3 EURO DEBT CRISIS SCENARIOS
As the Euro crisis flares up again it’s helpful to take a look at some potential outcomes. As I have stated before, this is one of the most dynamic and complex problems the global economy has ever confronted. What we essentially have is a single currency union that was never really finished. What I mean by that is that the Europeans essentially formed a United States of Europe, but neglected to actually unify it with full political and fiscal union in the form of one government and one treasury.
So, what we have instead is a version of what the world looked like under the gold standard – a disjointed multi-government system with one inflexible currency. The results are similar to what we witnessed with the gold standard – current account deficit nations experience inherently high debt levels and ultimately succumb to deflation pressures as there is no floating exchange rate to alleviate the disequilibrium caused by the single currency system.
One by one the current account deficit nations have succumbed to the inevitable need for foreign aid. Under the gold standard nations would just opt out. But that is not an option here (at least not yet). The core nations have made that clear. But what will be the ultimate outcome? Danske Bank published a superb piece of research that covers the potential outcomes:
Scenario 1 : Crisis Contained
We believe a scenario in which the crisis can be contained to be the most likely outcome of the European debt crisis but we should expect continued high market volatility for some time. Ambitious mechanisms have already been put in place to dampen the crisis and with the amount of political prestige that is already invested, we believe political leaders are willing to go even further to ensure a solution can be found.The current measures are extensive and if they are increased further it is less likely that they will have to be used for e.g. Spain as bolder measures may help to restore calm in the financial markets and thus reduce the cost of sovereign debt financing on market terms for peripheral countries.
According to our estimates the current European Financial Stability Mechanism (EFSM), the European Financial Stability Facility (EFSF) and IMF measures are sufficient to cover almost all of the government financing needs of Ireland, Portugal and Spain over the next three years (Greece has its own EUR110bn package). If the EFSF is to cover Italy it would have to be increased substantially. An increase in the EFSF seems to be the most likely development and is already partly anticipated in the market.
It has also been suggested that the EFSF should be allowed to purchase government bonds in the secondary market in much the same way as the ECB does today with its Securities Market Programme (SMP), but possibly on a larger scale. Alternatively the EFSF could lend money to the countries themselves so that they can buy their own government bonds back at market prices. This manoeuvre has the advantage that it would help to reduce the countries’ nominal debt without being a default event. Finally, a reduction in the interest rate charged to countries in need of help from the EFSF has been considered. Ireland currently pays a spread of almost 300 basis points, which puts additional pressure on fiscal sustainability.
ECB governor, Jean-Claude Trichet, has been calling for an increase in “both quantity and quality”, which can be interpreted as a call from the ECB to have the EFSF increased in size and (at least partly) take over the current role of the ECB’s Securities Markets Programme. We do not believe that the current uncertainty will prevent the ECB from hiking interest rates later this year if needed.
We expect that the Eurogroup will announce a strengthening of the EFSF at their March meeting and that this will include a combination of the above measures with an increase in the total amount available and the use of EFSF funds for purchases in the secondary market as the most prominent measures.
Initially the EFSF was to expire on 30 June 2013, but with the agreement on a permanent crisis mechanism in November 2010 the existence of the facility will continue. What form it will take after this date, however, is less clear.
Continued public consolidation and structural reforms will have to be implemented before the crisis can be beaten for good. This will continue to be a central theme throughout the year.Scenario 2: E-bonds and quasi fiscal union
Political leaders have called for a common European bond, or what is often referred to as an E-bond. In December 2010 the president of the Eurogroup, Jean-Claude Juncker, proposed the issuance of E-bonds of up to 40% of euro area GDP. The idea is that each member state would be allowed to borrow up to 40% of its GDP at low interest rates through an AAA rated E-bond market. To achieve an AAA rating the best performing countries will have to guarantee for part of the less well performing countries debt. Debt above 40% of GDP would have to be issued by the member states themselves at an expected higher interest rate. This structure should give the member states an incentive to consolidate and ensure sound public finances. Furthermore, the E-bond market depth and wide basis would be similar to that of US public debt, ensuring better access to capital for the minor countries despite their economic difficulties.The proposal has so far been rejected by Germany, indicating that an enlargement of the EFSF is probably more likely. German Chancellor Angela Merkel is concerned about moral hazards and has said that: “We must not make the mistake of thinking that collectivising risk is the answer”. To avoid moral hazard problems an E-bond would have to be supplemented by a more coordinated fiscal policy and further central supervision from EU authorities. The introduction of E-bonds could thus lead to the “quasi” fiscal union that Trichet has been calling for. Japan has said that it would like to purchase 20% of the issued E-bonds and more importantly, it did not say anything about potential purchases of any of the PIIGS sovereign debt.
