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The Tipping Point into Economic Collapse

This week the European bank Dexia was partially nationalized by Belgium because the Fed’s bailout two years ago didn’t work. Belgium and France has already nationalized part of the bank months ago. That essentially amounts to bailout after bailout, now reaching the third round. The large international bank, in other words, is a very sick patient that has resisted aggressive treatment. Moreover, Dexia’s vital signs are worse then they appear. The bank has only written down the value of its Greek “assets?” by 21% while other institutions have already written them down by as much as 50%.

Could Dexia be the Credit Anstalt Bank of 2011 — the private Austrian bank that collapsed in 1931, greatly deepening and broadening the depression that had already begun? Dexia was bailed out by the Fed on October 24, 2008 because it guarantees many of the municipal bonds in the U.S. Matt Fabian of Municipal Markets Advisors reflected, “If Dexia went bankrupt, it could have been a catastrophe for municipal finance and money funds.” U.S. Money Market funds are heavily invested in those bonds. Dominoes.

Economic collapse happens in stages of catastrophic failure

The more highly leveraged institutions and nations are, the more things happen in punctuated movements from one state of temporary equilibrium to another. Smaller triggers become more and more capable of catastrophic shifts in the balance of things as there is such a heavy load ready to move … like removing a pebble from a mountain slope and causing a landslide. That’s what happened when Credit Anstalt Bank failed. A highly destabilized global economy in recession took another plunge. (The Great Depression comprised more than one crash.)

The more bad banks get piled on top of nations, the more likely entire nations will go bankrupt. If Dexia goes bankrupt, for example, Belgium’s liability from that one bank alone is 17% of its GDP. If Dexia pops, it’ll be a very large boom for Belgium! Being next to Dexia right now is sort of like working beside a boiler that is about ready to blow, hoping you can bring the temperature down in time.

Another major bank at risk of collapse is Bank of America. It has been doing exactly what Credit Anstalt did in the twenties and for the same reason: During a time of weakening regulation, banks in Austria began failing. At the insistence of regulators, Credit Anstalt, one of the largest banks, took over the failing banks. You are what you eat, so Credit Anstalt became as sick as the bad banks it was consuming.

We see the same thing happened today, as I had predicted it would a couple of years ago when Bank of America took over Countrywide. It is now as sick as what it consumed.

How great recessions become great depressions

The lesson here is simple: don’t eat bad meat. The question is, with so much rot being consumed by large banks and now by nations, how long until the contagion is so bad throughout the world that we have a complete global financial  and social collapse? The further question, as so much pressure builds, is what will be the small trigger — the tipping point — that brings the greater collapse?

In the case of Credit Anstalt, it was required to re-evaluate its books because its assets had lost value, just as Dexia needs to do now that its Greek assets are worth less than they show on the books. In light of clearer information at Credit Anstalt, depositors started withdrawing their funds, and the Austrian government stepped in with guarantees to prevent a run on the bank by nationalizing it. Credit Anstalt failed anyway. The failure of Credit Anstalt happened in a small country like Belgium, but it triggered a run on banks throughout Europe that turned a deep recession into a long-lasting depression. Austria, at the time was a tiny place at the epicenter of this change, much smaller in significance than Belgium.

Like standing on a soda can, you can pile up so much pressure on a nation that merely touching its side will cause it to implode. How much more bad debt can nations absorb from banks before even the strong nations go down from a small triggering event? It does not have to be the strongest nation (like the U.S.) that triggers the worst of the market’s plunges. When structures (including economic structures) become highly overloaded, they do not move with grace. A jolt by one small failed nation can move even the mighty.

It was through this same process of nationalizing bad banks and staged collapses that the great recession at the end of the twenties became the Great Depression of the thirties.

As nations took ownership in banks to save them, the failure of banks became the failure of nations. The economic distress in Austria exacerbated conflict between socialist and fascists over such things as national ownership in banks, and that paved the way for Adolph Hitler to enter Austria as a savior. Economic collapse became social collapse, which became world war. As nations slid with their banks, the landscape of Europe changed forever. Granted, the banks were only part of the change of nations, but they were a big part. And a large bank in a small country played the biggest role.

 

More reading on causes of the Great Depression and Great Recession:

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