By Marc Chandler, Global Head of Currency Strategy, Brown Brothers Harriman
With increased talk of a country leaving the euro zone, or even of the end of the whole project, it is worth sketching out our view. Here are the main points of our view of Europe.
1. EMU itself is a culmination of two trends: 1) the integration of western Europe since the 1950s and 2) efforts to keep Germany wedded to the fortunes of Europe. The elite, and it is an elite project, knows no alternative strategy.
2. Because there is no Plan B, there is no mechanism to formally eject Greece or any other member. Polls indicate a majority of Greeks want to stay in EMU.
>3. If Greece were to leave, they would likely be significantly worse off. About three quarters of its debt now is in the hands of the IMF, ECB and EFSF. This debt is denominated in euros. While they could default to the official sector, it would be unprecedented. If they do, it is not clear what kind of international assistance they could count on. Its economic downturn would be more severe and price pressures would soar. Unemployment would rise further from the 21.7% in February (twice the euro area average). Pensions which were largely halved during the PSI would get decimated again. If introduced, a new drachma might not be accepted by shopkeepers and people and could produce a still euro-ized economy. Greece does not have the industrial capacity to boost exports even if the drachma were accepted. Tourism is 20% of GDP. The social unrest and chaos would likely deter tourists who are not simply attracted to cheap destinations.
4. Greece is a symptom of what ails Europe, it is not the cause. Greece’s departure would not solve the debt crisis. In fact, Greece’s expression of the crisis is unique. There and only there does the German narrative of profligate state hold. There the debt caused the crisis. But in Ireland, for example, the crisis caused the debt. The end of the housing market bubble caused the banking crisis. At the EU’s insistence, Ireland nationalized the bank. Hence the private sector debt became public. These public-private sector linkages, as Spain has shown once again, are critical and a source of vulnerability.
5. EMU is an institutional expression of the comity of Europe. These nation states have lived with each other for longer than the US has been around. It is very much like a family, even if dysfunctional (what family isn’t?). They did not get to chose each other. Their histories are intertwined. There is a great desire for peace and prosperity. It is difficult to prove that integration has made peace on the continent, but is sure looks that way.
6. The ECB’s Draghi and EC’s Rehn came out in favor of a growth/investment pact prior to this past weekend’s election results. This changed the political discussion. German officials recognize the shift and have sought to get ahead of the curve. Some suggest that this is always what was intended. Austerity was phase 1 and growth/investment was phase 2. The debate is now really over the content of a growth/investment pact, not whether one will be forthcoming.
7. We never were crazy about the media and market’s fascination with “Merkozy”. Nor do we like the Merkel-Hollande formulation of “Merde”. One of the sources of crisis in Europe is that France seemed to abandon its more traditional role as a check on Germany. The crisis has demonstrated that France is not Germany’s equal, but it can still offer an alternative to the Berlin Consensus. What made Europe work, arguably, was that France was speaking for the debtors and Germany for the creditors. France’s weakness has meant the creditors can ride roughshod over the debtors. That seems to violate the spirit of the comity. The comity of Europe requires no existential battle but a sustained cooperative/competing relationship. Historically, there are numerous examples of success in Europe when the heads of France and Germany came from different political parties.
8. The resilience of the euro, which despite the break of the $1.30 level is still over-valued on a PPP basis (OECD calculation), can likely be explained by 1) repatriation of European foreign assets or what may be viewed an reduction of their commercial empires, just as WWII forced the end of territorial empires (not just portfolio investment, but for example, say a Spanish bank selling it branches in Mexico); 2) foreign investors picking up European assets (e.g., Carlos Slim buying a Dutch telecom company; 3) underlying pessimism about the US, including the prospects for QE3, large debt/deficit, for which a strategy to address is still lacking; 4) reserve diversification (should lessen given smaller trade imbalances and lower oil prices).
9. Even if by some miracle, the European debt crisis would end tomorrow, there is no returning to status quo ante. Given the demographics and the low potential growth capability, what may ultimately be involved is managing its relative decline in the world. For more than a quarter of a century now, more good cross the Pacific than the Atlantic. If the 21st century is a Pacific Century, what is the role of the western tip of the Eurasian landmass? The world of our children and grandchildren will be less Euro-centric. This is all the more reason why the trans-generational dream of a integrated Europe is not dead. As Ben Franklin told original 13 colonies on the east coast of North America, more than 236 years ago, as they fought the more powerful empire at the time, “hang together or hang separately”; so too for Europe.
10. In the various models of currency determination wishes and needs are not often key considerations. Yet, a weaker euro would seem to help most countries in the euro area (except Germany). Indeed a euro, say 10% lower (near its birth rate), would be tantamount to some degree of monetary stimulus without the ECB doing anything and without what the Financial Times claims today to be signals that the Bundesbank’s anti-inflation resolve is softening.