I owe readers a mea culpa on Europe as of late.  The LTRO far surpassed my expectations of helping stabilize the region.  But my position hasn’t changed much.  I still think the European debt crisis ultimately comes down to a question of budget sustainability and the road to sustainability runs through growth.  As I’ve shown in the past, Italy and many other peripheral nations have to grow substantially if they’re going to reduce budgets meaningfully without fiscal aid.  That idea is completely at odds with the austerity that is being imposed.  So, my thinking in a nut shell is that this crisis will flare up again when investors realize that the ECB’s funding programs are merely kicking the can.  But so far, I’ve been wrong and the mantra “don’t fight the ECB” appears to be the strategy of choice….

Further supporting this thinking is the continuing balance sheet recession in the region.  Richard Koo’s latest note discusses this and shows a frightening trend where loan demand is now contracting again:

Eurozone loan demand has resumed contracting

The ECB report also points to a continued and marked decline in eurozone loan demand stretching back to 2011 Q3. One reason for sluggish demand is that economic weakness is prompting businesses to put off capital investment.

Eurozone loan demand contracted sharply in 2008 as regional housing bubbles collapsed, and the situation grew worse following the collapse of Lehman Brothers. Later the declines moderated, and by 2010 H2 demand was growing again, albeit at a modest pace, and was helping to fuel a eurozone recovery (Figure 3).”

“The sharp renewed drop in loan demand is a sign that the eurozone economy is entering a double dip and is once again in a balance sheet recession. That this is happening at a time when euro interest rates are at all-time lows highlights the severity of the crisis.”

Something doesn’t add up here.  They can’t impose austerity, suffer a balance sheet recession and grow their way out of the budget mess.  I could be wrong, but this analysis tells me that we haven’t seen the last of the Eurozone debt crisis.


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • http://merrillovermatter.blogspot.com Greg Merrill

    Steve Keen and the credit impulse is going warp 10 backwards right now.

  • jt26

    Stagflation is the answer?

  • CN

    I agree, the crisis is not over. However, as the LTRO is a relief to banks and reduced the systemic risk in the short term (Taleb would say that means we will see a bigger adjustment in the future), and assuming that the public (business included) is only perceiving this now, perhaps we could see a pickup in the loan demand. The last of months of 2011 were not encouraging with all those bad news in the media, and that had a negative effect in animal spirits. We might see a bit of the opposite now. I´m not trying to make a bull case here.. long term fundamentals remain weak, things remains fragile and vulnerable to shocks.

  • lairdwd

    the LTRO (i.e. LMFAO) bought them a year at most, a month after elections more likely. Enjoy it while it lasts

  • http://pragcap michael schofield

    The correct question may be “Can they get it right before they run out of money?” If fiscal union is as far away as I think it is, they’re going to need a lot of money.

  • Ben Wolf

    I don’t see the situation as having stabilized at all. The European Commission is forecasting growth for this year of 0.6% and EMU unemployment is at 9.9% and rising. Countries like Germany can only throw so much debt onto their CBs unless they decide to allow the ECB to open up the spigot. With Angela “The Dominatrix” Merkel demanding Greece immediately punish itself even more harshly I don’t see this situation turning around any time soon.

  • Andrew P

    I would not ignore the possibility that LTRO can be used as a stealthy backdoor fiscal operation by the ECB. Since the ECB is allowed to purchase unlimited amounts of gold with printed money, they can lend out trillions, tell the banks to buy gold with the money, which will drive up the price of gold, and then secretly purchase that newly inflated gold from the banks, extinguishing the debt. Trillions in profit will have been printed. Abracadabra, the banks are solvent again and have plenty of capital. They can do the same thing with EU State government debt of course, but the States have to pay that debt back. Gold is better because the ECB can buy it and hold it forever.

