Euro doom

Delusional Economics has led the MB debate on Europe. His regular readers will know that he has identified the fundamental problem at the heart of the euro, structures that do not enable different members countries to be competitive.

I have fought against this fundamental diagnosis, preferring to believe that the EU project is passionately supported and that its leader would find a way through.

But two pieces today have left me feeling empty and naive. The first is a piece at Kantoos Economics that compares today’s European travails with those of the Europe of the 1930s:

  • Scene 1: establishment of a currency union, celebrated as a milestone on the path to cooperation and mutual understanding in Europe (NOW: Helmut Kohl’s euro. THEN: the restoration of the gold standard in the mid-1920s in the context of the Briand-/ Stresemann rapprochement policy).
  • Scene 3: a sudden stop of capital flows during a global financial crisis. The stop leaves behind economies that are as overindebted as they are uncompetitive and have large external financing needs (NOW: the GIPS-economies from 2009 / THEN: Weimar-Germany from 1929).
  • Scene 4: attempts to reign in the crisis with austerity measures and multilateral financing packages cobbled together during painful negotiations. Everything is subjugated to the objective of avoiding sovereign defaults and preserving the currency union. The packages treat structural overindebtedenss as a problem of illiquidity, not insolvency (NOW: support packages for the GIPS-countries / THEN: Young plan, Young bond and Hoover moratorium); competitiveness has to be restored through falling wages rather than currency devaluation (THEN: Brüning’s deflationary policies) – both entirely inadequate to eliminate macroeconomic imbalances.
  • Scene 5: continued loss of confidence, intensification of the crisis, upheaval in the debtor countries, whose populations are no longer willing to carry the crushing burden of adjustment, and tired frustration on the side of the creditors (THEN particularly destructive U.S. Congress that refused to follow the lead of a well-meaning but weak President – Herbert Hoover).

The susbsequent scenes from the 1930s (assumed to be known) do not need to repeat themselves, or course. Ryan Avent is arguably right that macroeconomic imbalances are less dramatic now than they were then, and Europe’s democratic foundations are (hopefully) more robust. Moreover, the parallel between the gold standard and the euro is far from perfect: as Kantoos notes, the ECB can print euros and thus assure, in case of doubt, its member states’ ability to pay, while in the 1930s no one could print gold.

But all this takes nothing away from Ryan Avent’s depressing observation:

A Europe hoping never to repeat its historical tragedies has gone and blundered into institutions that make those same tragedies more likely. The European project, as it looks now, has failed.

In my own words: introducing a common currency may have harmed the European project more than it helped, by provoking that countries would fall into debt/competitiveness traps, while taking away the policy instruments needed to escape from these traps.

The second is a Bloomberg video (h/t The Lorax) of former external member of the Bank of England’s Monetary Policy Committee, David Blanchflower, in which the economist pulls no punches:

Houses and Holes
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  1. Question for H&H, Prince and others:

    If you believe Euro breakup is inevitable, and given the political ineptitude displayed so far, the break up is likely to be “disorderly” (code for catastrophic) what is your investment strategy for the next few months?

    Gold, gold and more gold?

      • Explain to me how its not inevitable.

        At the very least several countries will have to exit the Euro. Perhaps they can come up with some kind of two-tier Euro, perhaps Euro North and Euro South, but regardless it will be traumatic.

        And given that the political leadership is pretending none of this can happen and are simply applying band-aids and kicking cans, they won’t plan for an orderly break-up, so the resolution is likely to be disorderly.

  2. The legal framework make it legally difficult to leave the Euro if not impossible, but it is on shaky ground now with even Germany struggling with the last GDP figures published.

    My view the Euro will continue until they are so hopelessly in debt (you could argue it at that point now) it will be impossible to continue. Even though the EcB can continue QE’ing if the bond holders bail out what then?

    It’s in Germany’s interest to keep the Euro going and eventually they will own all Europe.

    “As US money market funds cut back on their European exposures, even the best European banks have to fill the gap by borrowing euros short term from the ECB, and swapping those into dollars.”
    “For many, the European Central Bank is now the last remaining source of liquidity.”
    Nasty.. Time to get into, what Mercedes Benz (Germans!) describes as Pre-Safe mode – precharge the brakes, inflate seats for extra support, move the passenger seat, position head rests to avoid whip lash, tension seat belts and automatically apply partial or full braking to minimize impact.

  4. The German mood is extremely intransigent, saw an interview with a Finance minister last night saying that Eurobonds would punish the prudent (ie Germany) and reward the weak (PIIGS). My guess is Merkel needs things to get very scary before public opinion will change.

    The trouble is, a) thats self-fulfilling and b) the German mood when things do get ugly could get even more anti-PIIGS because by then the -ve impact on the German economy from bailing these countries out will be even greater than it is now.

    This is the problem. Wars have resulted from less. Who knows how this will finish.

    • Hahaha!!! So true GB…I wonder if he will use his holiday to come back and reinvent himself as a Bear.

      I wish Chris Joye would go on a holiday – permanantly…his post in BUsiness Spectator today should be illgeal it is so misleading!

      • yeah saw the CJ article today, made me puke. Watching these guys arguments getter sillier and sillier as they battle the blatantly obvious, held hostage by their prior forcast is pathetic. They are in the final stages of denial. Next comes fear. thats when the comedy really picks up as they start to back track on their ridiculous predictions and are exposed as the fools that they are….bring it on!

  5. Stavros, they are not misleading. A market to be a market has to have 2 sides. They are (importantly IMO) voicing the other side. It needs to be listend to even if you and I belive it is dead wrong.

    GB I feel for you that you have wound yourself up so much that you want to puke. It is damaging your self. They are far from fools. Follow their arguments they are logical and structured but I would add incomplete. The bull hawks are not trying to deceive they realy belive what they write.

    For me, my enemy is my greatest teacher.