Euro Crash

Chart of the Day: It’s Not Just the Fed, ECB’s Eurozone Also Set for a Dark Future

The GDP (global Gross Domestic Product) value of the Euro Area represents 11.06% of the world economy, and the US accounted for 15.93% of global GDP. Since the financial world is so interconnected, what happens in Europe will affect the US. With this notion, it is helpful to examine what is happening at the Fed in the US and the central bank in Europe.

The ECB (European Central Bank), through its system of satellite national central banks, is now almost solely committed to financing national government debts and smothering over the consequences. The result is a commercial banking system both highly leveraged and burdened with overvalued government debt secured only by an implied ECB guarantee.

The table below shows government spending for leading Eurozone states as a proportion of their GDP last year, ranked from highest government spending to GDP to lowest (column 1). The US is included for comparison. Both the Eurozone, though mostly in the southern European states, and the US are both trending toward a financial time bomb.

Country Gvt spending to GDP (2020) % Debt to GDP % Gov. debt to PS GDP %
France 62.1 116.0 310
Greece 60.7 206.0 524
Belgium 60.0 114.0 285
Austria 57.9 83.9 199
Italy 57.3 156.0 365
Euro Area 54.1 98.0 214
Germany 51.1 69.8 143
US 44.0 128.0 229
Source: Trading Economics

Some of the increase in government spending relative to their economies was due to significant falls in GDP, and some of it was due to increased spending. The current year has seen a recovery in GDP, which will have not yet led to a general improvement in tax revenues beyond sales taxes. And now, much of Europe faces new covid restrictions and lockdowns, which are emasculating any hopes of stabilizing government debt levels.

The final column in the above table adjusts government debt to show it relative to the tax base, which is the productive private sector upon which all government spending, including borrowing costs and much of inflationary financing, depends. This is a more important measure than the commonly quoted debt to GDP ratios in the second column. The sensitivity to and importance of maintaining tax income becomes readily apparent and informs us that government debt to private sector GDP is potentially catastrophic. As well as the private sectors’ own tax burden, through their taxes and currency debasement, they have to support far larger obligations than generally realized.

The figure below shows how the Eurozone’s central bank balance sheets have grown since the great financial crisis. The growth at the ECB has virtually matched that of the Fed, increasing to $9.7 trillion equivalent against the Fed’s $8.5 trillion, but from a base about $700bn higher.

ECB Balance Sheet 2021

The failings of this statist control system have been covered up by a pass-the-parcel any collateral goes €10 trillion-plus repo market, which with the TARGET2 settlement system has concealed the progressive accumulation of private sector bad debts ever since the first Eurozone crisis hit Spain in 2012.

TARGET2, is a term that is never mentioned in the media, yet it is the crucial point of the fragility of the Euro. A note from the French Treasury (Les déséquilibres TARGET2 en zone euro – TARGET2 imbalances in the Eurozone) clumsily attempts to defuse this risk.

The Euro is an extraordinary currency because its creation did not lead to the disappearance of the central banks of the member countries: we, therefore, find ourselves with one single currency managed by several central banks. The use of TARGET2 is mandatory for the settlement of any euro operations involving the Eurosystem.

These national central banks are shareholders of the European Central Bank (ECB), which determines monetary policy, but they still exist, so their monetary exchanges must be regulated, and this is done through TARGET2. Learn more here, here, and see the imbalance of each country’s credits and debts to the ECB in the chart below.

Target2 Country Imbalances 2021What could happen? These growing imbalances will force the ECB to provide more and more liquidity to the banks of the South, and inflation will loom. And if Germany rebels against this prospect, forcing the ECB to turn off the tap, the deterioration of the situation of the Italian and Spanish banking systems will make its debt (1.1 trillion euros today) worthless (making the Bundesbank German central bank bankrupt). The “uniqueness of the currency” will therefore be called into question either by inflation or because Germany will accept its deconstruction because it will want to get out of this mess.

The ECB is resisting interest rate increases despite producer and consumer price inflation taking off. Consumer price inflation across the Eurozone is most recently recorded at 4.1%, making the real yield on Germany’s 5-year bond minus 4.67%. 

The reality is Germany controls Europe – perhaps the real reason the Brexit occurred. So the question is – how long will the Germans and other northern European countries continue to bail out the southern European countries?

However, Germany needs Europe for security. For example, continued rumbling from the east, Russia, causes Germany not to want to go it alone. Ukrainian and Western officials are worried that a Russian military buildup near Ukraine could signal plans by Moscow to invade its ex-Soviet neighbor. The Kremlin insists it has no such intention and has accused Ukraine and its Western backers of making the claims to cover up their own allegedly aggressive designs. Learn more here.

Many look at the Dollar Index to see how the value of the Dollar is doing. But this only is comparing the Dollar value relative to other currencies. The Dollar Index is a weighted geometric mean of the Dollar’s value relative to select world currencies – the top three are Euro (EUR), 57.6% weight, Japanese yen (JPY), 13.6% weight, and Pound sterling (GBP), 11.9% weight.

The Dollar Index does not provide its value in terms of purchasing power. Almost all currencies are being debased in our global fiat currency monetary system – the issue is that some currencies are worse than others.

So if we are going to look at the Dollar Index future prices, it is all about the Euro. See in the chart below a recent chart of Euro vs. the Dollar. From a technical analysis viewpoint (see chart below), the Euro has been trading in a tight range between about $1.05 to $1.22 since about 2015. It is building a massive and long trading wedge. Trading history tells us that the longer a trading range persists, the bigger the move will be once the instrument breaks free of the wedge. About 60% of the time, wedges tend to break in the direction of the wedge trend (the size of the move is the height of the wedge) – in this case, down. Hence, a big move in Euro is potentially coming in the next 6 to 18 months.

A fundamental analysis catalyst of some significance to make this big move will be required. Perhaps a US or Chinese crisis favoring the Eurozone or a European event – such as Germany balking on the Eurozone or a geopolitical event. What it could be is another story. But considering all the tumultuous events occurring in the world today that some are calling the Great Reset, anything is possible.

EURUSD_2021-11-28The future of the Euro is still in question. The ECB has ignored the economic consequences of its actions and has just two priorities intact from its inception: finance member governments by inflationary means and suppress or ignore all evidence of the consequences.

What could go wrong?

The Right Wire Report does not provide investment advice. This post is for information only and is not a solicitation for you to buy or sell any financial asset.

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Written by Tom Williams

Born down on the farm in America's Midwest, my early life was spent climbing the ladder via a long career in information technology. Starting as a technician, and after earning a degree going to night school, I eventually found a place working at ATT Bell Laboratories as a software engineer.

Later moving into management and then a long stint in a major management consulting firm working with major banking, telecommunications, and retail companies. Working in various states in America, I also spent considerable time living and working in several European countries - currently expat in France. As a side career, I was heavily involved in real estate development and an avid futures trader. This experience can give one a unique view of the world.

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