Why Italy’s Banks Are a ‘Doom-Loop’ Risk that Could Bury the Eurozone


Eight years after the global financial crisis, Italy’s economy remains weak and the country’s banks have a very high rate of shaky – or non-performing — loans at about 18%. That compares with rates of 5% in France and 1.5% in the United Kingdom. Since Italy is the third-largest economy in the European Union, a breakout of loan defaults or a run on bank deposits could quickly spread eurozone-wide, where many banks have been struggling, in part because of record-low interest rates cutting profit margins. What’s more, companies in Europe depend on bank loans far more than in the U.S., so struggling banks can mean that even successful companies face a credit squeeze.
This has led to fears of a “doom loop” because the potential failure of Italy’s banking system might require a state rescue at a time when the country is already heavily indebted at around 135% of GDP. What’s more, a financially incestuous relationship between the two already exists — Italian banks are heavily invested in Italian government debt. And it is all further complicated because as of January, new regulations require European banks to bail-in shareholders and bondholders – use their holdings to recapitalize a troubled bank — before any taxpayer-funded bailout can occur. Yet in Italy, many bondholders are actually small investors who were duped into buying bank bonds under the impression that they were as safe as insured deposits, explains Franklin Allen, an emeritus finance professor at Wharton and a finance professor at Imperial College in London. If small investors start to take a hit, it could spark a run on bank deposits and kick off a major crisis. In this Knowledge@Wharton interview, he looks at the big picture regarding risky Italian banks, assesses the odds of significant problems breaking out, and considers how officials might avoid a major new financial crisis.

An edited transcript of the conversation appears below:

Knowledge@Wharton: A new rule passed by the European Central Bank that takes effect next year calls for bank authorities to tap stockholders and bondholders for recapitalization before they would tap taxpayers for any bailout. This so-called “bail-in” is in contrast to what happened after the financial crisis when the U.S. — and many European countries — bailed out their banks using taxpayer money. But many of the bondholders in Italy are small investors.

They are similar to small depositors in the U.S. [and the small bondholders in Italy] thought that buying bonds would be a safe investment. These smaller holders may not be aware of the precarious financial position they are in because of these underperforming loans held by the Italian banks. Do you agree with this context? And what are the risks of these bondholders suddenly panicking, if they were to realize that the banks are in a fragile condition, and starting a run on deposits?

Franklin Allen: I agree completely that this is a very important issue and I think it’s off the radar screen of most people who aren’t involved in the financial sector. People in the financial sector realize that this is a potentially existential problem for the European Union. The reason is that Italian banks are very big and if they need to be bailed out by taxpayers, large amounts would be required.

But the problem is that the Italian government is already heavily indebted, so there’s what people sometimes call “the doom loop” between banks and the sovereign. That’s the general background.

You laid out very well that under the new rules — the [European Union] Bank Recovery and Resolution Directive — the banks need to bail in shareholders and bondholders before they can get state funds. This is problematic because it seems as though many small investors were missold. In other words, they were not really told the truth about what they were buying. In many cases, they thought they were buying something that was equivalent to insured deposits.

But these subordinated and other kinds of debt are not like that. They have the potential to be bailed in.

I think everybody agrees that it’s fine to bail in the shareholders, but it’s problematic to bail in these small bondholders. Politically, this represents a big problem for Italian Prime Minister Matteo Renzi’s government. There was a case at the end of last year where four small banks were bailed in and the same problem occurred there in that many didn’t realize what they had.

There was a tragic case of a retired pensioner who lost his life savings and was so distraught that they committed suicide. This obtained quite a lot of publicity, as you would expect.

But I think you’re right, there are still many people who don’t fully understand what they’re holding.

It seems that if there are bail-ins, the Italian government is going to recompense the small savers who have this kind of debt. But we get back to this problem of, can they afford to do that? And who exactly will get compensated? Will they go back and compensate the people in the banks that had the bail-ins last year? How far will it go?

Knowledge@Wharton: If that were to escalate up, if they weren’t able to contain it on a local level, then you start to open up all of the things that people have worried about for the last several years since the last financial crisis, which is this whole idea of systemic risk. This could spread to other banks in Europe that are facing some lean times and would have difficulties dealing with big challenges. One in particular is Deutsche Bank. Could you talk about the risk of systemic contagion and Deutsche Bank, in particular?

Allen: In Italy itself, there are a number of banks that have problems. Banca Monte dei Paschi di Siena, which is the oldest bank in the world dating back to the 15th century, has been bailed out twice already but is still on the ropes. The first question is, what will happen to them? They are the No. 3 bank in Italy, so they’re significant. They’re not huge in a global sense. The bank that is globally important in Italy is UniCredit, and it has operations in many other parts of Europe and the rest of the world. They have had a big drop in their equity price since the beginning of the year. This represents the fact that people are worried about these issues that you’ve talked about, the nonperforming loans and how the government will deal with them if they get into trouble.

I think if there is a meltdown, particularly if it spreads to UniCredit, then other banks in Europe will also face problems. I think Deutsche Bank has potential to have problems. The nature of their business is such that the very low interest rates and the fact that there isn’t much difference between long-term rates and short-term rates is problematic for them because of their business model. So, there is likely to be some contagion.

Once it starts, it’s very difficult to stop because I don’t think people understand what’s going on, and they are going to be quite surprised by these new bail-in rules. That in itself will cause significant problems both for small retail investors and, potentially, institutional investors.

Knowledge@Wharton: The new bail-in rules had a good intention. We don’t want to have bailouts funded by taxpayers the way we did last time. But the ECB [European Central Bank] is holding tight to those rules at a time when they might have said, for example, “We will be the lender of last resort if Italy gets into real trouble. We don’t really want to bail them out.

However, we’re not going to allow it to spread beyond Italy’s borders.” But it’s those very bail-ins [the ECB says it will enforce] that could cause the runs on deposits and the systematic risk spilling over the border. Could you explain why they want to hold fast to these rules — yet without some flexibility they could create the very problem they’re trying to avoid?

Allen: I think it’s even more complicated than what you just laid out because the other player in all this are the competition authorities in Brussels, because one of the aspects of providing bailouts using government finance is that this is regarded as unfair state aid to these companies and that’s ruled out in the EU.

In addition to the ECB, there are a number of players here — the national governments, the commission and the competition authorities. It’s a very complex set of issues, and I think many of the players are still very much in the mindset of macroeconomists, that problems occur when there’s a big macroeconomic shock or some big macroeconomic problem.

A number of the governments are saying, “We should stick with it and not solve this problem.”

Now we should see it play out because it doesn’t look like it’s a systemic problem. But I think these systemic problems can arise out of nowhere or out of small beginnings and take over very quickly. That’s what we saw in the financial crisis. And I think this problem with the Italian banks has that potential, and that’s why it’s so worrying and so important.

Knowledge@Wharton: There are also problems where economics and finance intersect with politics. In Italy, there is the Five Star Movement, a rising political party that has called for a referendum on staying with the euro. If taxpayers had to bail out Italian banks, that would be bad for Renzi. At the same time, that could mean that Five Star could do well in fall elections and introduce a resolution for Italy to leave the EU, which would be very serious. It would not threaten just the financial system in Europe, but the whole EU system.

Allen: The political situation in Italy is complex. They’re going to have a referendum in October on constitutional reform, which will effectively change the way their political system works quite dramatically. At the moment they have a two-house system. If approved, this referendum will change that significantly and effectively eliminate the upper house. The latest polls that I saw were that Five Star Movement is ahead, and we saw in local government elections the Five Star candidates were

It’s not at all clear at this stage what will happen in the referendum. Renzi has said he’ll resign if he doesn’t get the result he wants. He’s trying somewhat to backtrack from that at the moment. But there are a whole set of volatile events. If it becomes effectively a referendum where people want to deliver a protest vote, which often seems to happen in these referenda in the EU, then he may well lose and then he may have to call elections. Even if he doesn’t, then when elections do come, the Five Star Movement has a chance of doing very well.

