Jimmy Buffet once said that a forecast tells you more about the forecaster than the future. Sorry, that was Warren Buffet. Jimmy Buffet gets drunk and sings about cheeseburgers. I think it’s time for me to have lunch, but first allow me to write about potential Eurocrisis endgames.
The eurocrisis is much too complex for anyone to forecast with certainty. The best we can do is narrow down the possible endgame scenarios.
Let’s consider the first scenario, which I call the Grand Bargain. The Germans and the northern tier realize that austerity is slowly strangling the periphery to death. They realize that increasing resentment in these countries could usher in governments that will leave the eurozone and default on all of their debts.
The northern tier is honest with their electorates and explains that billions of euros are necessary to bailout their eurozone partners and maintain the common currency.
The PIIGS-C are also honest with their voters and tell them that they need to reform their economies and government budgets or else they will have years of depression-like economic conditions to look forward to.
The periphery and the core eurozone countries get together and negotiate a Grand Bargain that trades closer political union, tight national budget constraints enforced by penalty, and fiscal transfers in exchange for monetary aid to tide the periphery over until the economic reforms begin to create economic growth.
This scenario is politically risky for everyone, so a Grand Bargain is unlikely. They may attempt to create the illusion of a Grand Bargain, but do not be fooled. Politicians only seek to maintain and increase their power, so a necessary ingredient for this recipe will be a severe shock or crisis that forces everyone to bargaining table as a matter of survival.
One of the countries leaving the eurozone is an event that could trigger the negotiations leading to a Grand Bargain. A periphery country leaving the eurozone, a Periphexit, is the next scenario for consideration.
Events that could lead to a Periphexit include the fall of a government, the rise of a nationalistic or populist party, a region voting to secede from its country or brinkmanship politics gone awry.
The last one requires some explanation. The reason why World War I started was that each country believed that the others would not go to war over the usual nonsense transpiring in the Balkans. None of them backed down and responded to receiving ultimatum by issuing their own ultimatums. In the end, they were all wrong and started a ruinous war. We live with the consequences of this war today.
The Greek government may believe that the other countries would never let it default due to the disastrous consequences and refuse to implement more austerity precipitating a default and Grexit. Rajoy could overplay his strong hand and not request a bailout until it is too late.
One of these countries exiting the eurozone causes the dreaded domino effect as each one races to leave before the others to reduce exit costs.
The Periphexit is the least likely scenario . These countries are broke and the bailouts or promise thereof are keeping them alive. As long as the money is coming in, the politicians can direct it to their cronies and maintain power. As long as the people stand for this, there will be no changes. Why give up free money?
It may not be a poor country leaving or being kicked out of the eurozone; it could be one of the rich core countries in the north, Corexit. One of these countries could experience backlash from the constant bailouts. A pro-euro coalition is replaced by a more isolationist, populist party. This country then leaves the euro and reverts back to its national currency wreaking havoc in the financial markets.
Another potential problem is that these countries realize that they can simply not afford to pay billions to straighten out the periphery. To avoid more bailout payments to the ESM, they leave the Eurozone.
Perhaps the ECB’s printfest leads to unacceptable inflation , and the country readopts its national currency to better control domestic prices. Avoiding bailout payments is a nice bonus.
A Corexit is more likely than a Periphexit, but still not probable. An exit of any kind is financially and politically expensive. It is safer to maintain the status quo and continue shoveling cash to the periphery.
Ironically, allowing euroskeptic countries like the U.K. and Sweden remain outside the eurozone probably helped to preserve it. The British would have been the first to leave under present circumstances precipitating a full breakup.
The last scenarios are two-sides of the same coin, Status Quo or Implosion.
In Status Quo, everything remains the same and the eurozone experiences stagnant growth for the next few years. The rich countries pay just enough to keep periphery afloat. The periphery performs piecemeal reforms to give the core political cover to request bailout money from their parliaments. The money and reforms are insufficient to fix the long-term problems but keep the train on the rails.
This is the most likely scenario. Even though there are riots and protests in the periphery, these disgruntled citizens have yet to coalesce around an alternative to the bailout to replace the austerity paradigm.
The Greeks voted down Syriza, whose leader promised to scrap the bailout. There has been no challenge to Rajoy’s leadership in Spain, and the austerity party in Portugal is humming along nicely no matter what it proposes.
The flip side to the status quo is an implosion of the eurozone. Basically, an adverse, unanticipated event, also known as the Black Swan, causes a crisis that no one is prepared to deal with.
The eurozone has become increasingly unstable since the Greeks admitted to phony budget numbers in 2009. Even though they have been able to maintain a stable disequilibrium for this long, past performance does not predict future results. A shock could occur for which no one is prepared, just like the failure of Credit Anstalt in 1931 caused an even deeper Great Depression.
This scenario is the least likely, but its likelihood grows every day Europe refuses to fix its problems.
There you have it. I am sick to death of the eurocrisis, but I see it being with us for years. Invest accordingly.