Is Europe really toast?

[Storm]

An interesting and somewhat unexpected thing happened today.  The German "bund" auction failed to draw enough interest from investors and a lot of the bonds were never sold.  This might herald the beginning of the end for the Euro zone.  A new Reuters poll says that 14 out of 20 leading economists think the Euro zone will not survive intact:

http://finance.yahoo.com/news/euro-zone ... 09818.html

It seems to me that the ECB has yet to step up and say they will be the lender of last resort, similar to what the Fed did in 2008.  They could probably make this all go away, or at least kick the can down the road a few years by backstopping all of the Euro zone.  The longer they fail to do so, the more market conditions will deteriorate.  It's sort of a self-fulfilling prophecy, in a way.

[MediumTex]

Picture a group of climbers getting ready to head up a mountain.  The climbers' experience level ranges from complete novice to 30 years+ experience.

Also assume that a couple of the climbers in the party spent the previous night drinking and one may have even been drinking shortly before showing up at the mountain.

If you were a climber of moderate experience and had a sober and serious mind, would you want to be clipped to that group of climbers or would you rather take your chances on your own?

The EU reminds me of the group of climbers I am describing.  Sooner or later such a group is going to encounter a lot of trouble.

[stone]

Here is something that details the legal constraints on the ECB:
http://www.hussman.net/wmc/wmc111121.htm

Incidentally it also says that QE by the ECB (which is not permitted) would be inflationary. To be honest I don't really follow the argument.

"From this perspective, it should be clear why the Federal Reserve's tripling of its balance sheet has not resulted in near-term inflation. There is significant demand for the U.S. dollar as a safe-haven currency, the creation of dollars is still viewed as temporary, even though the Treasury is still bailing out Fannie and Freddie in order to make the mortgage securities held by the Fed whole. The problem for the Fed will emerge in the back half of this decade if (and I suspect when) it becomes clear that there is no easy way for the Fed to disgorge its balance sheet without causing disruptions in an economy where the U.S. debt/GDP ratio will then be well above 100%. At that point, the dollars that the Fed has created may be looked upon as more permanent than the markets bargained for, and we are likely to see inflationary pressures. For now, however, we continue to expect only modest near-term inflationary effects from the Fed's actions, despite being reckless and misguided in a broader sense.
Against this backdrop, consider a situation where the European Central Bank begins to print new euros in order to purchase the debt of distressed European countries that are deeply indebted and likely to become more so (barring a major restructuring of their existing obligations). In this case, would people be likely to view the newly created euros as temporary or permanent? Would people be likely to seek the euro as a "safe haven," or would they seek the relative safety of some other currency? For my part, I am convinced that a move to buy distressed European debt by creating euros would be seen as permanent money creation, and that far from seeing any safe-haven demand for euros, we would instead see a flight from the euro. As a result, European inflation would predictably accelerate."

[MediumTex]

Here is something that details the legal constraints on the ECB:
http://www.hussman.net/wmc/wmc111121.htm

Incidentally it also says that QE by the ECB (which is not permitted) would be inflationary. To be honest I don't really follow the argument.

"From this perspective, it should be clear why the Federal Reserve's tripling of its balance sheet has not resulted in near-term inflation. There is significant demand for the U.S. dollar as a safe-haven currency, the creation of dollars is still viewed as temporary, even though the Treasury is still bailing out Fannie and Freddie in order to make the mortgage securities held by the Fed whole. The problem for the Fed will emerge in the back half of this decade if (and I suspect when) it becomes clear that there is no easy way for the Fed to disgorge its balance sheet without causing disruptions in an economy where the U.S. debt/GDP ratio will then be well above 100%. At that point, the dollars that the Fed has created may be looked upon as more permanent than the markets bargained for, and we are likely to see inflationary pressures. For now, however, we continue to expect only modest near-term inflationary effects from the Fed's actions, despite being reckless and misguided in a broader sense.
Against this backdrop, consider a situation where the European Central Bank begins to print new euros in order to purchase the debt of distressed European countries that are deeply indebted and likely to become more so (barring a major restructuring of their existing obligations). In this case, would people be likely to view the newly created euros as temporary or permanent? Would people be likely to seek the euro as a "safe haven," or would they seek the relative safety of some other currency? For my part, I am convinced that a move to buy distressed European debt by creating euros would be seen as permanent money creation, and that far from seeing any safe-haven demand for euros, we would instead see a flight from the euro. As a result, European inflation would predictably accelerate."

It's funny how impressive something can sound when it is actually saying almost nothing.

As best I can tell, the passage above is saying "The Fed's policies haven't thus far been inflationary in the U.S., but the same policies in the EU might be inflationary."  I would respond to this simple speculative statement with: "But then again, such a policy in the EU might not be inflationary, right?"

In my view, the unsuccesful application of the IMF austerity voodoo in Greece has exposed multiple veins of defective thinking that underpin the whole EU experiment.  At this point, collapse should be a foregone conclusion, with the only question being the timing and the shape of a post-EU world.

