good, with just the odd bump here and there that is part of the human condition. If you have seven kids, there’s going to be a little drama every now and then.
But then Dad gets it sorted out (or maybe he gets himself sorted out), and things return to normal. I have to remember that, as I am still in the sorting-out phase.
In any event, there will be a smallish gathering of friends, neighbors, and family for barbecue and watching fireworks from my apartment on the Fourth. Year before last we actually saw 12 different fireworks displays around the region from the balconies. Admittedly, some were 15 miles away, but it was still fun to watch, especially the much closer ones. Stay safe, enjoy the holiday, and have a great week!
Your wondering how Europe sorts this out analyst,
John Mauldin
John Mauldin is editor of Mauldin Economics' Outside The Box.
This article was originally published at Mauldin Economics.