While I don’t think they will try and pull out of the EU, they may hold a referendum on pulling out of the eurozone. I think it’s widely perceived that a lot of Italy’s problems and lack of growth for many, many years now is the result of being a member of the eurozone. This, again, is something that has huge ramifications all around. This is a reason to be worried about what’s going on in Italy at the momento.

Knowledge@Wharton: What would happen if Italy were to exit the eurozone?

Allen: Greece and Portugal are very small countries, and their GDPs are a small proportion of the eurozone total, but Italy obviously is a big country with lots of debt. If it were to do something like leave the eurozone, then it would be a major event. This is potentially much more serious than what happened with Greece over the last few years. Again, this is the reason so many people in the financial sector are worried about what’s happening in Italy at the moment.

Knowledge@Wharton: Let’s go back to possible solutions for the financial problem that we talked about. Right now, the ECB is holding to its position, and the Italian government is asking the ECB to give some sort of guarantee and not enforce this bail-in rule. Is there a compromise there? Or if some financial crisis did break out, is there something they could do to contain it quickly? [The Financial Times reported on July 21 that Mario Draghi “now favors a public bailout of Italy’s troubled banks ‘in exceptional circumstances….’” But so far Renzi and EU officials have not been able to hammer out a “deal on state help for the country’s lenders — notably for Monte dei Paschi di Siena.”]

Allen: I think what’s quite likely to happen, which is being discussed, is that there will be a bail-in. And that will be followed by the small people and maybe the institutional investors being compensated for the losses because they were missold. That’s the justification for the small investors.

For the larger investors, I think it will cause problems because they’ll essentially withdraw from many of the markets for subordinated debt and other kinds of debt to banks, and the intent to bail then will also be problematic. So, I think they will try and do something like that, and we’ll see how it all plays out. But it has got the potential to become big quite quickly. If that does happen, what’s likely is that the Italian government may well just simply ignore what the EU says and bail out the banks that need it.

Knowledge@Wharton: So the government would just issue more debt over some period and use that money to bail the banks out?

Allen: Yes, exactly. Either that, or have some kind of taxes or in one way or another raise the money that they need to bail out the banks and make sure there isn’t a systemic event.

Knowledge@Wharton: Then the markets would immediately start worrying about Portugal and Spain?

Allen: They would, but it’s really Italy that is the big problem. The other big problem in the background there potentially is France, because the terrorist attacks have increased the popularity of [ultra conservative party leader] Marine Le Pen. If there were one or two more large terror attacks before the elections next year, they also have as a policy to pull out of the eurozone and also to have Frexit [French Exit] to pull France out of the EU. So that’s also in the background there. Although, there I think the risks are much more of the terrorist type rather than the economic type that they are in Italy.

Knowledge@Wharton: What do you think the odds are that the situation in Italy could spin into a very major financial crisis?

Allen: My own assessment would be something like 15% to 20%. It’s still low, but it’s significant.

Knowledge@Wharton: What else is it important to understand about this whole issue?

Allen: We touched on it briefly, but it’s this basic thing that Italy has 135% or so of GDP as government debt, and that’s problematic. At the moment, interest rates have gone down, they’re at all-time low levels. The Italian government has a spread above the German bund rate, for example, but there’s always this chance that interest rates will jump up because people start pulling their money out in anticipation that there’s going to be a problema.

That’s always the underlying issue — that people will start running both on the banks and the government. That’s this doom loop, which is so worrying, particularly for Italy, where the banks hold a lot of Italian government debt.

Knowledge@Wharton: The International Monetary Fund recently reported that in Italy productivity remains weak, debt is still climbing and it’s very difficult for the economy to grow when the banks are in such trouble because they are not in a position to lend money to companies. The IMF also said that the economy would not get back to its pre-crisis level until 2025. Could you comment on that?

Allen: I think Italy has a major growth problem. They are essentially, in terms of their GDP, where they were 20 years ago. Their growth rate is very low, and it doesn’t look like they are going to get back to before the crisis anytime soon. This is very problematic for the population in Italy, but also for the political system. They also have a very high youth unemployment and so on, and these are problems that tend to fester and cause feedback problems that are also difficult. I think that if everything goes fine and Italy survives the next few years without some kind of financial crisis, it still has a lot of long-run problems, which always has the potential to bring back this financial crisis kind of situation that we’ve been discussing.

K@W: Another doom loop, it sounds like. What advice would you give them? Back when the EU was in real crisis several years ago, there was talk of some countries, including Italy, dropping out of the eurozone for a short time so they could take advantage of devaluation, and then coming back in. Could that work or are we past a time when that would be useful?

Allen: Italy is so big in terms of the amount of debt that it has. It’s a couple of trillion Euros.

That those kinds of solutions are on the cards again, because they are too big for the Germans or the Dutch or the strong countries to pay off the problem, that’s the real issue. In many ways, this is much more serious than what we saw before a couple of years ago, if it comes and turns into a full-blown crisis.

Bank of England’s Juggling Act Gets Ever Riskier

The length of time monetary policy is spending at emergency settings raises concern

By Richard Barley

No disappointment. Unlike other central banks, the Bank of England on Thursday overwhelmed markets by pulling every stimulus lever available to counteract the shock of Brexit—and making clear they could yet be pulled harder. This effort, while prudent for now, is further exposing the risks of aggressive monetary policy.

Gov. Mark Carney and his colleagues certainly weren’t timid. The BOE cut rates by a quarter percentage point to a record low 0.25%, with a further cut possible, although Mr. Carney made clear that negative rates weren’t on the cards. It launched a new program to provide up to £100 billion ($133.25 billion) of cheap funding to banks to support lending and reduce concerns about squeezed margins. And it announced plans to buy another £60 billion of gilts, taking its holdings to £435 billion, topped off with £10 billion of investment-grade corporate-bond purchases.

Markets had priced in easing, but not such a big-bang approach. Sterling fell more than two cents against the dollar, 10-year gilt yields hit a new record low, the FTSE 100 rose and sterling corporate bonds rallied.

There are two trade-offs the BOE is juggling here. The first is a traditional one for central banks: growth versus inflation. The answer here is easy—the BOE is right to focus on growth and overlook a possible rise in inflation. The bank lowered its forecast for growth by the largest amount ever, showing the economy crawling through the next 18 months. Despite the weakness, the bank does forecast a jump in inflation. But that is due to the steep fall in sterling, which will push up import prices.

The second is much trickier: the trade-off between growth and financial stability. Globally loose monetary policy has already raised many worries about distorted markets. Mr. Carney repeated the mantra that bond purchases would push investors to take more risk. But this process risks inflating bubbles as the search for yield has already pushed bond prices sky-high and led investors to embrace riskier assets such as emerging markets and high-yield bonds. In the process, it has made the outlook for future returns poorer.

The BOE’s bank funding measure is more evidence of the risks that central banks are adding to the financial system. Low rates squeeze bank margins and hurt profits, making banks look weaker. Investors have sold off bank shares in part because of that weakness. And there is some evidence that low stock prices can make banks less likely to lend. The BOE plan is designed to offset that risk by giving banks cheap funding if they maintain or increase lending.

Mr. Carney insisted that the positive effects of the stimulus outweighed the risks to financial stability, but the plan to aid banks makes it clear he’s aware of the risks.