    Of course, my scenario is not sustainable over the long term, but it does not have to be. The ECB only cares about the banks. As long as cascading bank failures are taken off the table, a global Second Great Depression is off the table as well. Everyone knows that the EMU system has to be fundamentally changed. This must be put off until after the elections, and could go in several possible directions – (1) A United States of Europe, (2) A restructured monetary union based on a gold standard, or (3) a complete, but orderly, breakup and a resumption of all legacy currencies. If the ECB accumulates lots of gold, #2 is favored. If the ECB accumulates lots of State debt, #1 is favored. If they do neither, but banks buy lots of their own State’s debt, #3 is favored.

  • Larry

    Cullen, you and the majority on this website have remained bearish about Europe’s crisis while the market action is going the opposite way. Not only European equities but also the Euro currency have risen significantly. Clearly market participants believe that when push comes to shove, the ECB will step up in even a bigger way than they have done with the LTRO. Apparently the market can stay irrational for longer than I can stay solvent. Can the ECB keep this going for a whole year?

  • pebird

    LTRO is Eurobond-lite. It is big enough through leverage to kick the can a ways longer. But nothing is resolved. Greece is continually delayed, Italy has a big rollover due and Spain not far behind.

    If you were cynical you might say the LTRO allowed the banks to move risky Euro government debt back to their respective Central Banks. Kind of musical chairs, since no one in the rest of the world is going to touch Euro debt (except Germany) for a while.

  • Larry

    Cullen, you have made a very good argument that we have not seen the last of the European debt crisis. However, Andrew P makes a good case that the ECB has three options they can use to postpone the crisis for a good while, more than a year or two. Cullen, do you still favor Andrew’s option 1, a U.S. of Europe? And do you think it is very likely they will be able to pull it together?

  • Andrew P

    Merkel probably wants Greece to just go away. Default already. But Greece doesn’t want to default. They have done very well under EMU, and have no desire to go back to the Drachma. Merkel knows that if Greece defaults and returns to the Drachma, the will become so desperate for imported food and oil that they will come crawling on their hands and knees to Germany, and they will beg Germany to buy their islands or whatever so they can just survive.

    Keep in mind that the shipping industry has massive overcapacity, so Greece is REALLY hurting right now. Greece’s one industry that brings in external funds can’t do much for them with the BDI in the dumper. Merkel has them over a barrel in her dungeon, and she is tightening the chains.

  • Andrew P

    If LTRO is actually used to get shaky sovereign debt back into each State’s own banks, then an eventual breakup of EMU is favored. This is John Mauldin’s scenario. I don’t know if this is happening or not. We will probably have to wait until after the 2nd round of LTRO is distributed to find out, but it is something to watch closely.

  • dgc

    If I controlled a Eurozone business, I would not be looking to expand into Greece, Portugal, Ireland, Spain, Italy, or France, so perhaps falling loan demand makes sense.

    James Kostohryz of “Seeking Alpha” states that the primary problem faced by the PIIGS is not the size of their debts or even the extent of their present fiscal deficits, but rather that they cannot maintain sustainable growth within the EU system. In 2010, Germany and the Netherlands had large current account surpluses [Germany (162B Euro)and the Netherlands (47 B Euro)], while the PIIGS and France had deficits (Italy 78 B Euro, France 74 B Euro, Spain 61 B Euro, Portugal 23 B Euro, Greece 20 B Euro, and Ireland 3 B Euro). Without correcting the purchasing power parity, the Eurozone can only kick the can … and how can you correct those deficits?

  • Kobayachi

    Europe is doing just fine. Employment numbers are improving in many countries and the economy as a whole is improving again. The main concern in Europe at the moment is the US economy. Europe was pushed into recession by the US in 2009 and the fear that the US will fall back into a recession is growing by the day. Bernanke’s latest speech only confirmed those concerns.
    Many analysts now believe there will be a double dip in the US and that Europe, China and the rest of the world will once again be dragged down with it.

    Does this sound like outrageous propaganda to you?

    Just replace US and Europe and you’ll get your usual propaganda back. But I hope it made you think about the news you’re getting every day and became more aware that all this nonsense about Europe breaking up and the euro collapsing was pure fear mongering and propaganda.
    What‘s the rate for EUR/USD? … 1,32 USD for 1 EUR and growing… but… but… wasn’t the Euro supposed to be dead by now?