Scenario 3 : Default or euro break-up
If overall sentiment starts changing and the political will vanishes in either the peripheral countries or the core this could trigger sovereign defaults. The defining event could be if Italy needs help, but it could also simply be a change in power following deterioration in the general support to further belt-tightening in periphery countries and/or an increase in resistance to further financial support in core countries. Another option that has been mentioned is an actual break-up of the EMU where all member states leave the euro.We see the probability of a euro break-up as very low. However, it may still be worth considering some scenarios of how it could take place. There exist different default and break-up scenarios that vary in terms of how serious an impact they would have on the financial system and economic growth. Common to all of these is that we do not exactly know how they would look as we are entering unchartered waters.
1. The mildest version would be that one, or maybe a few of the periphery countries default on their debt resulting in a debt restructuring. The candidates most in danger of this are Greece, Ireland and Portugal in descending order. It is less clear how this technically would be done. However, this does not automatically mean that they would have to leave the EMU, just as nobody expects Florida to leave the US should it default.
A sovereign debt restructuring within the euro area is not necessarily a “quick fix”. If , for example, Greek sovereign debt is restructured this would result in losses for German and French banks among others, but more importantly it would also result in renewed fears about which other countries could decide to restructure with both Italy and Belgium being likely candidates for speculative attacks. The country that defaults would also have to be prepared for a period with limited access to financial markets and the default option thus appears most attractive for a high-debt country that isn’t far from having a balanced primary budget. A debt restructuring also does not help the country to improve its competitiveness due to the common currency.
Alternatively a periphery country may decide to leave the EMU if it deems it too tough to get the economy out of the doldrums without being able to devalue and regain some competitiveness this way or if internal public opposition becomes too strong. This is likely to initially cause a bank run in the respective country due to fear of losses on deposits relative to banks in the core euro area. A capital flight from assets likely to be redenominated should also be expected. The risk of redenomination of the government debt (from the euro to e.g. the drachma in the hypothetical case of a Greek exit) and expectations of currency depreciation will result in higher sovereign spreads. But if the government decides not to re-denominate, the debt to GDP ratio will increase, which would put further pressure on fiscal sustainability. It is likely that confidence in the new currency would be so low that the country could see “dollarization” with euros to be used in parallel to, or instead of, the reintroduced domestic currency.
A way to go would be to undertake an initial depreciation/devaluation followed by a peg to, for instance, the euro at a much lower level. If the country doesn’t peg the currency but instead allows it to depreciate further, increasing inflation from imported goods could result in a vicious cycle with increasing inflation and inflation expectations. To defend the peg, sound public finances have to be combined with high official interest rates until confidence in the currency is restored. Confidence in a peg may take years to establish as Denmark experienced after it pegged the currency in 1982 and stopped with occasional devaluations in 1986. It was not until 1991 that the 10-year sovereign spread to Germany tightened to below 1%.
The implications for financial markets and the global economy of periphery countries leaving the euro area would depend on the fragility of the financial system at the time. Concerns about which other euro area countries may leave could result in a prolonged period of high volatility and a continuation of the debt crisis.
We believe that this scenario has a very small likelihood of materialising as the economic cost seems to outweigh the economic benefits – at least in the short term. However, in the end the decision really depends on public opinion and political leadership. The scenario can thus not be fully ruled out.