That judgment may be right in the short term. But increasingly, it is not just that monetary policy is at emergency settings, but the length of time that it is continuing to spend there that is raising concerns.

Markets have had a sugar rush from the BOE’s policy action, but doubts about the long-term effects of policy makers’ actions just got a boost too.

America’s Exploding Déficit

Martin Feldstein

Newsart for America’s Exploding Deficit

CAMBRIDGE – Two recent pieces of budget news are a grim reminder of the perilous state of fiscal policy in the United States. President Barack Obama’s Office of Management and Budget announced that the federal government’s deficit this fiscal year will be about $600 billion, up by $162 billion from 2015, an increase of more than 35%. And the annual Long-Term Budget Outlook produced by the Congressional Budget Office (CBO) predicts that, with no change in fiscal policy, federal government debt will rise from 75% of GDP to 86% a decade from now, and then to a record 141% in 2046, near levels in Italy, Portugal, and Greece.

Although the US debt-to-GDP ratio doubled in the past decade, the Obama administration and Congress ignored the problem, focusing instead on the annual deficit’s decline since 2012 and the relative stability of the deficit as a share of GDP. That temporary progress reflected the economic recovery and congressional votes to limit spending on defense and nondefense discretionary programs.

But the longer-term rise in the annual deficits – owing to an aging population, changing medical technology, and rising interest rates – and the resulting increase in the debt-to-GDP ratio were inevitable (and were clearly predicted by the CBO and others). The larger number of older Americans who are eligible for Social Security benefits will drive the program’s costs from 4.9% of GDP this year to 6.3% of GDP over the next 30 years. Half of the rise in the cost of the major federal health-care programs, from 5.5% of GDP now to 8.9% in 2046, will result from the increased number of older beneficiaries, with the other half caused by the technologically-driven extra cost of treating them.

The Federal Reserve’s unconventional monetary policy has driven down the cost of the net interest on the federal debt to just 1.4% of GDP, despite the increase in the volume of the debt.

But as interest rates normalize and the volume of debt grows, the cost of servicing the interest on the national debt is projected to increase to 5.8% of GDP.

That projected interest cost may be much less than it would actually be if the rest of the deficit and debt forecast turns out to be correct. With a federal debt of 141% of GDP, that 5.8%-of-GDP interest cost implies an average nominal interest rate of just 4% and, given the CBO’s inflation forecast, a real interest rate of about 2% – similar to historic rates when the debt ratio was less than 40% of GDP. But investors in Treasury bonds might demand a much higher interest rate in exchange for loading up their portfolios with US debt. In that case, the interest cost and the debt would be much greater.

The fact that more than half of the publicly held US government debt is now owned by foreign investors might make the interest rate even more sensitive to the debt’s relative size. Foreign investors might fear that the government could adopt policies that reduced the real value of their holdings. While the US government would never explicitly default, it could adopt policies such as deducting income tax on interest payments, which would disadvantage foreign holders and depress the value of the bonds. Moreover, foreign investors might fear that very high debt levels could lead to inflationary monetary policy, which would depreciate the value of the dollar and lower the real value of their bonds.

Here is an amazing and disturbing implication of the CBO’s forecast. By 2046, the projected outlays for the “mandatory” entitlement programs (Social Security and the major health programs), plus interest on the debt, would absorb more than all of the revenue that the government would collect with current tax rates. A small deficit (1.6% of GDP) would emerge even before spending on defense and other annually appropriated “discretionary” programs.

There is no way to offset the growth of the mandatory programs by slowing the growth of defense and other discretionary outlays. Total defense spending is now just 3.2% of GDP and is expected to decline to 2.6% over the next ten years and to remain at that level for the next 20 years. That would be the lowest defense share of GDP since before World War II. The same reduction is projected for all non-defense discretionary programs, also a record-low share of GDP.

The bright spot in this bleak picture is that it would not take much in terms of annual deficit reductions to prevent the rise in the debt ratio, or even to bring it back to where it was a decade ago. Reducing the annual deficit by 1.7% of GDP by any combination of reduced spending and higher revenue would, if begun in 2017, prevent an increase from the current 75% debt-to-GDP ratio. And reducing the deficit by 3% a year would reverse the debt trajectory and bring it back to where it was in the decades before the recession.

Neither of the presidential candidates has indicated either a plan or an inclination to reverse the projected rise in the national debt. But it should be a top priority for whoever moves into the White House next year. Given the need to act quickly to avoid the worst-case scenario, there is no excuse for waiting.


Italian Banks: The Phantom Menace

by: And Value for All

- A recount of what happened and is happening to the Italian financial system.

- EU regulatory framework in place can regulate the banking crisis, yet Italy is trying to avoid compliance.

- Despite recent happenings, the system will hold, thus enterprising investors might consider bargain opportunities on the market.

Sometimes I forget that, even if I am a business graduate and an investor for quite some time now, my first love has been actually economics. When I do remember though, I still amuse myself spending time trying to understand broad economic issues and their impacts on people, businesses and countries. These days, I am reading with interest about the recent "Italian banking crisis". As I read more and more comments and some article referring to the issue here on SA during the last days, I gradually convinced myself that it might have been a good idea, as an investor, an Italian and a SA contributor, to share a couple of thoughts with the community about it. Here is a brief account of how it went so far and a few takeaways for investors.
Is this really a new crisis?
The failing status of Italian banks is nothing new. It has been an ongoing domestic problem for at least six years now: a never solved vicious issue that has recurrently appeared on the news in a big yet fragile economy that has never really recovered from the 2008-2009 crisis.
These days, because of the international scrutiny raised by some media outlets and IMF reports, the government's "decree to save banks" made its way back to headlines and everyone's mouth. The amazing fact is that, if you make a Google search (in Italian) on the issue, the first headline about a "decree to save banks" is dated December 2011. In fact, it was 2011 when the Italian government of PM Mario Monti passed a decree aimed at supporting troubled banks through state aids. The legislation, approved as a part of a broader financial maneuver for the next year, assigned the role of guarantor of subordinate bank bonds to the already debt-plagued Italian state. It also gave the possibility to intervene in covering banks debts with the issuing of new equity financed by the state.