    My advice: If you want to be a successful trader or investor: Stay PRAGMATIC! And ignore the propaganda.

  • Alberto

    Just before Christmas Randall Wray wrote a piece on naked capitalism where he stated that EU was going to dissolve early 2012 because of the default of Italy on late january early february. Because prof. Wray is one of the leading MMTers I think he did really a great job in destroying the credibility of that theory that day after day looks more like a church or a sect than an ordinate economic thinking

  • Neptune

    Cogratulations !!! I think you have just made the most intelligent comment on this entire site. Just too bad the propaganda is working !!

  • Octavio Richetta

    CR, nice point on credit contraction in the EU. Here in the us the oposite is happening. The banks have finally starting to lend. The latest us economic and interest rate forecast from Kasriel makes out of this the center piece of the us ongoing recovery. Furthermore he believes the FED will have to blackout of its promise and start raising rates in the second half of 2013. IMHO, a well balanced, sensible analysis.


    Europe may derail the us recovery but this will happen with a lag, and given all Europe is doing the impact on the us economy will be much softer.

    What may be going on here is that finally the effect of ZIRP and QE is kicking in. In a recent daily commentary from NT, they argue against BG recent FT commentary against ZIRP. They argue it is working.

    On lending, it looks like the large banks have no choice but start making money the old fashion way. This is because they can no longer play the WS leveraged game and the flat yield curve makes long Ts unatractive. New York Magazine had a great article on how new regulation is hitting the “too big to fail” banks. I got the link via the reformed broker log.


    Forecasting the economy is hard; even harder at turning points. Lots of noise complicate matters. To me, it looks so far that ECRI will miss its recession call window. Given their record and force with which they have defended their call, missing the call would be one more example of how this crisis have humbled most. I say once again it is difficult to see how we can have a new recession when housing is at the bottom and apparently starting to recover, and with increased lending PCE refusing to decline significantly. What is left is net exports and unless something really bad happens in the middle east driving oil above $150 again, the drop in exports due to the WW slowdown may not be enoug to trigger a recession call.

    So with a us recovery, how much higher can expensive us stocks go? They have been more expensive before. With the ZIRP winds in favor the game may go on a lot longer.

  • Richard T.

    Did you see this, from Benoit Coeure of the ECB?


  • Optimist

    IMO, this blog entry is unduly pessimistic: the Euro survived a tumultuous 2011 without too many resources being used – so surviving in the improving conditions of 2012 will be a breeze.

    I do not accept the austerity v growth argument: in 2004, Germany’s Agenda 2010 programme was VERY unpopular (and Gerhard Schroder was voted out of office) – but the German economy has benefited greatly from it in recent years. The UK in the early 1980s is another example of austerity leading to sustainable growth. Real growth comes when investors have the confidence to invest: the growth that comes from governments throwing money around like confetti is ephemeral.

  • Larry

    @Octavio, it looks like you have turned bullish now, is that right? If US housing has bottomed and US banks have started lending again, doesn’t it make sense that the US equity run can continue for a while? And Andrew P’s point that the Greeks are in a weak position due to the weakness of shipping, their top industry, that they are forced to compromise with Germany and the EU. So what is there to stop the S&P 500 from going on to exceed its April high, and maybe keep going from there?

  • faramirrr

    It looks a bit deja vu no ? QE2 and the rally after that was pretty similar and impressive, no ?

  • DVWilliams

    I don’t think that you can make such broad statements about Europe as if it were one entity. The true picture is much more mixed.

    The countries that have a trade surplus: Germany, Netherlands, etc are doing well. Their unemployment levels are dropping (Germany 5.5%, Netherlands4.9%)and businesses based in these countries will probably remain successful and competitive.

    However, the economies of the deficit nations: Greece, Portugal, Ireland, etc are getting worse. The austerity is pushing down domestic demand and only making things worse. Unemployment in Spain is nearly 23% with youth unemployment (I don’t know how this is defined) is over 45%!

