Thursday, April 11, 2013

The Future of the Euro

The Cyprus rescue, the political situation in Italy, and the unacceptable unemployment levels in Spain and Greece make it absolutely clear the approach of can kicking will lead to nothing. The situation in the euro area is getting worse and worse, but at the same time the European Commission, Germany and now even the ECB do not seem to plan to end their policy of making only the smallest steps possible at the very last second. This has to change and it has to change now.

It has been Germany's position that every country has to deal with its own problems from the onset of the euro crisis. Reluctantly, Merkel was forced to give in to first a bailout of Greece, followed by Ireland and Portugal, the EFSF and the ESM and now to the rescue of Cyprus. But instead of actually helping the countries in need, every one that has received a bailout is stuck in recession, with no hope of recovery since the austerity measures which had to be enacted, have caused significant additional damage to the economies. What is more, the austerity measures have also caused the debt to GDP levels to rise. The fiscal multipliers were larger than one.

In a sane world we would recognize our mistake and change course or at least reduce the extend of "fiscal consolidation". Instead the Euro-Titanic has accelerated and is heading steady towards its own demise. The Cyprus rescue has in fact basically forced the island out of the euro area. Yes, it still has the euro, but capital controls which had to be enacted to buy the banks some time have made a mockery of the principle of a common currency area. Shortly after the situation in the island was resolved for now, the Portuguese Constitutional Court declared some of the austerity measures unconstitutional. Instead of using this opportunity to reduce the damage caused, the European Commission outright threatened the countries government:

At the same time, it is a precondition for a decision on the lengthening of the maturities of the financial assistance to Portugal, which would facilitate Portugal's return to the financial markets and the attainment of the programme's objectives.
While also mentioning the very much disproven myth that austerity leads to growth:

Continued and determined implementation of the programme offers the best way to restore sustainable economic growth and to improve employment opportunities in Portugal.
 One of the other major players in the euro crisis in my opinion the most important one the German government went a step further, with Schäuble saying:

"Nobody in Europe sees this contradiction between fiscal policy consolidation and growth,” Schauble said. “We have a growth-friendly process of consolidation, and we have sustainable growth, however you want to word it."
Well, I guess said contradiction is so blatantly obvious, that even I see it. Some call it a recession: E.g. the IMF and the European Commission but that's just wording. In truth everything is double-plus-good especially in Germany. For example new orders:

 See the one month uptick in the end? Everything will be fine is fine.The production index looks even better. It can almost be described as stagnation and everybody knows stagnation equals sustainable growth.
 Also Germany isn't in recession, yet. The growth-enhancing austerity is working, and every one claiming otherwise should get his wording straight.

Now this week Soros commented that Germany should either leave the euro or allow eurobonds. He also stressed the need for an actual banking union. Well, I think the most likely scenario is his worst case:

By contrast, if Italy left, its euro-denominated debt burden would become unsustainable and it would have to be restructured. This would plunge the rest of Europe and the rest of the world into an uncontrollable financial meltdown. The collapse of the Euro would likely lead to the disorderly disintegration of the European Union and Europe would be left worse off than it had been when it embarked on the noble experiment of creating a European Union.
I very much agree with Soros but as Weidmann's comments this weekend have shown, Germany will not accept a real banking union. Just as recession isn't sustainable growth; Weidmann's "banking union" isn't. The SPD is for Eurobonds but since the party is unlikely to catch up to Merkels CDU/CSU sister parties, it will - if it even is in the next government - only be the junior partner in a coalition. With the CSU being basically the tea party of the CDU it is also unlikely that we will see Eurobonds. At the same time Soros' idea that Germany should leave the euro won't happen. We are very much profiting from the single currency.

So I think it is likely that the Euro-Titanic will hit the iceberg and sink.Yes, there will be further rescue attempts and we might even see a Brüning like minority government in Italy, but at the moment there is no player left, that is even willing to do anything, anymore. Inflation is at 1.8 % and likely to decrease further. ECB reaction? None. This looks even worse when we look at statistsches Bundesamt's inflation measure (1.4 %). At some point the citizens of a country in the euro area will force their government to exit the currency. At least then we know whom to blame for our mistakes.

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