In 2012, Monte dei Paschi di Siena (OTCPK:BMDPY) - from now referred as Montepaschi in the article - became the first large bank to effectively take advantage of the government decree. The bank was not new to state aids though, having recently benefited from similar measures already under the Berlusconi government. The ECB, guided by Governor Mario Draghi, reluctantly granted permission to the Italian government to give away an already approved help package of 4 billion euros.
At the end of 2013, UBS already estimated that the amount of non-performing loans (NPLs) of Italian banks topped 243 billion of euros, with one of the worst risk covering indexes in Europe.
Two months before, IMF had already warned that Italian banks were facing a potential loss of 125 billion euros on corporate loans alone, but the "financial sector was still solid". At the time, international scrutiny was all on Spain, so Italy somehow managed to get away with it.
The 2010 Basel III agreement, which included strict rules on NPL coverage ratios and bank's capital adequacy was also supposed to come into effect starting this year and be fully deployed by 2015, but subsequent changes deferred implementation until 2018 and then again to 2019. It was a strong call to action, but delays helped the new Italian PM Enrico Letta to keep avoiding structural reforms in financial sector and to concentrate in selling the fairy tale that economy was recovering to investors abroad and voters in Italy. Readers are left with the hard task to find growth and economic recovery looking at this Italy GDP graph.
Italy GDP 2006-2015 (current USD trillions)
  (Source: World Bank database)
In the meantime, Italian banks were becoming very efficient covering NPL and various inadequacies with false accounting practices. This was the first "Italian Job" that international media outlets could have cared about. In fact, by beginning of 2014, prosecutors were taking judicial actions for false accounting and other malpractices against Banca Etruria (March 2014) and Banca Marche (April 2014). Hearing about the competitors' disgrace, Italian mid-sized lender Banca Popolare di Vicenza started to plan the acquisition of Banca Etruria. A not-so-smart move by the management to put itself on the spotlight since it was later prosecuted for similar malpractices as well. Later the same year, government was starting to plan the salvage of troubled Banca Marche while Montepaschi and Banca Carige (OTC:BCIGY), another medium sized player, failed to pass the ECB stress tests evidencing more weaknesses in the system as a whole. Despite adequate domestic media coverage, many financially illiterate household savers kept subscribing subordinate bonds of the aforementioned lenders.
The situation was domestically downplayed, but it just kept getting worse, and by mid-2015, roughly one year later, four banks went bust. These were the already cited Banca Etruria and Banca Marche and other two small lenders, CaRiFe and CariChieti, which were also already under judiciary compulsory administration for irregularities emerged in 2013 and 2014.
However, the cases of Banca Marche and Banca Etruria ended up to be particularly problematic to handle because the forceful clean-up had to start after January 1st, 2015. What happened in the meantime? The new EU Bank Recovery and Resolution Directive (BRRD, or "bail-in" directive) came into effect.
To make a long story short, the directive forces shareholders and bondholders to step in and effectively "bail-in" banks in the event the institution becomes insolvent. Not only shareholders, but also bondholders of Banca Etruria and Banca Marche became among the first investors in Europe to experience the effects of the new European regulation. In theory, there's nothing bad if bondholders take the risks of their investments. The problem was that, in a country where households' main financial advisors are the bank clerks, Banca Etruria and Banca Marche employees were selling their banks' subordinate notes to small savers, including pensioners with no financial knowledge whatsoever, well over the portion that should be allowed in any diversified portfolio. Small savers "Mario the plumber and his friends" lost their lifetime savings, thanks to the BRRD in order to save the banking system. You can imagine the degree of social mess that followed.
The current situation
Despite the scars of Banca Etruria and Banca Marche bondholders, brave Mario the plumber and friends are still heavy buyers of other Italian banks' securities.
(Source: IMF publication)
In the meantime, non-performing loans have reached a record high 360 billion of euros, 18% of the total lending. Although the figures have been suddenly showcased with great emphasis and worry, Moody's was looking with cautious optimism at the same figures six months ago, well before the media spotlight. At the time, the rating agency was giving a hopeful outlook on the issue by informing investors that something was moving at the political level (article here).
We can therefore trust Bank of Italy governor's recent declaration that "they (non-performing loans) are not an emergency". Even if the NPL ratio is a problem for Italy, the issue has been known all along by the institutions and professional investors. Increased international scrutiny may turn to be the driving force to push forward a solution. However, reminders from EU officials to act within the BRRD framework obstruct the efforts of the heavily indebted country to find alternative solutions.
The main issue with Montepaschi and the lenders in real trouble which are however only a portion of the whole sector is actually of political nature. Italy's PM, Matteo Renzi, who has been even more active than his predecessors selling the tale of the recovering Italy to international investors and Italian voters, is saddened by the issue as he faces an important ballot in fall. He is domestically pressed to find alternatives and might somehow manage to sell the necessity of state aids to the Italian population as a new "financial stabilization measure," but he has hard time to sell it to the EU. The Union has already indicated that it would not tolerate further state aids, and EU officials know well that the BRRD mechanism could solve the Italian issue again if such necessity arises.
Still, Renzi is battling to avoid to comply with the bail-in directive following Banca Etruria's mess of last year. More money-stripped Mario the plumber and friends means more angry voters, and this could pose a serious threat to the Renzi's popularity and career, especially since Montepaschi is a regional bank of Tuscany, a vote powerhouse of the PM.

The last government-backed initiative has been the backing of a PE fund (the Atlante Fund) whose primary function is to recapitalize troubled banks and buy NPL. However, the small size of the fund (5 billion euros) has only allowed to focus on the recapitalization issues.
Government and banks are consulting on how to enlarge the size and scope of the fund. It is speculated that the main actor in this new phase would be Cassa Depositi e Prestiti, which is however nothing less than a state-owned bank (80.1% shares controlled by Italian government). Since this is just another badly covered direct public aid, it remains to be seen how the EU will react. IMF is more flexible on the issue of state intervention, but it is also pushing Italy for deeper reforms on the bankruptcies and judicial recovery.
Since current regulations make judicial recoveries a difficult practice, Italian NPLs have been trading at a discount compared to European peers on the specialized market, making them harder to be sold without large write-offs and contributing in penalizing Italy's position within the EU.
Because of the "phantom menace" of the BRRD directive, shareholders and subordinate bondholders of Italian troubled banks are now reasonably worried. Bank's equity and bonds issued exceed NPL by a large amount, so there is limited risk for the economy as a whole in the short term. Nevertheless, the fear of an upcoming bail-in is the main driver behind the stock's free-fall not only of Montepaschi and Carige, but also of UniCredit (OTCPK:UNCFF), Italy's biggest lender, and Intesa (OTCPK:ISNPY). Intesa has however a better coverage ratio and usually performs well on ECB stress tests, so the downside of the stock so far has been somehow limited compared to peers.
A few takeaways for investors
The Italian banking system is not on the verge of collapsing. Should all the worst hypothesis come true (all NPL being written off and bail-in eating household savings again), the system would not collapse. This is hardly a real scenario as at least some impaired loans will be in the end recovered, thus the system would remain solvent if NPLs rise even further than 18%. You can take a look at IMF data and judge by yourself: the bail-in-able capital is well above the NPL level.
(Source: IMF publication)
Corporate bankruptcies in the country peaked in 2012, suggesting the country is still in pain yet somehow better off now than few years ago, or at least more solvent. It is highly unlikely that NPLs will go far higher from the current levels. They have gone so far because bank malpractices were not changed, but this is hardly to continue much further. Taken all these points, it is undeniable that banking problems are an issue today, but Italy is getting more and more pushed by the international community to swiftly address its financial system problems.
In the current situation, substantial risks remain for shareholders and bondholders of the institutions cited in the article. Conservative investors seeking the highest level of safety might be therefore better off avoiding Italian banks at the moment, but more enterprising ones, while avoiding the most troubled issues, might bet on the stabilization of the sector. These investors can seek bargains in representative household names which have been strongly beaten down but maintain a good NPL coverage ratio such as the cited banks, Intesa Sanpaolo, and UBI Banca (OTC:BPPUF), another major player in a relatively better position than competitors.
As Mr. Market, in such situations, always penalizes the sector as a whole, possible bargains are likely to be found also in quality issues such as Banca Mediolanum (OTCPK:MDLAY). The Bank (I would say, this bank which is associated with former PM Berlusconi) has relatively low exposure to the problem and has been suggested as a new possible shareholder in the Atlante Fund. Another institution in good financial shape is Banca IFIS [BIT:IF], which has been actively trading NPL of other banks and has been quite profitable in the activity, thanks to its competent management. Similar considerations apply also to Fineco Bank (OTC:FCBBF).

Banks traditionally related with insurance businesses such as Unipol (BIT:UNI) and Banca Generali (BIT:BGN) are also definitely interesting choices which have experienced huge sell-offs during the last year because of sector fears. They may definitely trade at compelling valuations for investors seeking some safety and an interestingly high dividend yield. In particular, Unipol, after reinstating dividend payments in 2012 (suspended during the worst crisis years 2009-2011), has been raising them each year since, and the yield is currently 7.4%.
As Baron Rothschild's quote goes, "buy when there's blood in the streets". For Italian banks, that time could be now.

