Eurozone crisis brings world to brink of depression

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July 24, 2012, 11:25 a.m. EDT

Euro crisis brings world to brink of depression

Commentary: Parallels to 1930s’ missteps unmistakable

By Darrell Delamaide

WASHINGTON (MarketWatch) — Europe is a tinderbox waiting for a spark.

The financial volatility in Europe may have created a situation that is now beyond the capacity of policy makers to control or curb.

When an accomplished fixer like Pascal Lamy, the head of the World Trade Organization and the longtime chief of staff for former European Commission President Jacques Delors, describes the situation in Europe as “difficult, very difficult, very difficult, very difficult,” you know it is time to run for cover.

The crisis has now gone well beyond the prospect of breaking up the euro to the threat of a full-fledged financial and economic collapse in Europe that could plunge the world into a second Great Depression.

Few Americans are aware that a worldwide banking crisis started by cascading bank failures in Austria and Germany was one of the major causes of that earlier Depression.

It was in the summer of 1931 that the collapse of Creditanstalt in Vienna forced one of Germany’s big banks, Danatbank, to fail, leading to a credit crisis that prompted bank holidays around the world and exacerbating an already severe economic crisis.

The spark in the current crisis could come from a bank failure, and not necessarily in Spain. It could be a bank in Italy — or Austria, or Germany. German banks are notoriously undercapitalized and poorly supervised and have created a number of mini-crises in the past few decades since the collapse of the Herstatt Bank in 1974.

German economist Fabian Lindner drew the parallel to 1931 in an op-ed last fall when he compared his country’s intransigence toward southern Europe now to the misguided harshness of the U.S. and France toward Germany in the earlier crisis.

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“Both the German public and politicians should learn from history,” Lindner wrote in a commentary for Die Zeit that was also published in The Guardian. “Solidarity with the crisis countries is in Germany’s long-run interest. The German government should stop abusing its power to dictate economic decline to other nations. The alternative is economic stagnation and increased tensions between European nations.”

The situation has deteriorated since Lindner hoped in vain for some enlightenment on the German side. Instead, German Chancellor Angela Merkel and Bundesbank President Jens Weidmann have held to the prescription Lindner saw leading to disaster: “Germany and the German central bankers demand drastic austerity and only give piecemeal and insufficient help in return — too little, too late.” Read Lindner’s op-ed in English.

The latest austerity measures in Spain, approved by the national Parliament last week even as the economy continues to contract, has led to new riots in the streets, pushing the yields on Spanish bonds above the 7% level deemed manageable, and increasing the likelihood of contagion to Italy.

Meanwhile, German Economics Minister Philipp Roesler whistles in the wind, saying the possibility of a Greek exit from the euro has “lost its horror,” and German Finance Minister Wolfgang Schaueble says Greece must try harder to meet its austerity commitments.

The problem, meine Herren, is not poor little Greece, long since written off by a smug German officialdom. The problem is the growing possibility of defaults in Spain and Italy that will lead to bank failures across the continent and incalculable consequences.

Paul Krugman quipped at the beginning of the current crisis that someone will be able to write a sequel to Liaquat Ahamed’s Pulitzer Prize-winning book, “Lords of Finance” — which chronicles how the four leading central bankers of that era plunged the world into the Great Depression with their wrong-headed policies — and call it “Lords of Finance: The Next Generation.”

The target of Krugman’s barb was Jean-Claude Trichet, then president of the European Central Bank. But his successor, Mario Draghi, has proven equally clueless in his public statements and actions.

Federal Reserve Chairman Ben Bernanke, an avowed admirer of Ahamed’s book, has nonetheless been relatively timid in recent months, keeping his distance from the European crisis and failing to make a convincing case for the Fed’s inaction in following its own mandate to promote employment in the U.S.

History is not likely to be any kinder to Bernanke and his cohorts than to the European policy makers who collectively have not been equal to the task.

The worst may still be averted but the challenge is indeed very, very, very difficult, and it is hard to see at this point where salvation could come from.