The Eurozone crisis is forever playing out like some form of long slow horror film. Indeed for the politicans I suspect its starting to feel sort of like one of those nightmares that goes on and on and never seems to want to end. On Friday…the 13th no less, events happened which confirmed some of my worst fears as regards the future stability of the eurozone.
Firstly we saw downgrading of the sovereign debts of France and 8 other eurozone countries. For once, Im in agreement with the rating agencies. There has been a distinct lack of solidarity among EU countries over this crisis and a failure to realise that were all in the same boat. If Greece or Ireland go down, the economic repercussions on all the other EU countries will be serious. And note that being outside the eurozone doesnt necessarily help. Britain (and Germany’s) banks are horribly exposed to the eurozone and the loss of trade if the eurozone imploded would be hugely damaging. If anything, I can’t understand how Germany or Britain’s AAA credit rating is still worth the paper its printed on!
There are in essence three critical mistakes that European governments, most notably the Germans are failing to appreciate:
#1 Expect the unexpected:
The risk of the current policy of using sticky tape to fix a leaky dam, is that it cannot cope with a sudden unexpected crisis. There are a host of things that could trigger this. The rumour currently swirling around that talks between Greece and its creditors are about to collapse is one example. The possible referendum on the eurozone bailout in Ireland failing (or opinion polls showing it was going to fail) is another. There could be a military coup in Greece or Italy (if that sounds far fetched, remember that Spain and Greece were under the control of Juntas as recently as the mid-1970s and that there is no better breeding ground for a coup than the unique combination of disgruntled underpaid soldiers, an angry populace and a government that appears to have lost its democratic mandate from the people). A major natural disaster in Europe or abroad, the looming election in America (Obama or Romney may promise to do certain things in order to placate their electorates).
I could go on, but the list is endless. The danger is that some unexpected crisis will come along and destabilise the already top heavy euro ship into a capsize.
A good example is the last financial crisis, which was sparked by the bankruptcy of Lehman brothers. With hindsight, this looks silly. Lehmans were neither the largest Institution to get into difficulty, nor even the worst offender. But its collapse made the Masters of the Universe suddenly realise that they were in fact mortal, and suddenly everyone was looking at everyone else wondering who would be next. That proved to be the trigger…what will be the trigger for the next crisis?
#2 Speed and scale
There is also a failure of politicians to grasp the speed and scale at which a crisis could unfold. There will in essence be no time to organise a conference to hammer out a deal over several weeks negotiation. Germany particularly seems to of the view that come what may they can just stitch something together at the last minutes. But by the time politicians start making travel plans, it will already be too late. Again, the panic that preceded Lehmans collapse took everyone, not least Hank Paulson by surprise. Within three weeks of its bankruptcy the entire western financial system tittered on the brink of collapse.
Another example was Britains forced devaluation of sterling and exit from the ERM in 1992. The Major and Thatcher governments had both ignored warnings from both right and left as regards their policy. Arrogantly they assumed that the bank of England would always be able to cope with any crisis and why the speculators, many of them based in London, would never turn on a Tory government. Oh yes they would! By the time Lemont and Major took action, despite spending the best part of £27 Billion to protect sterling and pushing interest rates up to 15%, it was too late. They faced a wall of money on the markets moving against them. There was nothing they could do…other than cower under their desks (which actually according to one rumour is exactly what John Major did on Black Wednesday)…Im wondering if at some point this year we hear reports that Sarkozy or Merkel were caught doing the same.
#3 Irrational thinking and errors of Judgement
Now one might well say that weve nothing to fear, why European governments would have to be incredibly foolish to allow the eurozone to implode. Then why arent they doing anything to fix the present crisis?
It is inevitable that politicians with elections to win will do things that turn out to be foolish or downright insane. Take for example the idea often expressed on the streets of Dublin or Athens that they should just default on their debts, bring back the punt/Drachma and moon the Germans on our way out of the room. Well because neither the Punt or the Drachma would be stable currencies, nobody would lend to them nor hold savings in them, so the governments would have to devalue them pretty quickly, pretty much on a daily basis after their introduction. Of course anyone with savings or investments would immediately withdraw their money (in the form of dollars, or Yuan most likely!) causing a mass capital flight and the collapse of every bank in the country. In short if Ireland or any other country were to do this, we would wipe out the savings and pensions of practically everyone in the country for a generation.