2016 External Sector Report
Summary:After narrowing in the aftermath of the global financial crisis and remaining broadly unchanged in recent years, global imbalances increased moderately in 2015, amid a reconfiguration of current accounts and exchange rates. Shifts in 2015 were driven primarily by the uneven strength of the recovery in advanced economies, the redistributive effects of the sharp fall in commodity prices, and tighter external financing conditions for emerging markets (EMs).

A relatively stronger U.S. outlook led to a further appreciation of the USD and a depreciation of the yen and the euro. The sharp decline in commodity prices, reflecting both supply shocks and concerns about rebalancing and growth in China, brought about a significant redistribution of income from commodity exporters to importers, and a weakening of commodity exporters’ currencies. Meanwhile, heightened global risk aversion, contributed to softer capital inflows and depreciation pressures in many EMs.

This moderate widening of current account imbalances was largely driven by systemic economies. Surpluses in Japan, the euro area and China grew, supported by improved terms of trade and currency depreciation, while the current account deficit in the U.S. widened amid the steep appreciation of the USD. These widening imbalances were only partially offset by narrowing surpluses in large oil exporters and smaller deficits in vulnerable EMs and some euro area debtor countries.

Similarly, excess imbalances expanded in 2015. External positions in the U.S. and Japan moved from being broadly in line with fundamentals to being “moderately weaker” and “moderately stronger”, respectively. This was partly offset by a further narrowing of excess deficits in vulnerable EMs and euro area debtor countries. Meanwhile, excess surpluses persisted among the larger surplus countries, some of which remain “substantially stronger” than fundamentals (Germany, Korea).

Currency movements since end-2015 helped to partially reverse the trends observed last year, although market volatility following the result of the U.K. referendum to leave the European Union have led to a strengthening of the USD and yen along with a weakening of the sterling, euro, and EM currencies. The implications for external assessments going forward, especially for the U.K. and the euro area, remains uncertain and will likely depend on how the transition is managed and on what new arrangements are adopted.

With output below potential in most countries, and limited policy space in many, balancing internal and external objectives will require careful policy calibration. In general, a more balanced policy mix that avoids excessive reliance on policies with significant demanddiverting effects is necessary, with greater emphasis on demand-supportive measures and structural reforms. Surplus countries with fiscal space have a greater role to play in supporting global demand while reducing external imbalances. Global collective policy action, especially if downside risks materialize, would also help address global demand weakness while mitigating its effects on external imbalances.


Worlds Made by Hand

By: The Burning Platform 

Harrowing a Field

Having recently finished reading The Harrows of Spring, the fourth and final novel of Jim Kunstler's World Made By Hand series, I couldn't help but compare and contrast his dystopian post economic collapse America versus our current warped egocentric pre-economic collapse America. His world made by hand is forced upon Americans who have survived some sort of conflict resulting in the destruction of Washington D.C. and Los Angeles by nuclear blasts.

The Federal government has ceased to exist. The nation has splintered and varied factions are vying for power in autonomous regions of the country, but the small community of Union Grove, New York has been left to fend for itself. The four novels detail the trials and tribulations of average Americans in a small rural town after the implosion of modernity, as the world is stripped of its technological oil based comforts, devastated by terrorism, racked by epidemics, and having endured the ravages of economic collapse.

Kunstler's dystopian future isn't as bleak as the dystopian visions of Brave New World. If dystopian means a world characterized by dehumanization, totalitarian governments, environmental disaster, or a cataclysmic decline in society, then Kunstler's World Made By Hand series doesn't match that characterization. There is more humanity and hope in his novels than you would expect in a dystopian vision of the future. The novels focus on various types of societal segments who represent the different courses society could chart after a breakdown of modern social norms, enforced by central authorities. Living through a national catastrophe and stripped of the modern conveniences provided by cheap plentiful oil, the citizens of Union Grove see their community falling apart from neglect, natural decay, disease, and lack of hope for the future.

The setting for the story appears to be only a couple decades in the future and is entirely believable when you step back and observe our current unsustainable economic path, increasing threats from Islamic radicals, warmongering politicians beating the drums of war with Russia and China, disintegrating social fabric, increasingly fragile electrical grid, and our brittle just in time supply chain, dependent upon cheap and ample supplies of oil. The faultless community of Union Grove struggles to regain some semblance of normalcy after events beyond their control force them to confront a new reality. The way of life they had taken for granted, with its modern conveniences, technological wonders, and taken for granted luxuries, had suddenly faded away.

Wallowing in their depression and sorrow would only lead to further needless death and suffering. It needed to be replaced with a new found respect for each other and a pragmatic approach to creating a new future based upon the reality of their situation. Gone was electricity, oil based transportation modes (automobiles, trucks, airliners ships), mass produced anti-biotics, frankenfoods sold at warehouse stores, policemen and soldiers to "protect" them from bad guys, and politicians bribing you with debt financed entitlements for your vote. That paradigm was always unsustainable, but Americans preferred the illusion of sustainability to facing the reality.

For people unable to adapt mentally and/or physically to these new challenging circumstances, it was a frightening, undesirable dystopian existence. In reality, society had essentially reset itself back to 1850, before the discovery of oil in Titusville, Pennsylvania by Edwin Drake. The people of Unionville, New York were forced into a pre-industrial revolution existence without warning. But they were the lucky ones. Most of the people in urban and suburban America perished, as their existence was totally dependent upon technology, oil based transportation, and food supply from foreign countries.

In the foreseeable future, Kunstler's less than apocalyptic vision is entirely probable, with rural communities much more likely to survive a catastrophic collapse of our high tech, oil dependent, head in the sand society of delusional willfully ignorant consumers. Kunstler focuses his stories on the characters inhabiting Unionville, but he provides glimpses into the regional breakup of the country, with the United States becoming a fragmented shell of itself, with little or no central authority. With Washington D.C. and Los Angeles uninhabitable, various other cities served as the capital after the collapse. The south broke apart into three new countries - The Republic of Texas, Firefox Republic, and New Africa - which went to war with each other and the remnants of the original U.S. With the current state of party politics and racial divide, this type of regional break-up is not farfetched.

When you put Kunstler's History of the Future scenario in context with the current insane path we are racing along, it is entirely believable and preferable to even more cataclysmic outcomes. With $13 trillion of worldwide government debt with negative interest rates, central bankers on a suicide mission of debasement, delusional Americans using debt to live far above their means as their standard of living declines, politicians continuing to obligate their bankrupt countries to even more social welfare liabilities, saber rattling by leaders at the behest of the military industrial complex against Russia & China, the Middle East ready to explode in a cataclysm of Islamic mayhem, nuclear weapons in the hands of unstable governments, radical Islamic terrorism spreading across Europe and America, and a U.S. populace more divided by race, religion, social beliefs, wealth, geography, and political parties than ever before, some version of Kunstler's apocalyptic vision is inevitable.

I read the final novel in the series The Harrows of Spring while vacationing at the Jersey shore in Wildwood. I was struck by the contrast in Kunstler's future world made by hand and the world made by hand currently on display in this decaying, delusional, empire of debt. Kunstler's world made by hand is forced upon survivors as the country and world encounter a systematic failure with no possibility for a reboot. All the creature comforts they had been accustomed to, like central air, electric lights, cable television, refrigerators, big box retail stores, smart phones, SUVs, superhighways, jetliners, junk food, high rise office towers, McMansions in suburbia, 401ks, and central bankers printing fiat paper like candy, evaporated like a puddle of water on a hot summer day.

They were left in a post-modern world where their survival depended upon their own two hands.

