This Time is not Different for the Eurozone

Analysis: Nobel-crowned EU risks future as loveless marriage | Reuters.

Wherever you find a burgeoning financial crisis, you will find commentators who predict that it will not reach the inevitable endgame because it is contained.

Just before the subprime crisis went completely out of control, the Chairman of the Fed and numerous pundits were saying that the situation had stopped deteriorating and was set to improve. A similar situation exists in the eurozone. We do not have a permanent abatement of the eurocrisis, but rather a temporary respite.

The eurozone has survived three years of turmoil, but there is more to come. The common currency has caused the periphery to become weak and politically unstable. These countries are now dependent on the northern tier, and dependency breeds resentment.

One day,  politician will tell the depression-beaten electorate that he can stop the euro-induced depression in its tracks by leaving the eurozone, and he will win. This will start the domino effect.

The resentment caused by the wealth transfers from the north to south may also start the domino effect. Imagine the Prime Minister of a small, northern tier country attempting to transfer billions of euros to the south while its own economy is flailing because of the eurozone depression. His political rival may now get points by taking the position that the country should leave the eurozone rather than transfer billions of dollars out of their own country.

Despite what the article claims, no one is lining up to join the eurozone. Sweden recognizes the value of maintaining its own currency, and its finance minister just predicted a Grexit within the next six months. A forecast says much more about the forecaster than it does about the future, and you can see how Sweden feels about the common currency.

Poland, Hungary and Latvia are not insisting that they be allowed to join the eurozone and begin paying large sums of money to bailout the periphery. Rather, their “hugging” of the eurozone is merely a way to hedge their bets. If this mess does work out, they will be in a position to take advantage.

Poland could have offered cash to bail out the periphery in exchange for a seat at the Eurogroup table, but instead it gave support for a financial transactions tax. This is hardly putting its money where its mouth is.

While three events have changed investor’s outlook for periphery eurozone debt, they have not altered the long term prognosis for an ill-fitting currency union.

Keep in mind that every currency union or peg that has created large internal imbalances in the past has eventually dissolved, and most commentators did not see the end coming. The gold standard, Bretton-Woods, the former Soviet Union’s continuing use of the ruble and even Britain’s currency peg to the continental basket in the early 1990’s all created unsustainable economic conditions that led to their downfalls.

The ECB has placed a floor on the price of periphery debt. Mario Draghi has stated that he will use all the “tools” at his disposal to prevent the breakup of the euro. Since eurozone taxpayers are on the hook for the ECB, how long do you think they will allow him to print euros to bailout the periphery before they begin questioning their leaders?

The article also touts the ESM, which is a paper tiger. Over 30% of the ESM capital comes from the countries that need to be bailed out. A full Spanish bailout will exhaust the entire fund in one fell swoop. At this point, the northern countries will have to stop talking about saving the euro and actually ante up billions of euros to do so. Will this be politically feasible?

Angela Merkel’s visit to Greece has been spun to mean so many different things. This is what it really means. For a few hours of her time, she gave the perception of supporting Greece’s continued membership in the eurozone.

Once again, don’t pay attention to her words, because her actions are more telling. It is nice to say that you support Greece, but what the country needs is a plan to stop its continuing depression. This plan will invariably involve more money in the form of outright loans or debt forgiveness. Will Merkel be able to get the Bundestag to vote for more bailouts in this year prior to elections?

If the Greek people do not see a light at the end of the tunnel, the communists have an alternate plan. Syriza supports disavowing the bailouts and defaulting on the debt. Don’t be surprised if the Greek people decide to take them up on the offer.

The eurozone can be saved, but it will take massive quantities of cash from the rich countries coupled with drastic reforms in the poor countries.

So far, the rich countries have been unwilling to pay the necessary sums and continue to prevaricate rather than opening their wallets. Note that the vaunted banking union has been pushed back to 2014, and that the Germans refuse to even extend Greek obligations let alone granting the debt write downs they need to return to sustainability.

The poor countries have made some painful cuts, but they still have social welfare states which they cannot afford. They also have over-regulated markets for labor, goods and services, and they have not taken the necessary steps to free them.

Until this deadlock can be resolved, the eurozone will remain unstable. In this fragile state, one shock is all it will take to begin its collapse.

 

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