The grim news from Spain's banks Friday along with Moody's warnings of mass downgrades for all the eurozone countries overshadowed the report from Germany's statistical office that the country's exports declined in April. If Europe's powerhouse is slowing, along with the Chinese, U.S., Indian and Brazilian economies, there is little prospect of any recovery in global demand.
The future is best described in the memorable words of former U.S. Defense Secretary Donald Rumsfeld, being full of known unknowns and unknown unknowns.
The first of the known unknowns is whether the $125 billion now offered from Europe's rescue funds will succeed in recapitalizing Spain's banks. It probably would, if one believes the banks' balance sheets, which have yet fully to write down the value of their property loans. So far, they have written down about 20 percent, but with a million empty or unfinished buildings depressing the property market the true write-down could be as much as 50 percent. That is why J.P. Morgan reckons the Spanish banks need more than three times the $125 billion now on offer.
The second of the known unknowns includes figures to be released in Beijing this week on just how badly the Chinese economy is slowing. The surprise announcement Thursday of a cut in lending rates suggests that Beijing, which knows the data for May already, is worried enough to ignore any threat of inflation and is hoping to spur the economy back to growth. The figure to watch will be consumer spending, since the shift from investment-led to consumer-led growth is the key to the government's strategy. The fear will be that the return of easy money will simply refuel the property bubble.
The third and most panic-making known unknown is whether next Sunday's Greek election triggers a Greek departure from the euro. The odds are close to even whether New Democracy wins the most votes and agrees to implement Europe's harsh austerity terms, or whether the upstart Syriza party comes out on top and tries (and fails) to renegotiate the European terms. That would mean no more money for Greece and a probable default, triggering who knows what forms of contagion.
The fourth and in reality by far the most serious of the known unknowns is whether the U.S. government can get through this year without triggering the dramatic spending cuts that Congress voted in an attempt to get itself to see sense. If the United States drops off the fiscal cliff in December, the rest of the world goes with it.
The unknown unknowns are a lot harder to envisage, let alone to define, because they are less economic questions that political ones, so rational thinking may not be much of a guide.
The first turns on the question whether the eurozone can muster the political will to take the bold financial measures required to hold itself together. If it cannot, would that mean the demise of the European Union? This is really a question about Germany, and whether Chancellor Angela Merkel can persuade the Bundestag and the country's constitutional court to approve the guarantees that would be needed.
The Germans themselves are divided. A survey in Germany's Focus magazine indicated 45 percent of Germans polled agreeing with Merkel that a failure of the euro would collapse the European Union. But 43 percent said that Europe would survive quite well without the euro.
The second unknown unknown is the nature of contagion and the way that panic spreads. Spain is already suffering a slow-motion bank run. Nobody really knows whether the global financial markets would freeze up once Greece leaves the euro and if Spain is next in the firing line does the contagion spread to Italy and France?
The third unknown unknown is whether the United States system of governance can reach any kind of compromise on the debt and spending crisis? The bipartisan Simpson-Bowles report offered a reasonable plan but U.S. President Barack Obama lacked the political courage to give it the kind of whole-hearted backing it would need.
What we do know is that there are three triggers that could set off a collapse of the euro, and the world-wide 1931-style Depression that could follow. The first would be a Lehman-style bankruptcy of one or more of Europe's top 20 banks. The second would be a forced default on bond payments by a major economy; Spain being most likely, followed by Italy. The third would be a political crisis, a riot that gets out of hand, burns a central bank and topples a government. There is no sign of this as yet but Greece has flirted with such a disaster, which brings us back to the known unknowns with which this column began.