Enjoy the holidays. It is the calm before the storm. The New Year will herald the end of Europe as we know it. Next year will be the most traumatic for the continent since the end of the war.
Europe has accumulated an astounding list of problems. It is almost certainly in a recession, and it has not yet recovered from the last one. Credit downgrades threaten the entire continent. Fitch has warned Italy, France, Ireland, Belgium, Slovenia and Cyprus of a "near-term" downgrade. Moody's has just downgraded Belgium.
The European financial system is on the verge of disintegration. The single currency is close to collapse. European banks are desperately scrambling for cash. The inter-bank market has stopped working. Banks are reducing their exposure to sovereign debt, making it harder, if not impossible for governments to finance their huge fiscal deficits. In January alone, Eurozone governments need to find €80 billion just a rollover their existing debt and keep the lights on.
Living standards are declining everywhere. Unemployment is rising, and inflation is creeping upwards. European politicians seemed overwhelmed and unable to develop any credible responses to the mounting crisis. There are ominous signs of unrest across the continent. Europe feels as if it is ready to explode.
The superficial reason for the crisis is well understood and can be summed up in a single word - debt. Yet the crisis begs a deeper question; why did seemingly rationale people allow their governments to accumulate unsustainable debt stocks?
The temptation is to point the scrawny finger of blame towards politicians, who were enticed to take up credits from bankers. It is an explanation that neatly targets two disreputable and discredited groups. Yet, on closer reflection, this explanation seems insufficient.
During the1960s, European governments maintained balanced budgets. Their banking sectors were conservative and managed risk prudently. European economy was growing rapidly and living standards were converging to those in North America. Europe, back then, was a well-run place.
Something happened along the way. The harmony of the the 1950s and 1960s was disrupted. A rough date for the turning point seems to be 1970. Thereafter, governments began to run fiscal deficits, accumulate debt, and use interest rates to engineer asset price bubbles.
This shift was demand driven; it was what the voters wanted. Europeans demanded two inconsistent things. First, they wanted governments to provide a generous social safety net, but they didn't want to pay high taxes to finance it. Second, they wanted to be rich, but they didn't want to work for it.
Politicians found a temporary fix for both problems - debt. Governments bridged the gap between expenditures and revenues by borrowing. Governments liberalised financial markets, allowing private households to accumulate large debt burdens to finance consumption. Financial market liberalisation unleashed huge asset price inflation that gave people the illusion that there were becoming more wealthy.
Nevertheless, the question remains why European attitudes to debt changed so dramatically in the 1970s. My best guess is that the answer lies in demographics. In the early 1970s, fertility rates across Europe collapsed. Many Europeans decided that they wouldn't have children. Those that did decide to have children, had far fewer than their parents.
Childless people have a very different attitude to the future compared to parents. People with children worry about the future in a deeply personal way. They worry about the world that their children will inherit.Leaving an inheritance of debt and financial disorder, for most parents, is anathema.
Childless people also worry about the future but in a more abstract way. Public sector debt, particular kind that matures in the distant future, is a problem for someone else, or to be more precise, the children of someone else. Childless people have no biological investment in the future.
This biological disconnect with the future has created a profound paradox in Europe today. Ask anyone individually how they feel about the future, and you will invariably receive a passionate answer, highlighting the need to protect the environment, to invest in education, and build a better future through investment in public services.
Actions are often a better guide to how people really feel about the future. Over the last 30 years, Europeans have behaved as if the world would end in 2020. Both collectively and individually,Europeans have built up unsustainable debt levels. People have not saved sufficiently to finance their pensions. Education standards across the continent have disintegrated. Europeans protest loudly about the environment, but continue consuming ever-increasing amounts of energy. They are mawkish and excessively sentimental about children, yet seem unwilling to bear the financial sacrifices of raising a new generation. They want high levels of public expenditure, but will evade taxes as soon as an opportunity presents itself.
In retrospect, the most surprising aspect of the crash was that everyone was surprised when it happened. Looking back ,it seems almost surreal that people believed that governments and households could build up such large debt stocks without consequences. It was stupid to think that asset prices could consistently outstrip the economic growth.Next year is when accounts are settled. The disconnect between rhetoric and reality will disappear. Europe is about to meet the future that it prepared for itself over the last forty years.