[stone]

Medium Tex, I totally agree. How does he explain the UK? We have rampant QE and a large trade deficit and yet fairly modest 5% inflation. It is hardly Weimer republic. The Eurozone as a whole has not got a net trade deficit. German trade surpluses to outside the Eurozone outweigh the deficits of the rest. The trade imbalances are all within the Eurozone.
I think such people think in abstractions. They do not place themselves in the shoes of the economic agents on the ground. If they did that, then they might realize how hard it is to imagine a way for their economic models to play out.

[stone]

With regard to the poll, Germany leaving the eurozone is the only thing that could give it some survival time. It is doomed so long as Germany is in even if it is just Germany with one other partner .

[moda0306]

stone... I don't understand that logic on Germany, though I've heard it before... can you elaborate as to why THEY of all countries have to leave the Euro?

[stone]

moda, Germany is a net exporter and a large economy. If Germany was on its own, the German currency would strengthen and its competitativeness would normalize. The exchange rate of the euro makes it easier for Germany to export than is compatible with equilibrium and harder for the other Eurozone economies than is appropriate for them. That creates unemployment in the other Eurozone countries and that worsens the cycle. If Germany left the Euro, Germany would be strong enough to create a new currency for itself with little problem.

[craigr]

The EU and Euro can't go away fast enough. Although I like Tex's comparison, I prefer to think of the Euro as a family deciding to pool all their money together and bringing in the extended family as well. It is obvious that sooner or later the deadbeat cousins and crazy uncle are going to start abusing the situation and causing problems.

The Euro is a collectivist idea that assumes all the countries and cultures are replaceable cogs. But the reality is that those people and countries are all much different from each other and have their own interests they want to protect. The idea of them coming together and sharing the resources equitably without abuse is insane.

When the Euro finally blows up I will be celebrating for the citizens of Europe because they will have regained their sovereignty over their own countries and affairs. It will be a very good day for freedom and a very bad day for central planners.

[stone]

To extend Medium Tex's mountaineering analogy, the rules of the Euro mean that not only are all the mountaineers roped together but also if one climbs quicker than the others, then that is rewarded by the quicker mountaineer getting to transfer some of the load from his backpack to the backpack of his slowest companion.

Possibly the crazy uncle and deadbeat cousin would be able to climb the mountain in their own haphazard manner if left to their own devices. When roped in with the surging energetic hero, who is compelled by treaty to transfer all of the contents of his pack into theirs, they haven't a chance.

I have to stress that I am full of admiration for Germany. If I could vote for a UK government that worked like the German government I would. They have great transport, low unemployment etc. It seems a happy, peaceful place where people live rewarding lives. That doesn't mean that the Euro is a good idea or even that fiscal and then political integration could lead to all of Europe becoming a happy, peaceful place where people live rewarding lives.

[MediumTex]

I have to stress that I am full of admiration for Germany. If I could vote for a UK government that worked like the German government I would. They have great transport, low unemployment etc. It seems a happy, peaceful place where people live rewarding lives. That doesn't mean that the Euro is a good idea or even that fiscal and then political integration could lead to all of Europe becoming a happy, peaceful place where people live rewarding lives.

Among other impressive thngs about Germany is that they are coming off a bad century where they lost two wars and were carved in half for several decades (not to mention the hyperinflation episode in the early 1920s).

To come back from multiple shocks to the national psyche to be a strong and stable nation is quite impressive.

I think that modern Germany also offers a strong counterpoint to the Austrian school economists' assertion that a welfare state like Germany would not be competitive with a more free market economy such as the U.S.

[Ad Orientem]

While option 2 on the poll is a possibility I am leaning towards option 3.  The problem with Europe is that they ignored history by creating a single currency without a central government powerful enough to enforce fiscal discipline and with sufficient authority to intervene in the event of a major financial crisis.  The dream of a unified Europe is not dead.  But it has hit a major reality check.  What comes next will be interesting to see.  I am not sanguine about the ability of Europe to avoid a really major, possibly catastrophic, crisis in the near to intermediate term.

[Ad Orientem]

From today's Daily Telegraph...

Death of a currency as eurogeddon approaches
It's time to think what hitherto markets have regarded as unthinkable – that the euro really is on its last legs.

The defining moment was the fiasco over Wednesday's bund auction, reinforced on Thursday by the spectacle of German sovereign bond yields rising above those of the UK.

If you are tempted to think this another vote of confidence by international investors in the UK, don't. It's actually got virtually nothing to do with us. Nor in truth does it have much to do with the idea that Germany will eventually get saddled with liability for periphery nation debts, thereby undermining its own creditworthiness.

No, what this is about is the markets starting to bet on what was previously a minority view - a complete collapse, or break-up, of the euro. Up until the past few days, it has remained just about possible to go along with the idea that ultimately Germany would bow to pressure and do whatever might be required to save the single currency.

The prevailing view was that the German Chancellor didn't really mean what she was saying, or was only saying it to placate German voters. When finally she came to peer over the precipice, she would retreat from her hard line position and compromise. Self interest alone would force Germany to act.