2. Germany leaving the euro. This scenario is very unlikely in our view. But it cannot be completely ruled out if, for example, public opinion against financial support for the periphery countries increases significantly, e.g. if a “tea-party movement” demands that Germany leaves the euro. It could also be triggered by the German constitutional court saying that politicians have gone too far and breached the no bail-out clause. We doubt that the court would do more than issue a warning not to go further though. In any case an objection from the constitutional court does not imply that Germany would have to leave the euro.
If Germany were to leave the euro zone, the D-mark is likely to be in high demand from day one and would be expected to appreciate. There would not be any bank runs or capital flight in Germany. However, bank runs could occur in the peripherals as the euro is likely to depreciate relative to the D-mark. Germany would, however, lose competitiveness. The flipside of the coin is that the euro zone would benefit from a much needed increase in competiveness as the euro depreciates. If Germany decides not to denominate its debt it would benefit from a decline in the debt-to-GDP ratio. On the other hand German banks and other investors could face substantial losses on their holdings in the rest of the euro area.
Another uncertainty in this scenario is whether other countries would follow Germany. This uncertainly could prevail for quite some time resulting in higher sovereign spreads and volatility in FX markets. In this scenario there are good arguments for Finland and the Netherlands to consider leaving too. But then we could see a monetary union continuation, with France taking the lead role. We believe that this scenario has a small likelihood of occurring. The costs for Germany of solving the current problems within the EMU are probably smaller than the costs of leaving and the political will invested in the project clearly weighs against this scenario. But if Italy needs help this could be a game
changer.3. The worst-case scenario is a total breakup of the EMU. This could happen by mutual agreement or as a resulting domino effect if Germany decides to leave. It is likely that some of the core countries would peg their currency to the D-mark. German banks could experience severe losses due to currency depreciation on its holdings as well as potential defaults. A period of wide sovereign spreads and high volatility in the foreign exchange market would be expected. Devaluations and expectation of further depreciation could also result in a period of high inflation in a number of countries. The national central banks would have to set policy rates high to gain credibility.
A break-up of the euro would affect the global economy, which is one of the reasons we see both China and Japan as willing to invest in funding for the most indebted countries. The turmoil and uncertainty could lead to severe losses in the financial sector that would impact the real economy, as we experienced it during the financial crisis. In contrast a scenario with a debt restructuring in Greece and maybe even Ireland would only have minor impact on the global economy as long as other member states can maintain their credibility. Since we believe a break-up is very unlikely we are not particularly worried about the impact of the debt crisis on the outlook for the global economy.
In any of the default/break-up scenarios, risk premia could be expected go up for some time. This would result in increases in swap spreads and an overall increase in credit spreads, as the current collateralisation and expectations to future collateralisation disappear.
Like Danske, I see the break-up scenario as unlikely, however, the environment is so fluid and unpredictable that it can’t be entirely discounted. For now it appears as though we are heading towards a larger bailout mechanism and as the crisis continues to flare up the need for fiscal unity will become increasing;y necessary. At this point I think the Europeans are too invested in the Euro to risk its collapse and that means they must move in the direction of unity. As I said earlier there is only one direction going forward and the key investment takeaway remains clear:
But the longer this plays out the longer we risk sinking back into recession. Austerity has already proven a failure for these nations. And an already disgruntled citizenry is unlikely to accept imposed depression for long. The risk in this environment is that Europe does not move quickly towards greater unification. The hope is that Europe can muddle through and eventually piece together some semblance of a working monetary system. But the risks remain enormous.
Revolts would be the likely worst case scenario in the region. While I see the odds of a full blown revolt in one of these nations as relatively low we cannot entirely discount it. But one thing is certain by this point – there is no middle ground. Europe must either move towards a more unified region (US of E) or they must allow some form of debt restructuring and defection from the Euro. I still think the prospects of a Lehman 2.0 will drive the region closer to a United States of Europe as opposed to a complete collapse, but the muddling along is only adding to the uncertainty and increasing likelihood of unrest.
