I think it’s safe to say the new crisis just killed the Schengen Treaty. That ridiculous document which guaranteed freedom of movement across the European Union finally hit something it couldn’t bully, COVID-19.

Regardless of whether you believe the pandemic is real or not, the reaction to it is real and is having real consequence far beyond the latest print of the Dow Jones Industrial Average.

The lockdown of Italy isn’t a temporary thing. Oh, the suspension of free movement is temporary, but it portends something far bigger.

It’s the beginning of the real political balkanization that’s coming to the European Union over the next few years. Old enmities and prejudices have not been stamped out under the boot heel of oppressive legislation coming from a bunch of disconnected technocrats in Brussels.

They have only been suppressed.

Because when there are existential threats there’s no time or desire to virtue signal about how we’re all one big happy dysfunctional family.

For decades Germany refused to lighten up on its fiscal inflexibility believing, rightly, that it shouldn’t subsidize profligacy in places like Italy, Spain and Greece if it didn’t want to.

At the same time, however, Germany transmitted those rules to the single currency regime of the euro. That was the price they forced on the rest of Europe.

This ensured that eventually they would have to do exactly that, subsidize or bailout debts, as the mispricing of labor and capital efficiency inherent in the any single currency applied over multiple economies drove capital to Germany and out from those countries.

Now Germans face the existential threat of COVID-19 imported into Europe mostly through Wuhan textiles workers in Milan’s leather shops/ Their leaders will force them to accept looser spending rules.

And do you think this will engender an outpouring of love and affection towards Italians?

If you do you might be delusional or an open-borders libertarian… but I repeat myself.

Chancellor Angela Merkel has signaled for months she would spend more to satisfy the rising Greens on Germany’s political left.

Her finance minister, Olaf Scholz, unleashed the full force of Germany’s sovereign wealth fund to offer unlimited support to German businesses facing troubles because of this virus.

This is as good a cover story for the gargantuan holes in the balance sheets of zombie German banks as they were likely ever going to get folks.

ECB President Christine Lagarde was brought in to ram through the political changes needed to loosen Germany’s tie. She knew the only way the EU would survive the growing crisis within its non-functional sovereign debt market was to print money to the high heavens.

Or allow the union to break up. But, there is no Door #2 in Europe. All doors lead to Brussels.

Germany stood in the way of that while at the same time Merkel ruthlessly enforced Schengen. She weakened the political center in Germany and inflamed memories of a Germany which rampaged across Europe militarily in the 20th century through enforced austerity hollowing out less-efficient euro-zone economies.

So in the midst of this mess comes COVID-19 and the uncoordinated and inept response to it from the political center of Europe to date. Only now are they coming to the conclusion they need to restrict travel, after sitting on their hands for a few weeks while Italians died by the hundreds.

And do you think that’s engendering waves of love and affection among Italians towards Germans?

If you do then you don’t know Italians… at all.

And this is your signal that this is the beginning of the real crisis. Because while COVID-19 may have been the catalyst for the breakdown of capital markets, capital markets were simply waiting for that spark to occur.

Any other type of spark, a bank failure from a run of bad loans, could have been handled and absorbed. There was no Credit Anstalt the central planners weren’t prepared for.

They’ve been able to keep Deutsche Bank operational for the past few years, for pity’s sake, they could have handled any other single bank failure.

But with COVID-19 being the ultimate form of exogenous shock to the global economy there is no containing the financial contagion. And that’s why we saw a strong unwind of U.S. equities and a sharp rise in both the Japanese yen and the euro when this thing began.

Part of what had been pushing U.S. equities higher was the capital flow from Europe and Japan into the U.S. That reversed for short time as the eurodollar markets seized up and the demand for cash locally rose sharply.

It’s no different than what is happening here.

I went to my bank yesterday to grab some cash and finish our self-quarantine prep (we’d bought extra toilet paper weeks ago). The teller told me she’d moved out a lot more cash than normal and it wasn’t even the end of lunch hour.

Then I told her the bank run on corporate credit began earlier in the week as companies like Boeing maxed their credit revolvers to front run the bank pulling it.

That got her attention.

The same thing on a larger scale was happening in Europe until Lagarde told the world that she wasn’t done blackmailing Germany to loosening its stance on fiscal rules at her presser on Thursday.

And the rally in the euro, which was already sick, died.

Republished by permission of Gold, Goats ‘n Guns. Subscribe!

Picture by European People’s PartyEPP Summit, Brussels, May 2019, CC BY 2.0, Link.

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