    Europe is much more like 2 entities, one flourishing and the other failing. The tensions come from the fact that they both sit within the same currency. Within a currency issuing country these tensions are solved through internal transfers. Eg, in the UK, London and the South East, which are relatively prosperous subsidised the formerly coal mining dependant areas in the north. These transfers happen to a small degree already with EU grants to ‘development areas’, but on the scale required.

    There are other solutions to the problem, such as internal devaluation (nominal wage cuts to reduce the unit costs of production), but they would have a significant human cost.

    To suggest that the problems of Europe are anywhere near being solved is, in my opinion, naive and overly optimistic.

  • Gary_UK

    Hey Cullen.

    You’re right it’s far from over, but at least it has begun eh?

    I wondered what you thought of Allan Greenspan as a Fed chief, and generally whether you have agreed with his philosophies on finance?

  • charlesM

    From Benoit Coeure ECB chief economist:
    “Finally, the debt crisis in the euro area has its roots in insufficient fiscal discipline and, even more importantly, in divergent productivity trends among the Member States. Such divergence sows the seeds of balance-of-payment imbalances and ultimately leads to a sudden stop of capital inflows into peripheral countries. Obviously, adequate policy responses will have to focus primarily on these structural issues.”

    So the ECB admits that to solve structural imbalances, you must :
    turn greeks and sicilians into german productivists
    create a fiscal union US-style ( impossible under merkel )

    yes crisis is far from over

  • Johnny Evers

    Any chance the Europeans can come up with a way to print Euros, the same as the U.S. can print dollars?
    But really, aren’t these ‘loans’ just electronic deposits to the banks. Nobody expects them to be paid back at any time — is that accurate?

  • Larry

    @faramirrr, Yes, looks like so far 2012 could be somewhat of a replay of 2011, with equities and oil rallying for the first 3 or 4 months, then after that the reality of ongoing problems and austerity programs makes and impression and the rally may be cut short. I think this is close to Cullen’s view, that EMU problems are far from solved, and all the gov spending cuts will ultimately cause such a slowdown that it will even impact US exports to Europe.

  • charlesM

    I wonder if the question should not be : How long will the markets be liquidity-driven until they are than fundamentals-driven ? In the last few years if you have been correlated to liquidity you won.

  • DVWilliams

    Banknotes (which are a slightly different issue) are all printed by individual National Central Banks, backed by their own individual reserves. Where inter-country banking transfers occur, the reserves are settled through the TARGET2 system.

    The treaties that established the Euro specifically ruled out ‘monetising’ Governmental running costs or accrued debts. This is why you have all the ridiculous ideas about ECB holdings being passed to the European Financial Stability Fund (EFSF) at Book Cost so the losses can be taken elsewhere.

    The idea of printed money isn’t all that popular in Germany and it might breach German constitutional law if enacted. There is a German academic that has fought against the ESM and EFSF in the German Constitutional Court to try to get them overturned, unsuccessfully. However, direct printing would almost certainly be ruled unconstitutional. Changing the constitution would require a referendum, which I doubt would be successful.

    The key to all of this is the lack of a central European treasury and there is no likelihood of this situation changing in the near future.

  • Andrea Malagoli

    It is very simple. We have to stop believing that “lender of last resort” facilities are a miracle cure for reckless and unproductive spending.

    Facilities like LTRO are just like trying to contain a flood by moving water into different containers. The problem is that eventually two things must happen:
    1) stop the flood
    2) get rid of the water

    For the world economies, this is going to be a long painful process.
    The markets are like spoiled babies hoping for an easy and painful solution.

    The reality is very simple and has not changed over the many centuries these crises have occurred.

    We live in a virtual world where we think financial engineering and video games can become a substitute reality of working harder for less.

    By the way, the EU is only the most visible case, but the US, China and the rest of the world are in the very same predicament: make no mistakes about this.

    What it means for investing? Be prepared to be pragmatic and “change your mind when facts change”, but wishful thinking that the crisis is about over will be a costly mistake.

    Incidentally, I was reading today that Larry Fink of Blackstone is recommending investors to be 100% in equities. I find this irresponsible advice.

