Every fall, the blistering Santa Ana winds sweep from the eastern California desert, raging through mountain passes and surging across the expansive Los Angeles basin. These winds push the smog that clings to the San Gabriel Mountains out to sea.
For a brief period, the sunsets are breathtaking from our vantage point in Long Beach. Rich oranges and vibrant pinks glide low over the Pacific as the sun sinks behind the Palos Verdes Peninsula. Yet, before long, the Santa Ana winds desiccate the vegetation, turning it into a fire hazard. Occasionally, this leads to devastation; sometimes, all it takes is a single spark for Malibu Canyon to erupt into flames.
This summer, a financial tempest akin to the Santa Ana winds is sweeping through Europe. Hot, dry economic conditions, originating from Greece, are cascading westward across Italy, reminiscent of the volcanic ash from Mount Vesuvius nearly two millennia ago. These winds continue their journey across the Iberian Peninsula, drying up the financial landscapes of Spain and Portugal into a precarious situation. But the winds do not stop there.
They gain strength as they rush across the Bay of Biscay, enveloping France and Germany to the west and howling northward past the Celtic Sea, draining Ireland’s finances like a poorly made Irish coffee.
Will this situation escalate? Could a single spark ignite a significant financial crisis?
The answer will soon be revealed.
The PIIGS Are Struggling
A major crisis is on the horizon—one that could rival the severity of a California wildfire. Unfortunately, Europe finds itself in one of these critical moments right now.
The PIIGS—Portugal, Italy, Ireland, Greece, and Spain—are financially struggling. They have become so complacent, wallowing in debt, that countries like Germany and France are unable to fully bail them out.
While a bailout might be feasible for Greece, Ireland, and Portugal, covering Italy and Spain would push the financial system to its breaking point. The PIIGS have become too large to rescue; yet their debts are too significant to consider defaulting.
If these countries were to default on payments to major European banks—particularly those in Germany and France—credit lines across Europe could dry up, stalling economic activity. Even the mere prospect of a sovereign default could ignite a massive bank run across the continent.
Germany and France cannot safely underwrite the sovereign debts of the PIIGS. Even in a best-case scenario, such support would be futile. The PIIGS are unlikely to repay the enormous amounts of debt their governments have accumulated, especially with their economies struggling.
Europe Escalates the Greek Bailout
What a tangled web the central planners have woven. Just a decade into their ambitious currency unification effort, instead of harmony, they face a baffling crisis.
During the recent emergency summit held in Brussels, Belgium, Eurozone leaders convened to address the escalating situation. By the end of the day, they announced what they referred to as a “sweeping deal.”
The cornerstone of this deal is a significant doubling down: a Greek bailout of €109 billion added to the previous bailout of €110 billion from a year prior.
In an effort to placate investors, this latest agreement includes a technical default for private creditors. Bondholders will endure a 21 percent loss, but Greece will have the opportunity to refinance its debts under more favorable conditions. For the moment, Angela Merkel and Nicolas Sarkozy can proudly declare that the crisis has been averted.
Yet, amplifying losses instead of cutting them is a strategy typically reserved for the foolish. European central planners have heavily invested in Greece. But Greece might just be the initial spark that ignites a widespread financial disaster. Once credit markets confront Greece’s facade again, the ensuing debt explosion could sweep across the continent.
Sincerely,
MN Gordon
for Economic Prism
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