Tuesday, June 26, 2012


Sometimes events seemingly outstrip human influence leading to worldwide catastrophe. August 1914 led to 16 million deaths (and ultimately World War II) all triggered by the assassination of an obscure Archduke from the Austro-Hungarian Empire on June 28, 1914.

1931 was such a year, when the failure of Credit Anstalt in Vienna triggered a world wide bank run and flight to safety that transmogrified the Crash of 1929 into the Great Depression. As BusinessWeek recently stated:

"In May 1931, a Viennese bank named Credit-Anstalt failed. Founded by the famous Rothschild banking family in 1855, Credit-Anstalt was one of the most important financial institutions of the Austro-Hungarian Empire, and its failure came as a shock because it was considered impregnable. The bank not only made loans; it acquired ownership stakes in all kinds of companies throughout the sprawling empire, from sugar producers to the new automobile makers. Its headquarters city, Vienna, was a place of wealth and splendor, famous for its opera, balls, chocolate, psychoanalysis, and the extravagant architecture of the Ringstrasse. The fall of Credit-Anstalt—and the dominoes it helped topple across Continental Europe and the confidence it shredded as far away as the U.S.—wasn't just the failure of a bank: It was a failure of civilization."

The end result of this bank failure in far away Vienna was massive bank runs around the world, first, in Berlin (because banks there had deposits in Credit Anstalt), then in London (because banks there lent to German banks) and ultimately the US (because who knows what bank is safe if all the European banks go down the tubes). The Great Depression then took full hold around the world leading to 25% unemployment in the US and a 30% plunge in economic output. Soon thereafter political extremism in Europe led to the horrors of World War II.

Today, mainstream economists are raising the specter of a 1931 type of event, where an economic shock in Europe leads to a global panic resulting in a massive and sudden withdrawal of credit from the global economy. Paul Krugman:

"As in 1931, Western nations have the resources they need to avoid catastrophe, and indeed to restore prosperity — and we have the added advantage of knowing much more than our great-grandparents did about how depressions happen and how to end them. But knowledge and resources do no good if those who possess them refuse to use them. And that’s what seems to be happening. The fundamentals of the world economy aren’t, in themselves, all that scary; it’s the almost universal abdication of responsibility that fills me, and many other economists, with a growing sense of dread."

From the University of California, Brad De Long and Barry Eichengreen:

"The parallels between Europe in the 1930s and Europe today are stark, striking, and increasingly frightening. We see unemployment, youth unemployment especially, soaring to unprecedented heights. Financial instability and distress are widespread. There is growing political support for extremist parties of the far left and right." As shown above, political extremism is on the march in places like Spain.

Nouriel Roubini and Niall Ferguson:

"Is it one minute to midnight in Europe? We fear that the German government’s policy of doing “too little too late” risks a repeat of precisely the crisis of the mid-20th century that European integration was designed to avoid. We find it extraordinary that it should be Germany, of all countries, that is failing to learn from history. Fixated on the non-threat of inflation, today’s Germans appear to attach more importance to 1923 (the year of hyperinflation) than to 1933 (the year democracy died). They would do well to remember how a European banking crisis two years before 1933 contributed directly to the breakdown of democracy not just in their own country but right across the European continent."

Obviously, we have reached a major danger point in economic history. I first wrote about the parallels of the Eurozone crisis to 1931 and Credit Anstalt in late 2011. Since then the European Central Bank flooded the system with liquidity--but liquidity never solves a crisis based upon insolvency. And, in Europe too many nations and banks are simply insolvent. So, the sugar high is about over and massive capital is fleeing Europe in favor of safe havens. That is why Treasury yields are so low

Economically, the pain of a financial crisis is a function of the volume and rapidity of the withdrawal of capital from an economy into safe havens. For a picture of economic pain projected for the Eurozone given its current path, see this graph from Der Spiegel out of Berlin. As I have repeatedly argued, these numbers, which must be added to already grim economic realities, portend a calamity worse than Lehman. Indeed, these numbers promise a global depression.

But, that may not be the worst of it. Painful economic disruptions historically lead to painful political extremism, especially in Europe. And, unfortunately, signs abound that severe political disruptions loom once again in Europe, as I will highlight in my next post.

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