To all the readers of the Pattaya Mail, I would like to wish
everyone a Merry Xmas and a Happy & Prosperous New Year.
More than a few readers have recently requested a guide to
the EuroZone problem and to the recent manoeuvrings. Here goes:
Post 1945 Europe had to rebuild after the devastation of two
world wars that straddled the Great Depression. Capital wealthy America funded
the recovery of Europe and Japan plus the emergence of newly independent
countries in Asia and Africa.
The universal mood focused on desperately avoiding further
wars at all costs. Allied to the distribution of the prosperity dividend this
helped bring about a collaborative Federal Europe. At the core of this
federation was Germany, with France attached at the hip to its erstwhile
adversary. This symbiosis reflected French deeply embedded suspicions and German
war guilt. In both countries the ravages of war dominated the thinking of
successive generations.
Ironically, Germany’s engine of growth, which drove much of
the post-war prosperity, dated back to the 19th century harnessing of phenomenal
natural and human resources in a powerful and energetic young country and
fuelled the over-exuberant economic development and ambitions that ultimately
caused World War I.
The EU grew out of a primarily Franco-German trade and tariff
organization for the steel industry that expanded to include the whole
manufacturing sector in the post-war era. Harmony and homogeneity were initially
and subsequently far from universal - military regimes prevailed at various
times in Spain, Portugal and Greece whilst the Iron Curtain cut a line between
central and Eastern Europe that provided the starkest aftermath of WW II long
after Western Europe had rebuilt, with Germany itself once again divided and a
small corridor providing the only access to the western sector of Berlin.
The same urge that eventually unified Germany also drove
forward the creation of a federal bloc that ultimately became the largest
economic entity on the planet, despite a bureaucratic administrative system that
famously interfered in every aspect of life.
To serve its relative prosperity this Franco-German alliance
sought the continuing evolution of the fragile Federation, which remained
divided by national borders, languages and currencies. A single currency was
conceived twenty years ago and introduced a decade ago as a way of keeping alike
the twin dream of a perpetually fast growing federation bounded by homogeneous
fiscal, monetary, political and social standards. This is where the wheels
started to come off. In fact, there had been clear warnings when the likes of
the UK had shown themselves unable to operate within the structures of the
Exchange Rate Mechanism (ERM) that had preceded the currency itself.
Stark national and regional differences continued in many
ways to grow ever wider. Giving previously unimagined access to cheap and easy
capital to those EU members whose economies featured a structural lack of
competitiveness merely facilitated a transfer of wealth to the more productive
core and a transfer of debt to the less competitive periphery.
Borrowing was suddenly so cheap and so easy for countries
that had previously experienced difficulties raising capital because the myth
was propagated that lending to all EuroZone members was the same. Basically,
when the bonds of the GIPSI countries (Greece, Ireland, Spain, Portugal and
Italy) were each rated as being similar to German or French bonds, institutional
buyers such as banks and pension funds bought the higher yielding but apparently
equivalent risk GIPSI bonds in preference to lower yielding Teutonic ones. This
caused the market price differential (the spread) between them to narrow to the
point that it virtually disappeared altogether, further embellishing the myth
that leverage had created uniform prosperity across the EuroZone, whereas for
the periphery the leverage had really only begat a series of bubbles.
Like all bubbles, these fed in a virtuous cycle: spiralling
asset prices fuelled high growth rates. However, like all leveraged bubbles, the
debt levels eventually started to impact on growth and asset values when
slowdown set in. The process of deleveraging caused these bubble economies to
slow even further. This coincided with the bursting of America’s bubble, further
showing European growth, further exacerbating the debt burden and suddenly
leaving Ireland, Greece and Portugal struggling to service their existing debts
in an environment where capital became much more difficult to access.
Shackled by a currency whose strength was far more to do with
Germany’s positive current account than the budget deficits of the smaller,
weaker economies, it was impossible for these economies to grow their way out of
trouble.
The heart of the federation’s economic system, the European
Central Bank (ECB) began providing short-term solutions to immediate cash flow
deficiencies in 2008 whilst failing to address the structural imbalances.
Despite astonishing endeavours by the likes of Ireland to cut spending, the
shortfalls have persisted strangling these economies into the recessions that
persist today. Less imbalanced larger economies, such as Spain and Italy, took a
little longer to reach the same point.
Having now reached that point, the crisis is of such a scale
that the entire EuroZone is in recession, the Euro banking system appears
grid-locked by mistrust and on the back of a liquidity crisis where the ECB
seems to be the primary source of bank funding and the domino ripple of
sovereign defaults still appears imminent, despite the agreement that each
country can now work around the EU’s own founding treaties and constitution to
do whatever bilateral deals are necessary to secure short and medium term
funding requirements.
Ultimately, capital is still available from the ECB via the
core, from America (whose own financial system might not be able to withstand
Euro defaults) or possibly from Asia, where neither Japan nor China want to see
Europe slow down any further. However, neither big bazookas nor tiny
pea-shooters of short-term liquidity will fix structural insolvency and
imbalances. It will merely delay the inevitable.
Beyond short term remedies, there are 2 structural solutions:
1. Countries revert to appropriate national currency
policies. ASEAN 1997 is the playbook for this - Europe 2011 faces the added
headache of a world that, except Asia, may well already be in recession (and
Asia may not be so far behind). GIPSIs can, however, choose to debts in Drachma,
Lira, Peseta, Escudo and Punt allowing for a much quicker healing after a period
of initial extreme volatility.
2. The core countries, primarily Germany, can point enough
Euros to plug the EUR5 trillion holes in Europe’s financial system, investing
this as permanent capital in assets that will depreciate sharply in value, along
with a much weaker currency. This might work. However, to create a sustainable
solution, it requires a homogeneous EuroZone to be created.
To create equivalence across the EuroZone may well be
possible especially after the monetization of the German balance sheet by
printing an unprecedented amount of currency to swap back some of the core’s
ill-gotten gains from the Euro experiment back to the periphery.
But to my mind it is far likelier to result in equivalence
being achieved by reducing the competitiveness and standards of Germany down to
the levels of Greece than by improving the standards and competitiveness of the
GIPSIs in line with the core. To that end the recent agreements amount to little
more than further kicking the can down the road with the added caveat that in
recent weeks the EU has supplanted democratic processes in Greece and Italy (in
the words of Eric Rosenkranz “Germany’s just chosen a new Prime Minister…for
Greece”) and abrogated its own constitution. This “democratic deficit” to use
Nouriel Roubini’s description, may well be a long-lasting problem, well after
the warm glow of the short term fix has worn off. Caveat emptor!
The above data and research was compiled from sources
believed to be reliable. However, neither MBMG International Ltd nor its
officers can accept any liability for any errors or omissions in the
above article nor bear any responsibility for any losses achieved as a
result of any actions taken or not taken as a consequence of reading the
above article. For more information please contact Graham Macdonald on
[email protected] |