They had to grow their own food or utilize a particular skill (medical, carpentry, hunter, laborer) to acquire food. They needed to scavenge, hunt, fish, sew, raise livestock, trade, barter, and make due with less, in their new world made by hand. Life was somewhat brutish and hard, compared to what most had been accustomed. The slightest illness or infection could lead to death. Lack of modern sanitation led to outbreaks of disease and death. For those who refused or couldn't mentally adapt to a new reality, depression, anger, and bitterness filled their lives and slowly destroyed them.

Those who acclimated themselves to their new existence and accepted the hardships with the frontier spirit that originally built the country were able to survive and sometimes thrive in the Unionville, New York of the future. They became a community again, not trapped in that modern iGadget world, living like hermits in their hermetically sealed 100% financed McMansions, shuttling to and from paper pushing jobs in their leased BMWs to 50 story office catacombs in filthy decaying urban concrete jungles. The rat race had ceased. Kindling the stove for heat, preparing meals, tending to livestock and gardens, fixing what had broken, and looking out for your neighbor became their daily routine.

As you would expect, leaders naturally arose, but in a small community the power and control was disbursed. Some of the leaders were religious, others led by the example of their humanity and intelligence, and others by their willingness to fight and defend the community. Men started businesses, people began to trade among themselves and with other communities, new buildings were constructed, using hydro-power to generate electricity was reintroduced, and the community spirit was boosted by shows, music, and social gatherings. Bad men are always present in every society, but the community rallied to fight them off. Violent death was an ever present danger in the world made by hand. Amazingly, the world survived without bankers and computer generated electronic currencies, derivatives of mass destruction, or paper fiat. Citizens and merchants conducted their business using silver, gold or barter.

The world made by hand I observed in Wildwood, NJ was as far from Kunstler's world made by hand as humanly possible. Rather than using their hands to produce, create, fix, hunt, plant, or fish, their hands are busy tapping on their iGadgets - tweeting, facebooking, instagramming, texting, taking selfies, and videoing their experiences rather than experiencing them. The people ambling on the Wildwood boardwalk and shuffling across the land are addicted to these technological chains enslaving themselves in triviality, irrelevance, and egotism. The gadgets are attached to the hands of millennials and middle aged alike.

They were gazing at their gadgets as they rode bikes, jogged, or gorged their pieholes with fried oreos and funnel cake. Rather than relaxing and enjoying watching the tranquil sunrise over the Atlantic ocean as seagulls darted about over the deserted beach, the majority have their heads buried in their smart phones retweeting the latest Kanye and Kim scandal. No one reads a book on the beach anymore, as they are consumed by the trivial culture available on their iGadgets. Rather than experience the beauty of a fireworks display, they must record it and send it to all their friends to prove they are having fun. The American public has an almost unlimited craving for diversions. Reality and the truth are drowned in an ocean of irrelevance.

The other frightening aspect of our current warped world made by hand is the madness of the masses in having their bodies deformed and covered in hideous tattoos. And if there was ever a place to witness this mass insanity in all its putrid glory, it's Wildwood NJ. The Wildwood boardwalk has a tattoo parlor on virtually every block and they are generally packed with herds of non-thinking masses making insane decisions, guaranteeing they will never get a decent paying job in their lifetime. How can the low income masses afford this high priced ink? How do they afford those expensive iGadgets? What a stupid question. Debt of course. Thank you Federal Reserve.

As I observed young men, middle aged women, teenage girls, fathers, mothers, and grandparents sporting repulsive ink on their arms, necks, legs, backs, chests, and faces, I was reminded of a quote by Charles McKay from his book  Extraordinary Popular Delusions and the Madness of Crowds written in 1841.
"Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one."
With the proliferation of mass media propaganda in the last few decades, along with the dumbing down of the populace through public school indoctrination, vast swaths of the population are unable to critically think, reason, or understand the long term consequences of their actions and the actions of their political and financial leaders. The madness of crowds is being borne out by millions of Americans copying each other and imprinting pictures and words upon their skin to be special. This herd like behavior has been seen in financial markets, the fashion industry, and elsewhere in popular culture. These pathetic attempts to be unique are nothing but a cry for attention in a world where they are nothing but a cog in the machinery.

As their standard of living has steadily fallen over the last three decades and their lack of education has left them wallowing in near poverty, they are desperately grasping at straws to be noticed in this egotistical world made by hand. When the inevitable economic reset occurs, these shallow displays of narcissism will cease. Americans have gone mad in herds, but when they recover their senses their permanent idiot stamps will still be there - forever. Debt financed tattoo removal will not be available. The psychosis is so intense today that Wildwood holds conventions to draw the herds of cattle to voluntarily receive their branding.

Tattoo Convention

There were two particular passages in The Harrows of Spring which captured the zeitgeist of our period of history and how denial of reality ultimately leads to collapse. The first passage describes the thoughts of a young character as she travels past the shattered remnants of modernity.
"She rambled past the intersection where the car dealers had battled for supremacy of annual sales, their vacant parking lots now miniature forests of poplar and sumac, the showrooms empty shells. The sight of these ruins and the monumental waste they represented made her momentarily angry. She knew that the people running things in the old times understood that their way of life was a dead end, and she could even imagine that they were so locked into their systems and habits that they were more or less trapped. What she couldn't grasp was their utter failure even to imagine another plan. So they took it as far as it would go and then just let it all crash. She remembered riding in cars, but they were all gone by the time she was seven years old, and then incrementally so were all the other things that had made life so comfortable. Yet she didn't especially miss it. She was used to the new ways and the new times, and ordinarily she didn't suffer from how it was now."
The description of vacant crumbling car dealer lots overgrown with weeds and trees is already a reality in the pre-collapse America of today. Driving along the pothole strewn roads of suburban Philadelphia, the landscape is dotted with dilapidated car dealerships, decrepit vacant gas stations, decaying deserted strip malls, empty moldy office complexes, boarded up industrial buildings, ramshackle residential properties, and a proliferation of Space Available signs. The urban ghettos of West and North Philadelphia resemble Dresden after the fire bombing. The road to ruin is pretty far along at this point.

The people running the show today know the country is on a burning platform of unsustainable fiscal, monetary, social welfare, and military practices which imperil the future of the nation. Wall Street/K Street oligarchs have financialized every aspect of our society, gutted the productive industries, indebted our grandchildren to the tune of $200 trillion, and outsourced the jobs needed to sustain our nation to foreign countries. The frantic efforts of the Federal Reserve, their minions in NYC & DC, and the propaganda press, to prop up this hollowed out carcass of a country are failing. The debt is too vast; corruption too entrenched; vital systems too damaged; populace too apathetic and distracted by bread and circuses; and leaders too feckless and corrupt to do what it would take to save the country.

Leaders willing to level with the American people and tell them the truth about the real state of our dire fiscal circumstances are virtually non-existent. Telling the truth is considered painting an unnecessarily dark picture of our situation. Everything is great according to the establishment, because it is great for them. Spineless weak minded politicians prefer platitudes, promises, and puerile happy talk, rather than the blunt truth when buying the votes of their constituents. The American people prefer willful ignorance, safety and security to liberty, freedom and personal responsibility, so they continue to elect feeble minded toadies as their representatives. Therefore, the country has gotten what we deserve - good and hard. The second passage captures the halting collapse as we squandered our dwindling financial resources fighting useless wars in distant lands.
"But the war in the Holy Land was far far away, and the situation was quite different. The nation was cracking under the weight of bloated modernity and all the patches pasted on to its excessive and malfunctioning hyper-complexity, and people were bewildered by the strange glitches, failures, and shortages. Going forward, nothing would really work anymore as it was designed to, yet the hope and expectation that it would all magically recover dominated the chatter in the rare moments when people could step back from their frantic lives and share a meal or drink."
We have wasted $2 trillion on wars of choice in the Middle East over the last fourteen years, while creating a police surveillance state of massive proportions at home. While recklessly pissing away our diminishing national wealth trying to police the world, and only stirring up Islamic fanatics, we are witnessing the slow disintegration of our hyper-complex systems of production, supply, energy, and finance. The ruling class pretends all is well and use their media mouthpieces to portray a narrative that is unequivocally untrue. We are consuming ourselves to death.