Personally, I don’t know if I have ever been more uncertain as to a particular outcome. Part of me is certain that the core will move towards greater unity (and avoid any banking system trauma), but the other part of me says that the periphery nations will wake up to the injustice that is being imposed on them. For now, the periphery appears to be willing to go along with the core’s playbook. Is that sustainable? I don’t think anyone can predict the outcome here. And while I think we’re likely to see some form of a United States of Europe (with a common tax and common bonds) in the coming decades I think it’s unwise to entirely discount the potential of a defection and the fallout that would ensue.
While there is much uncertainty regarding the potential outcome I believe the biggest takeaway from all of this is crystal clear – there are better regions of the world in which to invest your money.
Source: Danske Bank
Scenario 2.5
The Euro reverts to the European Currency Unit, modified from the previous entity to be more like an SDR, comprised of member nation currencies weighted by contributor real GDP.
Nations on the Euro revert to their own currencies under the control of their own central banks.
International trades within Europe are settled in the SDR-like Euros.
Nations can inflate as necessary to handle their debts with natural forex market forces taking care of relative economic relationships.
The boffins in Brussels keep their seats but are now an advisory council rather than a regulatory body.
European elites have now stopped trying to put the cart before the horse, calm down, and try to achieve European unity the proper way, over a longer timeframe.
Just get rid of the damn Euro. It was a stupid idea to start with, it’s always been a stupid idea and it always will be. I still can’t believe they went ahead with it after Soros demonstrated how stupid the idea was by breaking the BoJ as it tried to stick with the ECU (a more flexible precursor to the Euro, but still just as flawed). Mind-numbingly idiotic.
*correction: BoE
Great idea, but I don’t see it happening. They’ve invested too much real money and time to convert to the Euro.
I think the most logical thing will be that the EU may be forced to kick-out a few dead-beat countries who cannot (or will not) manage their financial houses adequately.
In the meantime, Germany (mostly) will continue to bail out the dead-beats until their people start screaming and voting the politicians out of office.
BTW: Great article here TPC!
You know who else is a deadbeat? The German Banking system. It had the highest leverage of all other banking systems. Yet what price are they paying?
Do you really think the bailouts are for the periphery? The bailouts are designed for the German banks.
Austerity for the people, bailouts for the banks. It’s a common theme worldwide, if you haven’t noticed.
I would love to see Germany stop “bailing” out the deadbeats. You know what would happen? The German banks would implode. How do you think Germany was able to get that trade surplus? German banks lent money to countries, and they in turn bought German goods.
How do you think Germany was able to get that trade surplus?
Yep. It really does seem that some people haven’t yet figured out that it isn’t possible for one nation to run a trade surplus, without having at least one other nation that runs a trade deficit. It’s not as if BMW’s are being exported to Saturn or Mars; there is some non-German earthling on this planet who is buying it.
Not only that, but that non-German earthling needs to either export some product of equal value, or else receive some amount of FDI and/or foreign-funded debt in an amount equal to the cost of that Beemer in order to balance the current account. If the banker/ exporter is intellectually and morally superior to the rest of us, then why was he dumb enough to underwrite and make the loan in the first place?
The EFSF is flawed, in the sense that participating countries guarantee a share of the EFSF. But the more countries seek assistance from the EFSF, the less countries guarantee the EFSF debt, so effectively the EFSF becomes smaller everytime countries seek assistance.
The new ESM (replaces the EFSF in 2013) is trying to circumvent that by injecting some capital in advance, and the rest as callable capital. However, as things stand now, the ESM will only be permitted to buy debt on the primary market, not the secondary. So debt buy-backs are for now not an option (which is one of the critisms of Trichet).
There still is a large question looming about the seniority of ESM assistance. It now seems that the ESM will be structured in such a way, that it will be able to force haircuts or partial defaults on existing bondholders. But, since these details are quite recently disclosed, some things remain unclear.