  • charlesM

    LTRO is not QE. The bonds stay in the balance sheets of the borrowing banks and are marked to market every night. That’s why it is costly and only cash-poor banks use it. But , nonetheless, it seems that state debts (except Bunds) are mainly bought by local banks ( Intesa buying italian bonds for instance) and that there is a kind of repatriation of debt in the emittor countries local banks. that sure would help in case of break up

  • Larry

    @Andrea, Yes, I agree with most of what you said. Especially agree that Larry Fink’s advice of 100% in equities is irresponsible. Instead of saying:

    “The markets are like spoiled babies hoping for an easy and painful solution.”
    You meant to say: hoping for an easy and painLESS solution, which I agree just ain’t gonna happen. And DVWilliams, thanks for your comment saying that the Germans, and their own constitution, will probably not allow the ECB to buy sovereign debt directly, thus they won’t be able to directly monetize the debt. If the EU banks get LTRO money and sit on it, not buying too much sov debt, then the rates could rise and crisis could erupt all over again.

  • Larry
  • boatman

    yeah when everythings rosy and money’s flowing no one even thinks of getting real or solvent, why should we? they say…..everythings fine……what politician is going to rock that boat?

    and when everthing is in the dumpster[now and more so soon] no one can get real or solvent or austere because it will kill the recovery.

    so when does anyone get real and solvent?

    when the whole deal finally cannot be papered over anymore.

    coming to a theatre near you…….not today….maybe not tomorrow but coming.

    the ultimate stupid socialist paper amalgumation [the EU] will blow up and be another [maybe THE] major step in the debt/credit bubble collapse that started in 2000.

    only more low and ZIRP from the fed has kept the house of cards up.

    the secular bull of ’82-’00——paid for [pushed ahead] by said debt/credit bubble.

    sooner or later somebody somewhere will actually have to buy and pay for something and own it.

  • Octavio Richetta

    It looks like the US economy will avoid a recession and grow modestly, even perhaps with a positive second derivative, i.e., accelerated growth. How will this affect the equity market? If you have read the stuff at D. Short on market valuation, market currently is about 30 % overvalued but it can spend years at this stage. Lonb term, Hussman is rite. Market priced to deliver about 4.5% nominal in next ten years. That is of course an annual average.

  • Ben Wolf

    I see no evidence unemployment is improving. In fact it’s even worse than I had thought at 10.4% and the trend is upward.

    Nor is GDP recovering:

    Anyone thinking the EMU is on the way to recovery is living in a faith-based world.

  • VII

    @ Andrea

    Thanks Larry Fink for the advice. I will take my equity exposure from 20% SDS to 40% depending on tomorrow action.

    You have to own them to short them. :-)

  • JWG

    The LTRO shows that the Germans have accepted the ECB’s use of keystroke money, as long as it is used to bail out banks and not sovereigns. This means that Greece is eventually going to default, because it is in such a deep hole it is a fool’s errand to try to bail it out. It will be much less costly to send Greece humanitarian aid after default than it is trying to keep a pampered and uncompetitive society afloat as a whole. This is the German calculus on Greece.

  • Nils

    Where exactly in the German constitution does it say that there can be no money printing? I think you are confusing it with the ruling by the constitutional court that said that the German government can’t extend unlimited credit/guarantees to other nations to draw from without a vote on the amount lent.

  • Nils

    The ECB is bound by the treaties through which it was created. The ECB only has a mandate on inflation and is prohibited from buying sovereign debt. To change that would mean changing some EMU treaties which usually takes a few years and can be derailed by any member state.

    It has nothing to do with the German constitution, as we know the Bundesbank sometimes buys/retains German government debt.

  • Nils

    The keystroke money (or money printing) was always a reality of the ECB system. LTRO is just a different facility to draw credit from the ECB. The real difference to QE is that the Banks get to keep the profit.

  • Kobayachi

    Seriously? nobody understood the message and the underlying sarcasm in that post?

    Off course Europe is not doing fine at the moment and neither is the US. Talking about unemployment, I’m not sure which continent is better of right now.
    Europe with its slightly distorted numbers abow 10%, or the US with its highly distorted numbers under 10%.
    I was shocked when they released the last numbers last week. Let’s just erase 1,2 million poeple from the stats and everything’s going to be fine. Nobody reads the whole report anyways.


