If you are like me you wonder what kind of leader knowingly commits his or her country to destruction. In the case of the Eurozone, (and the US), I find myself asking this question almost daily. I believe I found an answer to the question today when reading a Bloomberg piece called "Saving The Euro Will Be Easier Than The Alternative" by Clive Cook.
This piece highlights a few of the troubles with the idea of the EU as constructed and even describes the fatal error of the creators of the currency union by growing too fast and not concentrating on deep foundational changes in a core of homogeneous countries. But, as we know, the planners and politicians didn't so we don't need to focus on that right now. Cook's piece does make an interesting assertion that there are not many choices available now that the stew is in the pot and this is unsettling because we get a better glimpse into the minds of the EU leadership.
"What politicians have built, you might argue, politicians can unbuild. It isn’t nearly so easy. When you put a currency union together, parities are fixed. When you take one apart, they are freed: Why else dismantle the union but to let exchange rates move? That obvious asymmetry has large consequences. Who would hold a deposit in an Italian bank if Italy were expected to abandon the euro? The new lira, in which those deposits might soon be denominated, would depreciate at the instant of its creation. The mere prospect would trigger a systemwide bank run."
Going on we find that Clive Cook may simply have opened the playbook and this message gives us the ultimate direction of the Eurozone, if this week's tsunami of debt and financial fear can be held back in the short run.
"Nonetheless, we may suffer the profound misfortune of finding out -- unless Europe’s governments see that the only sane choice is to accept the logic of the currency union they created and the obligations that go with it. In the medium term, that means closer fiscal union. In the immediate term, it means one thing above all. The European Central Bank must be granted whatever powers it may need to underwrite public debts across the EU."Did you catch that?
"the only sane choice is to accept the logic of the currency union they created and the obligations that go with it."
That is right, Cook describes how leaders in France, Germany, and elsewhere (even China and the US) see the world. The dish is beyond the point of return and the main course cannot be made into another entree. Instead of tossing it into the garbage, all efforts will be made to fix the broth. The leadership cannot adjust course, because failure in their eyes is just not tolerable. In a sense, they are now in the "too far along to fail" just like there is the US version of "too big to fail". Essentially, the currency union cannot be broken without a total fiery crash of all their economies and so the only course of action is to actually speed the process up!
Remember too, that the EU is not just an economic philosophy, it is really a political and ideological movement that attempts to coalesce Europe and make future wars impossible. These ideas are not quickly abandoned by leadership when economic times get tough.
TONE DEAF OR JUST COMMITTED?
Cook's article helps me clarify that these politicians are not just fiddling away while Europe is burning, they actually see no other choice than to solidify efforts to "save the system". In their rational thoughts, the undoing of the Euro is not only admitting that mistakes have been made, it is more like surrendering to an army that eats their prisoners. I detect a hint in Cook's writing that he actually supports the notion that the Eurozone must forge ahead, but as we know there are often many choices that can be made even when we think there is only one. My sense is that the EU leadership thinks there is only one pleasant choice available, and that is to save the union. Unfortunately, I don't believe that they agree with the notion that I hold that they can still save themselves if they simply stop now. There will be suffering and pain, but at least the process with be limited to some countries and they can get working on recovery. Unfortunately, countries like Greece, Spain, and Portugal will suffer immensely while the EU groups "saves" them, and then they will suffer even more if the fix doesn't work. Ultimately a botched job will bring down even more than the trouble spots and will potentially destroy the very large economies like France and Germany as well.
There is actually another choice here that we keep hearing. The ECB could simply begin monetizing their debt (start printing) and then purchase all of the Italian and Greek bonds in the open market. The move to do this would immediately crush any bond shorts and it would drive sovereign bond yields down. What stops the Eurozone leadership from doing this? Simply the Germans are fearful that the move would devalue their currency and usher in longer term hyperinflation.
PROMISES, PROMISES
There is another problem with printing and it simply is that Europeans all have a promise problem. What do I mean by that? Developed countries in Europe and the USA have gone wild promising benefits to aging workers that simply can't be met. In time, each of these countries is finding that the future obligations of supporting retirees is just too great. As troubled debtor countries like Greece make attempts to cut those promised benefits we see riots and strikes as a result. The EU countries have only scratched the surface of their spending problems and until the expense side is adjusted, there are no "fixes" that will solve the debt crisis. Ultimately, I believe the Germans will not get their wish and the EU will print as there is no fix for this problem other than wiping out a lot of debt (which won't happen). Let me be clear as well regarding Italy, despite what we are hearing, the country is not in collapse mode like Greece, in fact, it is the 3rd largest economy in the EU. Having said that, it is spending too much and is now facing interest expense costs that no developed country can endure for the long term. The attack on Italy must be dealt with with the overt action of the fiscal leadership to stop bond yields in their tracks.
NEXT STOP, FISCAL UNION
In my opinion, no matter what efforts are made by the ECB and EU leadership, they will fail. The failure of all bailouts and bond buying will result in the last ditch political move to wrest national sovereignty from the nation states and consolidate economic power where taxation and revenue decisions can be made for the entire region. Clearly this was the goal all along, we just haven't seen a big enough crisis to push the Europeans to abdicate their self rule.
SO WHERE DO WE GO FROM HERE?
I don't think there is a simple answer to this question. The reality is that if Europe would go all in and become a fiscal union, I think the short run would make the Euro much stronger and the USD weaker. US equities would go nuts and go much higher. You might actually see gold reverse on this news which would be quite odd, but I think it would take the fear premium off of gold significantly even though the act of "printing" should send things higher. Before this happens I am still convinced that we will remain in this trading range from 12,750 on the DJIA to 11,500 or from 1345 to 1185 on SPX. The movements in the indices in this range will be driven by rumors and retractions of statements. The "healthy" market with 2% and 3% moves in either direction will continue till we have some sort of resolution.
GOATMUG
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