The non-thinking tattooed masses are unaware and apathetic, as their inability to think critically has left them trapped in the "all is well" paradigm peddled by their government keepers and their corporate fascist benefactors. But a growing minority of critical thinking individuals recognizes the desperate attempts of the elite establishment to cover-up the systematic breakdown of our degraded systems of commerce and finance. The alternative media proliferating on the internet is providing rational, fact based analysis of our true situation. That is why the establishment wants to lock down and control the internet.

The increasing level of power failures, electric grid blackouts, water shortages, drinking water contamination, droughts, oil price spikes and crashes, crumbling bridges, disintegrating highways, bursting water mains, train derailments, refinery explosions, aging nuclear plants and lack of capital investment by businesses and governments ensures an inevitable breakdown of our infrastructure.

This structural decay is far outweighed by the frantic efforts by the Federal Reserve puppets and their Wall Street puppeteers to use their supercomputers and electronically created currencies to prop up this debt laden, insolvent Ponzi financial system.

The non-stop bubbles and subsequent crashes over the last sixteen years are a flashing red signal of vulnerability. The fragility of this house of cards built on a foundation of bad debt is extreme. At this point, any grain of sand added to the pile of debt could trigger the catastrophic collapse. And the "experts" will declare no one could have seen it coming, as their establishment employers strip mined the national wealth of the people until the very end. That the establishment disregards the warning signals is not surprising, as they live in an insular bubble reaping the riches of easy money and crony capitalism. The oligarchy is thriving in NYC, D.C. and Silicon Valley. They will take it as far as it will go until it all crashes in a heap of destruction, despair and death.

Kunstler's World Made By Hand is inevitable. It's just a matter of time. Today we only exist for the benefit of the state. Society does not have to be built for the benefit of an essentially criminal organization - the coercive state. There is nothing in human nature that makes it impossible to create communities of people that respect each other's natural rights and follow accepted moral standards for working out differences. Humans can collaborate, trade, exercise personal responsibility and create social order without the dictates of authoritarian government rulers. What binds communities together are not thousands of overbearing laws and a ruthless police state - it's basically peer pressure, moral suasion, and social censure. We interact with other humans every day, without some higher authority dictating how it should be done.

Despite the catastrophic conditions faced by the people of Unionville they never lost their integrity, humanity or sense of community. Hard work, kindness, generosity, intelligence, adaptability, courageousness and willingness to use whatever means necessary to survive are traits essential to living in the future world made by hand. Approaching every situation in a realistic, resolute mode and choosing to not deny the reality of your situation will be indispensable in a post collapse environment. There will be no time for the trivialities of tattoos and tweets in the world of the future. Survival of the fittest will replace checking in on Facebook from your favorite five star restaurant and posting pictures of your meal for all your friends and followers. I don't think we'll have an obesity epidemic in the world made by hand of the future.

Doug Casey on President Hillary Clinton… World War III… and the Deep State

Will Hillary Clinton win in November and ensure the Deep State stays in control?

I recently sat down with Casey Research founder Doug Casey to discuss this. Doug is a former classmate of Bill Clinton and has met him several times, including once at the White House.

Doug shared his insights on why a Clinton win could accelerate the onset of World War III.

We also touched on how Donald Trump will destroy the Republican Party… and why it’s a good thing.

I think you’ll find our discussion insightful.

Until next time,

Nick Giambruno

Nick Giambruno: There is a popular conception that only the “best and brightest” go into government. I think this is a sacred cow that needs to be slaughtered. What’s your take, Doug?

Doug Casey: It’s a real problem when a pernicious myth subverts reality. Everybody believes that the institution of government is like Camelot—a wise ruler assisted by noble paladins. Maybe that meme gained traction in recent times with John Kennedy and his good-looking wife, Jackie. They looked like an ideal couple. They weren’t. But they were a lot better than what followed for the next 50 years…

The fact is that the high levels of government do get people with high IQs. They can pass tests. They’re skilled at manipulating both laws and people. But they tend to be of low moral character, number one. Number two, despite their high IQs, they’re actually quite stupid. Let me explain these things.

From a moral point of view, there are two types of people in the world. People who believe in coercion when dealing with their fellow humans. And people who believe in dealing voluntarily with their fellow humans.

Government is force. The essence of government is coercion. So, people attracted to it are necessarily the wrong kind of people, coercion-oriented people. Government draws much more than its share of criminal personalities.

And they’re not the most intelligent people—completely contrary to common belief. It’s because one sign of intelligence is not just seeing the immediate and direct consequences of an action—any intelligent six-year-old can usually do that. It’s seeing the indirect and delayed consequences of actions. They’re very bad at that.

Almost everything government does, certainly relative to the economy, creates distortions and misallocations of capital. Their inflation of the currency discourages saving and creates the business cycle. Their taxes and regulations destroy capital. Their actions are almost purely destructive of society. This reminds me of one definition of stupidity—it’s an unwitting tendency to self-destruction. So, people in government are not “the best and the brightest.”

Everybody should purge these false memes about the state and its employees from their mind and look at reality as opposed to what they’ve been told is reality.

The problem is compounded by the fact that television and movies generally portray government officials as noble, thoughtful and virtuous. But this is a completely false impression. Almost an alternate reality. They’re generally not that way. Prosecuting attorneys, for instance, tend to be much more interested in collecting scalps for their self-advancement than they are in justice. Cops have been transformed from peace officers into law enforcement officers.

Frontline cops on the beat used to use common sense in keeping the peace; that was their job. But that’s becoming less and less the case; they’re now, instead, mostly charged with enforcing a myriad of arbitrary laws. More than in the past, the wrong kind of people are going into policing now. They’re guys who have an extra Y chromosome. Most are now ex-military, who have picked up a lot of bad habits in the government’s numerous foreign adventures.

Nick Giambruno: This kind of thinking—that government employees are naturally good, virtuous people—appears to have even infected Gary Johnson, the Libertarian Party candidate for president, who, unfortunately, is no Ron Paul. He recently called Hillary Clinton “a wonderful public servant.”

You were talking about how there are two types of people, those who favor voluntarism and those who favor coercion. For me, at least, Johnson has muddied the waters on where he is exactly.

Doug Casey: Regarding Johnson, I don’t know what his philosophical beliefs, if any, are. The only thing that I think I know about him is that he wants to see pot legalized on a national scale.

Well, bravo. I’m all for that, even though I’m not a toker. It’s a step in the right direction toward dismantling the insane War on Some Drugs. But does he have any other libertarian tendencies? He doesn’t seem to have a grasp of the basic principles… although he seems better than the average politician. But that’s not saying much.

I’m especially concerned about his running mate, William Weld, who’s an actual neocon. He’s an overt statist, an active promoter of warfare, welfare, taxes and regulations. He has no libertarian tendencies at all that I’m aware of.

I mean, he’s a pure Deep State guy.

It appears that the Libertarian Party has been captured by the Republicans, which is surprisingly clever on the Republicans’ part. Now they have two parties that are registered in all 50 states. It’s kind of a backup system to the regular Republican Party. They’ll need a backup, since the old GOP is a dead duck.

One thing you’ve got to say about the Democratic Party is that, while their ideas are destructive and evil, at least they’re more honest about them than the Republicans are about their own.

