Is Europe Primed for Chaos, as It Was in July 1914?


Summary: Europe nears the brink, with the potential for a severe crisis if its leaders cannot agree on a solution before the G-20 meeting in Cannes on November 3-5. The clock ticks. Here we examine the situation, and seek relevant historical analogies.

ByFabius Maximus


  1. Summary of the situation
  2. Bulletins from the front
  3. Is this like July 1914?
  4. A grim analysis from a well-wired economist
  5. For more information

(1)  The current situation

Europe’s leaders remain obsessed with preserving the bankers, not just the banks (the latter is essential for the national economy, the last is essential because they are the masters).  Investors (the class owning everything, with the bankers the center of their universe) are euphoric about an imminent deal to recapitalize the banks (ie., a massive transfer of risk and wealth from the taxpayers) — and perhaps even a pre-packaged default for Greece.

We have seen these rumors before, repeated this year (see this post for one example). These widespread rumors (even I’ve heard them; like urban legends, always from a friend of an insider) suggest that someone is leaking highly confident information (which is what Central Bankers do as standard operating procedure, to influence markets and generate front-running profits for their bankers).  These are trial balloons, representing surface ripples from deep efforts to arrange a deal.

Assessing the odds of an effective deal materializing lies beyond my pay grade.  My knowledge of euro-politics is almost nil, but the political foundation for such a move at this time seems low.  Loans and guarantees of loans to banks and Greece seem destined to eventually become (to a large extent) liabilities of the core EMU states.  This is not small change, unlike the US S&L bailout to which is so often compared.  The man in a Friedrichstraße cafe must know that by now, and (from what I can tell) does not want that — irrespective of his/her opinion about eventual unification (see below for more about this).

This all looks esp doomed by the Europe’s leaders (especially the Germans running the ECB) continued insistence on relatively tight monetary and fiscal policy (see austerity, until “failed policies” in the economists’ cookbook).

The need and desire for bold action is obvious, but that gap between that and reality seems to require literally a quantum leap.  That is, an instantaneous shift from here to there.

Two weeks ago experts said that Europe’s leaders 12 months to resolve this crisis..  Now they speak of 180 days, or 60, or even 30 (see below for more about deadlines).

(2)  Bulletins from the front

While great deeds are discussed, some reports say that Europe’s leaders still squabbling over how to spend the existing EFSF fund, as in this article from Handelsblatt (a business newspaper published in Dusseldorf; circulation 40% of the FT’s): Berlin and Paris argue about EFSF“.  I don’t know how accurate is this Google translation, but the gist is clear.

Between Germany and France, a debate has erupted over the extent to which the euro rescue fund EFSF may buy government bonds in the future. France wanted to make the EFSF respect no rules, told the Handelsblatt by a senior EU diplomat. This would theoretically mean that the EFSF could not use its entire volume of funding expended to buy bonds of a single Euro-state.
EFSF has a total of 440 billion euros, part of it, however, has been scheduled for the loan packages to Ireland and Portugal. The federal government wants to limit the amount used for bond purchases {per euro government}, it said in Brussels. Think Germany will also want a time limit on bond purchases.
The purchase of government bonds is one of three new instruments of {the extended} EFSF. The design of these new instruments will be governed by guidelines {written by} high officials of the euro finance ministers now in Brussels. The guidelines must then be approved by the Budget Committee of the Bundestag. The German Parliament has made this a condition for agreeing to extended EFSF.

Why so much caution by German’s leaders?  See the polls..

(a)  This article in BusinessWeek nicely describing the situation in Germany.  German leaders love the euro, and will support almost anything necessary to bailout the banks and Greeks.  But:

“Seventy-five percent of Germans oppose expanding the EFSF, according to a FG Wahlen poll published Sept. 23. At the same time, 68% of respondents said a Greek default would harm the German economy. The Sept. 20-22 poll of 1,229 people for ZDF television has a margin of error of as many as three percentage points.”

(b)  More evidence from Bloomberg on 18 September:

“A euro skeptic political party in Germany would find strong support among an electorate increasingly fed up with bailouts for free spending euro zone partners, according to a poll published on Sunday.  Some 40% would consider voting for such a party, and 50% said they would welcome such a group on the political scene, according to a study by Emnid Institute, published inBild am Sonntagnewspaper.  The poll canvassed 500 Germans.”

On the other hand, the rumor that Germany is secretly printing Deutsch Marks (preparing to leave the European Monetary Union) is an urban legend.

(3)  Is this like July 1914?

Could something large and bad happen?  We — leaders, investors, serious experts — tend to underestimate tail risks (in the “tail” of the probability curve) because it makes career sense to always bet against tail risks.  These things happen only once a every generation or so.

In practice that makes us confident that our ramshackle global financial machinery will avoid a crash — because our leaders have managed (with spit and bailing wire) to hold it together through every previous crisis.  The similarity between today and July 1914 is striking (substituting money for bullets).

Look at July 1914.  In hindsight WWI was inevitable and obvious, the result of growing tensions in Europe.    William Lind explains

One pebble touched off an avalanche.  It did so because it occurred, not as an isolated incident, but as one more in a series of crises that rocked Europe in its last ten years of peace, 1904-1914. Each of those crises had the potential to touch off a general European war, and each further de-stabilized the region, making the next incident all the more dangerous. 1905-06 witnessed the First Moroccan Crisis, when the German Foreign Office (whose motto, after Bismarck, might well be, “Clowns unto ages of ages”) compelled a very reluctant Kaiser Wilhelm II to land at Tangier as a challenge to France. 1908 brought the Bosnian Annexation Crisis, where Austria humiliated Russia and left her anxious for revenge. Then came the Second Moroccan Crisis of 1911, the Tripolitan War of 1911-1912 (a war Italy actually won, against the tottering Ottoman Empire) and the Balkan Wars of 1912-13.
By 1914, it had become a question more of which crisis would finally set all Europe ablaze than of whether peace would endure. This was true despite the fact that, in the abstract, no major European state wanted war.

But this was not obvious to people at that time!  Harvard historian Niall Ferguson looks at the prices of UK bonds (gilts).  These show complacency right up the brink.  City investors read of the mobilization orders, panicked, and the markets imploded. Of course, we are much smarter than they.  We would know if the world was on the brink of a crisis.  For more about this, please read “Political risk and the international bond market between the 1848 revolution and the outbreak of the First World War“, Economic History Review, February 2006.

If Europe crashes and burns (economically, not physically), future experts will see it as inevitable.

(4)  A grim analysis from a well-wired economist

Worthwhile reading by Dr. Philippa Malmgren (bio here) posted at her website

News to expect in the coming days and weeks:
Greece defaults
Germany protects German banks but other countries cannot do the same thus quickly provoking multiple sovereign defaults and or bank failures, all of which may easily lead to a payments crisis in the global banking system. Derivatives are particularly at risk in terms of operation and execution.
The Euro falls in value especially against the US dollar
The Germans announce they are re-introducing the Deutschmark. They have already ordered the new currency and asked that the printers hurry up.
The Euro falls even more on any news that Germany is withdrawing from the Euro.
Legal wrangling begins as to the legality of Germany’s decision. Resolution takes years.
Germany insists that the Euro continues to exist even they do not use it any longer. They emphasize that European unification will continue and suggest new legal instruments to strengthen European Unification including new EU Treaties.