If the euro survives and there is so called harmonization it will be very painful and take a long time – which maybe we don’t have. Is there the political will to transfer power to an unelected Brussels Bureaucracy? There is no meaningful control of the Bureaucracy by the European Parliament and countries will not be too happy implementing tax increases and public spending cuts (social security and pension reductions). National politicians will have to accept reduced scope for bribing their electorates and will come to point the finger at Germany as the origin of austerity. Greek and Irish politicians have already seen this. The harmonization will in any case require increased cross-border subsidies – the EU already has a limited regional policy but this will have to be very significantly expanded – the Germans might not appreciate being the paymasters. And in any case such regional policies are usually unproductive and do not have a lasting effect. Harmonising fiscal and budgetary matters has not been tackled until now because it is such a political hot potato – trying to do it in hard times may prove impossible – harmonizing up is fine but down could spark a groundswell of resistance. Recent surveys in the US prove people have little idea of how their money is spent – US citizens surveyed thought the US spent 26% of its budget on foreign aid and were happy to see it cut to 13% – little did they know it is already below 1%. So don’t expect to be able to communicate the underlying necessity and logic for change to the Europeans and get their support even if there were a mechanism to do it – dream on!
Given all we have just read and the huge uncertainties that exist, why is the euro so strong ? Does anyone have an explanation other than the weak USD. I only say this because the reason people hate the USD is because of the QE (int rate differentials are minimal and the US is actually growing faster than Europe). The ECB has also bought bonds in the open market for very similar reasons to the Feds. The EFSF is even going to buy directly from the governments, so thats QE in the primary markets. I realise its on a smaller scale than the US ($1-$1.5 trn), but the EFSF will be €450bn or so which is nothing to sneeze at and you can be sure it will all get used and then some. So why is it euro positive when there is intervention in the european bond mkts and USD negative when it happens in the US bond markets. Also, countries like Ireland have been basically printing their own euros (€50bn by the Irish central bank). I may be completely missing an important point and if so I would love to be set straight. I just find it hard to believe that rational investors are waking up every morning to a deteriorating European situation and feel like the answer is to get long the euro.
Why are austerity measures a failure as Danske Bank suggests? In the long run countries in the European Union will have to adobt a responsible fiscal policy. This should have happened a long time ago anyway and is the reason why there are so called “convergence criteria” when you first join the Union as a country. Moral hazard already happened there, why would it not happen again when Europe would introduce E-bonds? Lowering risk premium for a lot of countries on the back of a few remaining AAA member states cannot be the answer when there are deeper structural problems that need to be addressed.
Investors will have to realise as well that there is and will be a credit risk that is refelcted in the yield of government bonds.
The sad fact is that too many people think that all a government needs is the political will to balance a budget, but a balanced budget at some level of the government is just outside if its control – by accounting identity.
Governments can set the tax RATE and can set the amount of spending, but they can not guarantee a balanced budget without cooperation from the private sector. In the end however the private sector’s behaviors will dictate the size of the deficit.
Here’s the identity:
Net Government Deficit (Surplus) MUST EQUAL Net Savings of Private Sector + Net Savings of Foreigners (inverse of the trade deficit).
In the periphery nations they have internal trade deficits with the Core Nations and the private sector typically prefers to net save (and if it doesn’t it just means they are going into debt – bad). Therefore these nations MUST by accounting identity be in deficit. However, they are not sovereign in their currency so they do run the risk of bankruptcy/insolvency.
In the USA, our state governments can run balanced budgets because they can push off the deficit needs (the accounting identity) onto the US Federal Government; however without a central fiscal authority in the Euro Zone, they can not do that. There is no central treasury to take up the spending gap to allow the individual nations to balance their budgets.
Most likely scenario is bailout after bailout for the next 5-10 years, then finally some defaults.
In the long run, some countries will exit the Euro.