But there comes a point in every crisis where the consensus suddenly shatters. That's what has just occurred, and with good reason. In recent days, it has become plain as a pike staff that the lady's not for turning.

This has caused remaining international confidence in the euro to evaporate, and even German bunds to lose their "risk free" status. The crisis is no longer confined to the sinners of the south. Suddenly, no-one wants to hold euro denominated assets of any variety, and that includes what had previously been thought the eurozone safe haven of German bunds.

Investors have gone on strike. The Americans are getting their money out as fast as they decently can. British banks have stopped lending to all but their safest eurozone counterparts, and even those have been denied access to dollar funding. The UK hardly has anything to boast of; it's got its own legion of problems, many of them not so dissimilar to those of the eurozone periphery.

But almost anything is going to look preferable to a currency which might soon be assigned to the dustbin of history. All of a sudden, the pound is the European default asset of choice.

What we are witnessing is awesome stuff – the death throes of a currency. And not just any old currency either, but what when it was launched was confidently expected to take its place alongside the dollar as one of the world's major reserve currencies. That promise today looks to be in ruins.

Contingency planning is in progress throughout Europe. From the UK Treasury on Whitehall to the architectural monstrosity of the Bundesbank in Frankfurt, everyone is desperately trying to figure out precisely how bad the consequences might be.

What they are preparing for is the biggest mass default in history. There's no orderly way of doing this. European finance and trade is too far integrated to allow for an easy unwinding of contracts. It's going to be anarchy.

It's worth stressing here that for the moment the contingency planning is confined to officialdom. This week, for instance, we've had the Financial Services Authority's Andrew Bailey, admit that he's asked UK banks to plan for a disorderly breakup of the euro. He'd be failing in his duties if he hadn't. Europe's political elite, as ever several steps behind the reality, still regards the prospect as unimaginable.

They need to wake up fast; it's happening before their very eyes. In its current form, the single currency may always have been doomed, but it has been greatly helped on its way by an extraordinarily inept series of policy errors.

First there was the disastrous suggestion from Angela Merkel and Nicolas Sarkozy that if Greece didn't buckle under it might be chucked out. Markets reacted logically, which was to sell bonds in any country that looked vulnerable and chase "safe haven" assets, thereby making it much harder for governments to fund themselves.

The blunder was compounded by attempts to underpin confidence in the banking system by forcing banks to mark their sovereign debt to market. This may only have recognised the reality, but it also destroyed the concept of the "risk free asset", forcing banks for the first time to apply capital to their sovereign debt exposures. Unsurprisingly, they stopped buying sovereign bonds, again making it harder for governments to fund themselves.

But perhaps the biggest sin of the lot was effectively to render all credit default swaps (a form of insurance against default) on sovereign debt essentially worthless, or void, by making the Greek default "voluntary".

This has made it impossible to hedge against eurozone sovereign debt purchases, and thereby destroyed the market. Worse, it's made investors believe that the euro cannot be trusted, that it'll repeatedly find ways of reneging on contract. That's the point of no return. This is no longer a serious currency.

Source...
http://www.telegraph.co.uk/finance/comm ... aches.html

[Storm]

I have to stress that I am full of admiration for Germany. If I could vote for a UK government that worked like the German government I would. They have great transport, low unemployment etc. It seems a happy, peaceful place where people live rewarding lives. That doesn't mean that the Euro is a good idea or even that fiscal and then political integration could lead to all of Europe becoming a happy, peaceful place where people live rewarding lives.

Among other impressive thngs about Germany is that they are coming off a bad century where they lost two wars and were carved in half for several decades (not to mention the hyperinflation episode in the early 1920s).

To come back from multiple shocks to the national psyche to be a strong and stable nation is quite impressive.

I think that modern Germany also offers a strong counterpoint to the Austrian school economists' assertion that a welfare state like Germany would not be competitive with a more free market economy such as the U.S.

Germany still makes some of the best goods in the world.  They have rigorous manufacturing standards, and the world knows that if it says "Made in Germany" it will likely last years, instead of the cheap "Made in China" stuff that will break in weeks.

[stone]

I guess Germany is exceptional in having a large chunk of its economy made up of privately owned family companies rather than corporations. Apparently those companies have a low debt, organic growth stategy and tend to concentrate on being world beaters for a niche market. I guess that makes for a solid economy with little waste. They didn't create Apple, Google, Intel etc though. That took you Californians.

[stone]

Is it true though that the German national debt was forgiven after WWII? I suppose that would have given them a helping hand.

[MediumTex]

Is it true though that the German national debt was forgiven after WWII? I suppose that would have given them a helping hand.

I don't know if debt forgiveness is worth having almost every city in your country bombed into little pieces.

[stone]

Medium Tex, I'm totally sure nothing is worth getting bombed like that.

[MediumTex]

Medium Tex, I'm totally sure nothing is worth getting bombed like that.

How would you like to have been a German insurance company in the first half of the 20th century?

Maybe that's where the "act of war" provisions in insurance policies originated.