Wednesday, 18 January 2012

This too shall pass

As may or may not be obvious from the previous post,  I remain extremely pessimistic about the future of the euro and the future of the  "European project"  in general.  It looks like the EU will probably end up becoming little more than a customs union in future.  Which is incidentally what the British seem to have wanted it to be all along,  so they'll be happy,  presumably.

I say this because the responses to the euro crisis on all sides have been marked by selfishness;  by petty-minded,  short-sighted nationalism which consistently places the short-term national interest ahead of shared,  long-term gains.  Germany's  "reform"  plan for the euro is running into trouble because,  despite the desperate situation,  the poorer countries are refusing to submit to such strict control of their budgets and borrowing rights.  Germany,  on the other hand,  continues to refuse any measure which would systematically redistribute some of the financial gains from the euro from the more prosperous countries to the less prosperous ones.  And this is not simply due to the attitude of Angela Merkel or her team.  Reading the German press,  you'll find criticism of the Merkel government's handling of the crisis,  but very few voices calling for a redistribution of euro profits to poorer countries like Greece,  Portugal and Italy.  The process of European unification was based on the principle of give and take,  but increasingly it seems that everyone wants to take and no one wants to give.

None of this should be surprising.  Petty-minded nationalism ruled Europe for hundreds of years before the disastrous wars of the early twentieth century shocked people into taking a different approach.  Unfortunately,  that old mentality has been gradually reasserting itself for at least the past fifty years now.  I don't think the current crisis is going to be enough to force a reversal of that trend. And if it doesn't,  there is simply no way the euro,  or the European project,  can survive in the long term.  The result will be a weaker Europe,  divided upon itself as before,  with its relative wealth and power in the world declining even faster than America's. And every nation blaming every other one for what is happening to them.

Saturday, 7 January 2012

Timeline of a disaster

1999-2009:  The euro is introduced. It brings benefits to the stronger economies of the eurozone  (Germany, Holland, Finland etc.)  because sharing a currency with weaker economies means their currency is weaker than otherwise would have been the case,  thus making their exports more competitively priced.  Germany becomes the world's biggest exporter nation in monetary terms.
The weaker economies benefit mainly from cheaper borrowing costs,  with lower interest rates for both private and public borrowing.

End of 2009  -  Stage 1 of the crisis:  Markets push up the Greek government's borrowing costs as doubts arise about Greece's ability to repay debt.  It becomes increasingly clear that Greece will not be able to remain solvent without external assistance.  Calls for a rescue take on increasing urgency due to fears the problem might spread to other vulnerable economies such as Portugal,  Ireland and Spain.
→  The German government,  strongly backed by German public opinion,  refuses any assistance to Greece.  The euro weakens,  making German exports even more competitive.  Germany experiences a minor boom in exports,  assisting the country's recovery from the Global Financial Crisis.  Greece introduces the first of a series of increasingly severe austerity packages.  Despite the austerity packages  (or indeed in part because of them)  the situation in Greece worsens.

Stage 2:  As Greece heads towards inevitable default,  Germany finally consents to a bailout package.  This consists of loans to Greece at interests rates which are high but not as high as the unsustainable rates now demanded by the markets.  However,  the markets have already begun to demand higher rates for Portuguese,  Irish and Spanish debt,  prompting calls for more far-reaching action,  such as the establishment of a common eurozone treasury which could issue shared  "eurobonds".
→  Germany staunchly resists the eurobonds idea,  as it would lead to a minor rise in the cost of German borrowing  (public and private).  Germany also resists expansion of the bailout measures.  The euro weakens further,  thereby sustaining the prosperity of the German export industry. Greece undertakes further austerity measures,  which eventually cripple its economy and cause widespread hardship.  Ireland,  Portugal and Spain also cut government spending.  Unemployment remains above 20% in Spain.

Stage 3:  Germany agrees to bailout loans for Ireland and Portugal but not before default becomes an inevitable prospect there too.  The ratings agencies state that they would give shared eurobonds the same rating as the weakest country in the group,  effectively ruling them out as a solution to the immediate crisis.  The best solution now seems to be to have the European Central Bank to act as  "lender of last resort",  effectively  "printing money"  to fund loan repayments by the vulnerable countries.  Inflation in the eurozone would rise as a result,  especially in the countries with healthier economies  (such as Germany)  but not to damaging levels.
→  Germany staunchly opposes the ECB becoming lender of last resort.  The situation worsens,  with serious fears arising about Italy,  Belgium and even France.  Italy's borrowing costs start to rise sharply.  The euro continues to weaken.  Consequently Germany's exports continue to sell reasonably well despite the loss of demand from the crisis-hit countries,  which are steadily becoming poorer.  Large numbers of young people begin to emigrate from Ireland and Spain due to the lack of jobs at home.  Suicide rates in Greece go from being among the lowest in Europe to the highest in Europe.

Stage 4 (the last few months):  Italy's borrowing costs remain at unsustainable levels despite a change of government.  Germany introduces a plan for reshaping the eurozone to suit itself,  to which the other countries acquiesce with barely a murmur due to the desperate situation they are now in due to Germany's stonewalling,  but which unfortunately offers little to solve the immediate crisis.  France's borrowing costs begin to rise as well and a downgrade in France's credit rating seems imminent.  The euro hits new lows against all major currencies and a recession seems highly likely in 2012 for the eurozone as a whole,  although Germany may escape with nothing worse than low,  near-zero growth,  buoyed as ever by its export sector.

What's next?

At every stage so far,  Germany has resisted the most obvious and cheapest remedies unless and until those remedies became the only possible course of action.  Extrapolating this into the future,  if Italy or France seemed in danger of imminent default,  presumably Germany would finally agree to let the ECB act as lender of last resort.  But will that even be possible now on such a large scale without the danger of double-digit or even triple-digit inflation?  Unfortunately no one actually seems to have a clue what is going to happen.

Update 10.01.2012:  Oops,  missed something rather important:  the ECB has in fact started  "printing money"  and acting as lender of last resort,  albeit in a rather limited,  indirect and not terribly effective way.  Its loans of 489bn euros to eurozone banks in late December were ostensibly done to reinforce those banks,  but the banks probably will in turn invest anything up to half of that money in eurozone government bonds.  So it's a backdoor way of the ECB buying government debt.  Of course,  the banks might not do entirely what is expected of them,  and in any case it is not a very efficient or even permanent fix.  Ultimately it's a continuation of exactly the course of action we've seen all along so far:  it prolongs the crisis,  prolongs the weakness of the euro and the suffering of the weaker eurozone countries,  while doing just enough to stave off the complete collapse of the currency.  We can probably expect this to continue until Germany's euro reform plan comes into force.