    Also bear in mind, in Europe they have a decent social and health care program that keeps poeple from falling into poverty.

  • http://www.deltafinancials.com delta financials

    The crisis certainly isn’t over, but to understand why, you sort of have to look at the entire global problem as a currency crisis. I’m not making a gold standard argument here. If you look back to china joining the WTO and the years since, there have been massive dislocations throughout the currency system since then. China’s trade surpluses with a controlled currency are someone elses trade deficits. Things will get better or worse in proportion with currency reform that allows global trade to run on market principles. In fact, i’ll reiterate cullen – i think your sectoral balance view is incomplete because you don’t delve deeply into the source of current account deficits.
    For europe to get through this, greece, spain and italy need currency devaluation – one way or another.

  • DVWilliams

    I don’t pretend to be an expert on German law and my comment was based on a recollection of various debates in the comments sections of FTAlphaville. I am perfectly happy to be corrected on this point.

    However, if there is money being created, the purpose for which it is being used is important if it cannot be used to subsidise the budgets of other Eurozone nations or used to write off their existing debts.

    It may not be directly outlawed, but it seems that most of the purposes that would make sense for its use are forbidden.

  • Leverage

    And there we go spinning the growth fetiche. Why should and economy be ‘growing’ to be stable?

    For centuries in most civilizations growth was slow or stagnant during long periods of time and yet there was full employment (or almost) and stability. With more advanced social standards, knowledge and productivity we should be able to drive out the growth fetiche (which is a modern one anyway) once and for all.

    The depedency on growth (even if only in nominal terms) is digging your own grave. If MMR does not have answers to this problem is as useless as any other economic theory and there should be changes to the current system.

  • jms.grmwd

    In 1980 the UK had a balanced current account, 20% of GDP in financial sector debt as opposed to 120% now, and 40% of household sector debt as opposed to more than 100% now. The confidence fairy isn’t coming to the rescue this time.

  • Larry

    Do any of you out there know any of the details yet on this Greece bailout package and its austerity requirements? Were the Greeks forced to take a hefty haircut on their pensions? My guess is that the northern Europeans have quietly vowed that this one will be the very last bailout for Greece. Next time let them default and leave the euro, may be the new prevailing attitude.

  • Larry

    Cullen, your very gracious “mea culpa” is accepted, but it is not necessary. You have always been very honest and generous in sharing your views with us. It is the timing that can be so very difficult. Last fall and early winter you shared with us your views that the EU crisis was unlikely to disappear, even with strong policy actions by the ECB. Most of us on this site share your view that the EU crisis is far from over. The only question is: how long will this honeymoon period last between the last and the next eruption of this crisis? Who knows, but erupt again it will, because, as you said: “They can’t impose austerity, suffer a balance sheet recession and grow their way out of the budget mess. I could be wrong, but this analysis tells me that we haven’t seen the last of the Eurozone debt crisis.”

    Cullen, thank you very much for this post.

  • Mark

    I was hoping someone could help me out with a question. With the ecb in a full blown qe and printing euros, it should naturally bring the value of the euro lower. If that does happen, the usd should respond to realtive strength. Does a rising dollar effect the plans that our Fed has in place to try and help our economy or their balance sheets.

    If our fed decides to print money to try and bring the dollar down or launches their own qe3, what would happen to the dollar if the ecb is in a qe program as well. If boith countries are printing money and the euro is pegged to the dollar, who would win that currency battle and would it effect would it have on our economy if any. Thanks in advance.

  • Nils

    That’s not because of the German constitution though. It’s in the treaties that established the Euro and the role of the ECB which can usually be changed without referendum.

  • pebird

    I agree with that. No one gets timing right on every call, especially something so politically complex. The foundation of the analysis is still solid. When they kick a can it’s hard to see how far it travels.

  • Coolidge Low
  • Nils

    I need growth because I want my life to be better ten years from now, not the same.