Max, there is no way Ireland and Greece last 5-10 years doing what they are doing. I view a unified Europe as the least likely scenario. I just don’t believe the people of Europe will stand for that. All countries have rich histories on their own. I think Cullen is right that it is the only way to solve the issue and maybe that is why he thinks it will happen. But I have to think the citizens will have a say.
the next crash(from a black swan or one already on the radar screen) with US main street in dumpster, eur already gagging, china banks(not to mention US zombies) technically insolvent(64 million empty condos financed–empty malls STILL going up), US public in no mood for more bailouts…….on n on…………sends the eur into the trash heap.
its not going to be pretty….now the can is getting kicked UP the hill….they’ve run out of downhill.
mutual fund guys on CNBC sooo funny…..’beginning of secular bull market’…..laughable….i guees u gotta cheerlead your book to get the sheeps money.
Trade deficit nations with high debt levels ?
Ireland has nearly always been a trade surplus country with low debt levels until the bubble (A colony) now it has the highest per capital trade surplus in the Euro area and the second highest nominal surplus in the euro zone although this is for the most part a artifact of the pharmaceutical and other multinationals.
The Euro is in trouble for one primary reason – the 3% deficit fiscal deficit rule and the corrupt equalising of fiscal transfers with shadow banking monetory flows – the growth of the shadow banking sector for the last decade or more is a direct consequence of the artificial deficit rule.
Ireland could have defaulted on private external debt obligations back in 2008 citing the spirit of the agreement as it would have had to go into fiscal deficit if it wanted to continue to make these payments ( there was also the 60% overall deficit ratio that it was still below at the time )
But the ECB was not too fussy at the time – this selective use of the rules by Frankfurt and their minions in the local CBs and executives goes to the heart of the crisis.
In essence its fiscal rules are a nonsense if you cannot default on private shadow bank obligations.
The ECB has constantly equated these shadow funds to at least sov status if not more – it is a bankers den of thieves with a false veil of fiscal austerity.
They lack beleif in the power of their own balance sheet – like all central banks they watch on the sidelines as private credit is hyper inflated – but do not incorporate this crime on their own balance sheet – although the FED and BOE at least recognize their crime after the rape the ECB still wishes to remain slightly virginal by not expanding its balance sheet to incorporate the malinvestment as a result of credit hyperinflation.
I predict that once their friends in the shadow bank sector escape to the core the savings in Irish banks will disappear as the deposits built up during the credit crimes of the last decade cannot be backed by its assets.
Truly remarkable crimality even for a cynic.
Current account deficit. Sorry for the error.
No problem Cullen – but don’t you think that the problem with the Euro is the equality or inferiority of fiscal debt with monetory flows.
Governments should have no responsibility for this risk capital.
These flows created a almost hyperinflationary explosion in certain asset classes creating titanic malinvestment yet these bozos win on the way up and on the way down.
The 3% rule merely channeled European core savings to these speculative investments rather then building core utilities that was always a integral part of the European economic ecosystem – privatisation and decapitalisation of core utilties channeled surplus energy to fruitless pointless speculative fluff with no long term yield.
I personally believe that’s a function of the way the system is currently devised. These govt’s are deeply involved in growth prospects because of the inherent restrictions that are caused by the single currency. They have to deficit spend and allocate money in order to sustain growth. Telling Spain to stop spending is basically like telling them they’re not allowed to grow. You can see how this is problematic from just about any perspective. Austerity is the only real response for Spain and that ensures meager growth. It’s a bad situation all around.
I can’t think of a good resolution here. I really can’t. I am not going to pretend to have the answers on this crisis. I just don’t.
Stick the entire M1 on the euro balance sheet and see what happens…………
A surprisingly good show from the irish state broadcaster with regards to the euro crisis
Constentin Gurdgeiv is one of the best economists in Ireland – he is nearly always worth a listen.
http://www.rte.ie/news/primetime/
click – watch the show , above the title
Sorry but as of now the earlier episode from the 22nd is available – tonight’s show is still in Internet limbo.
Its wildly unlikely, I’d bet against it for decades.
But what if they actually formed a unitary monetary, fiscal, and political entity? Making the USD/EURO comparison Apples to Apples.
It won’t happen, but couldn’t it do a great deal to help the problem?