So you might well say, then this isnt going to happen, as only a crazy politician would allow it to happen? Actually Id give a 50/50 chance of it happening to one eurozone country in the next 6 months. And the suggestion by German politicians that any eurozone country that defaults should leave the euro, shows such craziness is contagious. If Ireland left the eurozone then it wont be just Irelands public debts that Foreign banks would need to worry about, but our private debts too…about a trillion euros all told, 104 Billion of them owed to British banks and 82 Billion owed to German banks. If Ireland either left the euro or was forced out of it, these Billions of euros would essential vanish from the balance sheet of Ireland and appear on the balance sheet of the German and British banks with a minus in front of them. As Ive pointed out in prior posts this is more than enough to bring down a few major banks and but a fraction of the losses that would be incurred if Spain or Italy followed Greece or Ireland into the abyss. Very quickly (days or weeks) we could well find German and British savers loosing their life savings and pensions also. No, it would insane for any politician, German or Irish to advocate Ireland or Greece leaving the euro, regardless of what happens. But like I said, its quite possible that this will happen sometime in the next few months.
Of course, once the politicians realise their error, made in haste, it will be too late. As I mentioned in a prior post, if G. W. Bush ever found a time machine, hed be making a few stops…and 9/11 wont be one of them! Was his and Hank Paulsons decision to let Lehman brothers go down wise? Clearly also the bailouts offered to troubled banks both sides of the Atlantic were way too generous, notably Fred Goodwins golden parachute. Much of the current crisis is the eurozone is a combination of this failing and ill-conceived bailout and the dithering of politicians (again the Morgan Kelly article gives an excellent synopsis of Irelands errors).
But hindsight is a wonderful thing! Rightly or wrongly, Lehman brothers was allowed to fail (and even if the Treasury had rescued it it could well be the crisis would have been sparked by AIG or Merrill Lynch going down the following week) and theres no use crying over spilt milk. Similarly there is a risk that during the looming crisis some politicians, frightened, angry and under pressure from equally angry and scared voters, will behave irrationally and make some crucial mistakes. Talk about an amicable divorce as an end game
for this euro is both foolish and politically naive. It would take extreme political patience and professionalism to complete such a measure and the present dithering should indicate over a crisis that could and should have been solved a year ago, should demonstrate that this is impossible. Whats more likely is that once one country goes down all the others will likely adopt an every man for himself approach (much as the banks did after Lehman Brothers) and all will go down with the ship.
So what are the solutions? I get tired of asking this rhetorical question, but as time passes the number of plausible options is forever narrowing. Since the beginning of this crisis, Ive been advocating either the Eurobond or direct ECB lending as a solution. We can scratch both those off now, thank to the downgrade. They would only work so long as the bulk of the eurozone retained a AAA credit rating, so this is now off the table.
The eurozone bailout fund? Forget it! Inadequate funding! Like I said, a quick few sums with a calculator should tell you the funds set aside are wholly inadequate. Also France happened to be one of the guarantors of the bailout fund, so Id argue thats kudos for this idea.
There is still the option of Quantative Easing or an across the board devaluation of the euro, but of course these are the very policies German savers fear the most and I for one would argue that such measures count as a defacto default on ones debts anyway. The political will to implement them is also simply not there.
I think its pretty clear therefore, that unless there is some significant change in the economic winds or a major shift in politics within the EU occurs soon, the situation is hopeless and its just a case of when and how. And theres not a lot the rest of us can do about…other than stocking up on dried food and bottled water :>>!
Of course, this doesn’t necessarily mean Armageddon. Countries, even European ones, have gone bankrupt before. Times were tough, but we got over it. Economies have recovered from far worse (2 world wars for example) in the past. But its the bit in the middle, where many millions loose their jobs and life savings thats the tricky bit. But life will go on after the crash.