Democrats make no bones about being the party of socialism, and they naturally attract the envy driven, the class warriors, the politically correct, the cultural Marxists, the gender Nazis and the like. The Democratic Party is beyond redemption.

The Republicans attract a different group. Religious people. Cultural traditionalists. People who generally favor what they think is the free market. They tend to be much more nationalistic and pro-military than the Democrats.

But, unlike the Dems, the Reps have no real philosophical foundation.

The Democrats can be viewed as the evil party and the Republicans as the stupid party. But they’re really just two sides of the same coin, at least when it comes to their leadership—they’re all Deep State members. The Libertarians once had a claim to being the party of principle, back in the days when people like John Hospers, Harry Browne and Ron Paul were their candidates. But now, the Libertarians can be viewed, at best, as the smart wing of the stupid party. It’s a sad testimony to the nature of politics…

With a little bit of luck, Trump will end up destroying the Republican Party, which is held together by chewing gum and bailing wire. Its disparate elements have very little in common with each other. The neocons, the evangelical Christians, the social conservatives and people who think they support the free market are there only for lack of a better alternative. They really have nothing in common except a dislike of the Democratic Party.

Although I suspect Trump will win, I expect the Republican Party itself will blow up. The situation is not unlike that before the War Between the States. Very unstable.

Nick Giambruno: Speaking of all this, I have to ask you about the Clintons.

Bill Clinton was your former classmate in college. What was your impression?

Doug Casey: He’s one of the most charming people you could ever meet. When you talk to him, even if the room is full of people trying to get his attention, when he looks at you and talks to you, he makes you feel like you’re the only person in existence. He’s that good. He’s got a lot of interpersonal skills.

I met him when he was campaigning for president of the class at Georgetown.

I never ran with the same group he did, but he was knocking at everybody’s door and that’s how I first met him. And then I met him again at our 25th class reunion, which he held at the White House.

I was shocked that when I walked up to him—and there must have been 400 people at the reunion—and I don’t know how, or even if, he saw my name tag—but when I said, “Hey, Bill, how are you?” he responded with, “Hey, Doug, it’s good to see you.” He’s a superpro.

Despite Bill’s charm, the Clintons are essentially criminal personalities. I’m not just talking about the $100,000 bribe Hillary got for supposedly trading cattle in the old days; now, she wouldn’t even walk across the street for that little. From the earliest days, starting with the strange death of Vince Foster, and then the strange death of Ron Brown, there are a lot of strange deaths that have surrounded the Clintons. They may well have gotten away with murder, quite frankly.

I think there are about 75 separate reasons why there should have been a full-scale investigation by the FBI in the strange death of Vince Foster. I wish there were some agency that was not part of the government that could investigate crimes, which is part of the problem, of course. The FBI is really just an overrated, bloated, politically driven bureaucracy. I sincerely doubt, for instance, that they'll ever go after The Clinton Foundation, which is clearly nothing but a gigantic slush fund.

The other thing I noticed at the reunion—and several of us noticed this—is that Hillary was sitting there with five or six really good-looking, young female velociraptors arrayed around her. Some classmates and I looked at each other and remarked that it was unusual for her to have all these good-looking young chicks around her. And, of course, since then, there have been rumors that she’s an aggressive lesbian. I have no other facts to back that up except for this one instance.

I’ve got to say, I couldn’t care less about Bill’s or Hillary’s, or anybody else’s personal sexual habits. As far as I’m concerned, that’s nobody’s business but theirs, and it’s got nothing to do with anything. But it’s interesting, for what it’s worth.

Nick Giambruno: I agree. I think focusing on their personal lives is a distraction from their real malfeasance. So, let’s talk about that.

Probably the most objectionable thing I find about Hillary is her reckless promotion of war.

I think she advocated for just about every conflict the U.S. has gotten involved with in the past 30 years, most of which have been unmitigated disasters.

She’s an ardent supporter of arming the so-called moderate Syrian rebels and toppling Bashar Al-Assad.

She’s supported the regime change in Ukraine.

She backed the surge in Afghanistan, which, predictably, accomplished exactly nothing.

She was the deciding factor in pushing Bill to bomb Serbia in the 1990s.

She infamously voted for the 2003 Iraq invasion.

And, of course, she was one of the main pushers of the NATO intervention in Libya that toppled Muammar Gaddafi. After rebels gruesomely executed Gaddafi—they reportedly sodomized him with a bayonet—Hillary said on national TV, “We came, we saw, he died.” It’s sort of a sociopathic spin on “Veni, vidi, vici,” a famous saying from Julius Caesar, the Roman leader, which means “I came, I saw, I conquered.”

These are just some examples off the top of my head. She has apparently learned nothing—or the completely wrong lessons—from this trail of disasters. She’s an unrepentant warmonger. And I think the odds of WWIII breaking out will be much higher under a Hillary presidency.

One nugget from Hillary’s email scandal, known as the Blumenthal Memo, basically disclosed that the real reason NATO wanted to go after Gaddafi was not a desire to bring freedom, democracy and unicorns to the Libyan people, but because NATO feared that Gaddafi would use his vast gold reserves to back a currency that would displace a version of the French franc that is used in Central and Western Africa.

After NATO-backed rebels toppled Gaddafi, plans for the gold-backed currency, along with the gold itself, vanished like a double cheeseburger placed in front of Chris Christie.

Strangely, this damning piece of information from her emails barely gets a peep in the mass media narrative.

Doug Casey: You’re absolutely right, because the media itself is part of the Deep State. They all are educated in the same universities by professors with horrible values, and taught the same things. They go to the same clubs. They socialize with each other. They have the same basic psychological, political, economic and philosophical underpinnings. So, of course, they look at the world through the same lens. And avoid mention of things that might be inconvenient, or conflict with their worldview.

And as far as Gaddafi, sure, he was a criminal. Can you name a head of state, certainly in the third world, who’s not? He was not a nice guy, but, as these people go, he was better than most.

Assad in Syria is much the same. It’s hard not to be brutal when your job description is to hold together an artificial non-country with dozens of different religions, ethnic groups and fanatical political factions—all of them anxious to take over the government so they can steal and massacre rivals, including yourself. Mother Teresa would have started acting like a thug if you put her in charge of one of these places. Of course, these people are all demonized—unless they’re stooges of Washington. But even that is dangerous—as Saddam Hussein, once a BFF of the U.S.—discovered. Vladimir Putin is another example of somebody who’s been made into the devil incarnate.

Nick Giambruno: Well, Hillary has basically said Putin is the new Hitler.

Doug Casey: It’s an amazingly stupid statement, in addition to being inaccurate. I mean, it’s almost like these people want to start some version of World War III. And they may succeed.

It’s really very scary.

It could happen with China in the East or the South China Seas. It could happen accidentally with Syria. It could happen with the breakaway provinces in Ukraine. There are a lot of trip wires. I’m pleased to be spending a lot of time in Cafayate, among the horses and grapevines of Argentina, where I can watch this stuff on my widescreen, at least somewhat insulated from what might happen…

Editor’s note: Highly decorated General Dwight D. Eisenhower first warned the American public about the Deep State. He did it during the farewell address for his second term as President in January of 1961.

Ike’s farewell address also served as a warning to JFK, who would succeed him as President. And JFK tried to take the Deep State head on…

A short while later, JFK was assassinated. We don’t know exactly who did it or why, but we do know that he was the last President to challenge the Deep State directly.

Recently, Doug’s longtime friend and colleague Bill Bonner issued an alarming video on this topic, including some footage from Eisenhower’s farewell address. You can watch this new video right here:

Now airing: JFK’s predecessor’s FINAL WARNING