TPC,
Thank you for the continued insight on the European Debt Crisis. It would appear that the ability to hold the Euro together through elongated bailouts relies on the citizens of the periphery countries accepting potentially lengthy recessions. How long do you believe we can reasonably expect these citizens to accept the brunt of the costs in order to protect the Euro and primarily the stronger countries/banks? Given the clear desire to protect the Euro at all costs, one might expect the peripheral countries to recognize their bargaining power in discussing bailouts. If that occurs (potentially with Ireland), will the pressure to reduce interest rates and requirements for all other countries being bailed out be possible to avoid?
Adding to a previous comment, while the strength in the Euro on the collapse of Portugal’s government seems strange, doesn’t an increasingly strong Euro make the potential recovery of the periphal nations even tougher/less likely?
A stronger euro along with higher interest rates (ECB as well as market determined yields) all but assures more years of pain in the peripheral regions. Irish Q4 GDP data released today showed a contraction of 1.6%. Exports actually fell by 1.4% in the same quarter. Now with eur/usd and eur/gbp making close to new 2011 highs, exports will struggle further. Do you think the EU or ECB care ? They just want to ensure a stable banking system and to hell with the real consequences. I think sooner or later the citizens of these peripheral countries will say enough. Little by little they are recognising that the austerity is not for their good but for the good of the European banking sector and this may not be tolerated much longer. Unfortunately the politicians lack the backbone to fight the Irish corner. Its time to stand up for the citizens and play hard ball.
Irish GNP (a more accurate calculation of Irish internal demand ) is down again by 2 and a half %.
Our exports may be slightly down but our trade surplus is reaching epic proportions – if Germany starts spending a bit more little Ireland will have the largest trade surplus in Europe !!!
There is huge spare capacity in the Irish domestic economy – i can think of half a dozen large scale investments that could be done by a Industrial bank withen a few months yet commercial banks here have a monopoly of credit creation and they cannot create credit until their balance sheets are repaired.
A truely crazy situation – the banks both central and commercial have us under their thumb to a extreme degree.
The Germans enjoy playing martyr on this issue, but they are the primary beneficiaries of the euro. Germany likes to operate a neo-mercantilist economy (i.e. the Germans want to run a trade surplus), and the euro makes it easier for it to do so, as it is in the unique position of having many trading partners that use the same currency.
If the net importers such as Greece were to leave the euro, they would buy fewer German goods (the drachma would devaluate and the Greeks wouldn’t be able to afford as many of them), and the Germans would lose out on the national income and employment that comes from the trade.
At the end of the day, they’ll figure out a way to bandage over the PIIGS debt, and nothing much will change. The ECB will remain an extension of the Bundesbank, and a return to normalcy will cause the powers that be within Europe to forget and ignore what just happened, until it happens again.
But the markets will remember, and the euro will never become the competitor to the dollar that it was supposed to be. Sort of disappointing, as this was one of the primary reasons for creating the euro in the first place, but on the whole, not all that important.
It’s not like the Germans really gain anything by it. Swapping goods for foreign debt doesn’t seem like a good deal given the yield/risk on that debt.
Swapping goods for foreign debt doesn’t seem like a good deal given the yield/risk on that debt.
The debt risk isn’t the only issue. By prioritizing a trade surplus over a trade balance, the Germans are creating a recipe for long-run domestic disinflation, which means higher structural levels of unemployment and reduced levels of prosperity compared to what they could have.
In other words, it’s a situation that (not coincidentally) resembles that of Japan’s. But like Japan, they don’t have any desire to fundamentally change it.
What really annoys me is that German politicians seem to expect others to implement the same flawed policies and be more like Germany. They seem to think that everyone can run a surplus at the same time.
What really annoys me is that German politicians seem to expect others to implement the same flawed policies and be more like Germany. They seem to think that everyone can run a surplus at the same time.
I question whether they’ve invested that much thought into it. Politically speaking, it’s simply easier to feed on self-pity and to feel superior to everyone else, than it is to accept any blame. They don’t care to admit that this problem happened because of their leadership, not in spite of it. Pride and avoiding responsibility trump good judgment much of the time.