Things fall apart

 So when I mentioned the “imminent collapse of the Eurozone” my old Army buddy Malachi Wolfe expressed some surprise. “Awww man you're kidding me,” he said. Some academics also seem surprised. When I sent an email around to HBS professors noting this story, a Spanish colleague said, “It’s only one observation. Maybe the manager’s bonus depends on deposits. What bank is it? I’ll move my money into a bank paying four percent.”

Sadly, no. I am not kidding. And while I am going to try to move some money into Spanish banks, I would be lying if I said that I was not nervous about it. 

 

The above are nominal yields on two-year bonds. (The eurozone countries that are not in chart are paralleling France and Germany.)

Brad Delong: “In Europe, the Creditanstalt's bankruptcy and what followed was what turned the recession into the European Great Depression...”

The Portuguese for Creditanstalt is “Instituição de crédito.” A few days ago, events reminded me of 1982, and the onset of the Latin American debt crisis. I am now getting a frightening whiff of 1931. Somebody please tell me why I’m wrong.

Comments

[David Allen]

Well, it's not 1931 any more?

The euro situation looks bad...for Europe, and for financial markets wherever. However, the world is now composed of nearly 200 independent countries, most of which have fairly activist central banks which have tools not widely considered 80 years ago, and Europe represents a much smaller percentage of global demand. So I don't see how Europe's crisis becomes the world's crisis without a lot of people screwing up.

So what am I missing?

[Noel Maurer]

I'm not sure that you're missing anything, just underestimating the risks.

(1) Hidden exposure. Consider how the collapse of the housing market in basically two states managed to sink the global economy in 2007-08. Well, defaults on Greek and Portuguese debt could have similar effects ... and a default on Spanish or Italian debt would be disasterous. U.S. institutions are highly exposed to European debt.

(2) Risk aversion, aka contagion. Markets don't really behave rationally. (This is why it is reasonable for conservatives to fear inflation --- even though I don't --- despite the fact that the markets show no sign of any coming down the pike.) Watching several OECD countries reschedule their debt could cause panicky investors to start diving for cover. After all, Spain is in fine shape ... the yield spike is clearly market overreaction. But such overreactions can be self-fulfilling, and when the bears are on the rampage it makes to get out yourself.

(3) The U.S. exports much more to Europe, as a % of GDP, than it did in 1929, let alone 1931. Moreover, U.S. companies now directly compete with European ones in most big export markets. In other words, a collapse in European demand combined with a big drop in the euro (and the resulting gains for European exporters) would be a bigger blow than back in the day.

Scared yet, David?

[Noel Maurer]

I should add that the easy way to deal with all of this is for the ECB to print a lot of money. (Of course, the southern countries would still need to liberalize their labor markets for that to have good effects.) But having a tool does not mean that it will be used.