So after a brief respite over Christmas and New Year, we get the resumption of the eurozone tragicomedy. How many Merkel/Sarkozy summits have we had over the past eighteen months? I’ve lost count. Carla must be worried that there’s something else going on.
Sarkozy and Merkel bring to mind that great put down by Abba Eban. They never miss an opportunity to miss an opportunity. You have to laugh that this has been labelled a “summit for growth” when the first initiative that emerges is a Financial Transaction Tax.
It was interesting to read yesterday of the Ernst & Young study that suggested that instead of raising €37bn of revenue, imposing the tax would result in a fall in tax revenue of €116bn when the secondary effects of lower GDP growth and decline in financial transactions are taken into account. The EU’s own figures suggest that GDP would be lowered by around 1.75 percentage points.
Is Sarkozy on drugs? How can a summit aimed at boosting growth come up with a measure that actually reduces growth? The problem with the political classes in Europe is they are not only economically illiterate but are positively delusional. It might be funny if it were not so serious.
There will be no solution to the eurozone problems until the elite recognise the underlying causes. As I and others have rehearsed, the root cause of the eurozone crisis is the trade and capital flow imbalances that have resulted from the shifts of competitiveness within the single currency zone.
These imbalances became self reinforcing for an extended period of time, causing a credit boom and higher inflation in the periphery together with rising trade deficits. To finance these deficits, capital flowed to the periphery, mainly from Germany, with the concomitant accumulation of debt.
For most countries the accumulation of debt was in the private sector (Greece being the notable exception). However, the credit crisis saw much of this migrate to the public sector, either explicitly (like Ireland) or implicitly through the accumulation of sovereign debt by the banking system.
Excessive fiscal deficits are the symptoms of the disease rather than the disease itself. The proposed tightening of fiscal rules is bound to fail as it doesn’t get to the root cause. Indeed it is likely to make things worse as it will reduce growth and increase credit defaults.
The policies that need to be pursued to rescue the eurozone never seem to make it on to the agenda. The correct policy prescription for recovery and growth is very simple. Germany needs to expand domestic demand aggressively, accept higher inflation and run a trade deficit with the rest of the eurozone.
This is the only way that the periphery can hope to repay its debts to Germany. By definition, the periphery has to run a trade surplus with Germany. The offsetting capital flow back to Germany would allow the repayment of accumulated liabilities to the German banking system.
The only way that the periphery can run a trade surplus with Germany is for German domestic demand to expand more rapidly than overall demand in the eurozone. This will entail two features that are likely to be unacceptable to German politicians and public. Namely, inflation will have to be higher than the eurozone average and domestic borrowing will have to expand.
This always supposes that the periphery has the goods and services that Germany will want to buy. Other than tourism, it is quite difficult to see what large economic sector might achieve this turnaround rapidly.
The only alternative way to achieve a resolution is to have a massive semi permanent fiscal transfer from Germany to the weaker countries. Mr Cameron has been roundly attacked for daring to speak this unpalatable truth.
Quite frankly, none of this is particularly new, but until these painful truths are addressed, there can be no solution. If the politicians can’t come up with the goods, then the market will force the solution.
The danger signs are coming thick and fast. The collapse in the Unicredit share price might presage a total collapse. Once banks lose credibility in the market, the end can come surprisingly quickly. Unicredit must be close to implosion, especially with its exposure to CEE and the potential domino effect of Hungary. Dodgy legacy loans from German real estate are also a concern.
The failure of the ECB’s LTRO is also a worrying feature. Nearly all of the liquidity appears to have been placed back with the ECB on overnight deposit. At least this provides some liquidity buffer but the increasingly scarcity of good quality collateral makes you wonder how long this game can go on.
Source: Zero Hedge
There was a really scary chart in the FT last week from Soc. Gen., showing the collapse of the money multiplier. Monetary policy has become largely ineffectual and the banking system is seizing up.
The only way to reverse this is to reduce the risk premiums in the sovereign bond market. The ECB will have to go “all in” and backstop sovereign bonds. The only reason yields are low in the US and UK is that investors know that they will get their money back. The ECB will have to do the same, however unpalatable that is to the Germans.
At the moment, it is difficult to see the politicians arriving at a solution. Their analysis and narrative of the crisis is not just wrong, it is delusional. Even if they adopt the correct analysis, the solutions may prove to be politically and culturally unacceptable to Germany.
Germany will have to weigh the cost of supporting the euro against the cost of its disintegration. The disintegration of the euro would bankrupt its banking system. Assuming a rise in the “new DM”, its export industry would also suffer a sharp contraction.
History teaches that in a credit bust, in the short-term, it is the debtors who suffer, but in the longer-term, it is usually the creditors who suffer most. In the 1930s, it was most notably the US and to a lesser extent France. To avoid the possibility of a Great Depression in Europe, Germany will need a complete change of mindset and embrace the profligacy of inflation and debt. Anything less will spell disaster for Europe and Germany itself.
