Big Change For Europe?

I am sure the Euro will oblige us to introduce a new set of economic policy instruments. It is politically impossible to propose that now. But some day there will be a crisis and new instruments will be created.

— Romano Prodi, EU Commission President, December 2001

So the intent for Europe was always that a future crisis would bring about the justification for a resolution to European financial disharmony — namely, that while countries in the Euro control their own budgets, they don’t control their own currency. This mismatch means that with countries pulling in different directions, the European Central Bank is posed with an unmanageable task — create one policy to fit a group of very different economies. At the time of the Euro’s creation, Europe adopted a cross-that-bridge-when-we-come-to-it approach: a crisis would produce the circumstances required to justify unifying fiscal policy, a policy that at the time of the Euro’s introduction seemed unnecessary (and now is deeply unpopular).

But what if disharmony — both in terms of the forces producing the crisis, and disagreement over how to handle the problems — has created such a huge turmoil that instead of crossing the bridge, Europe falls into the water beneath?

From the Economist:

September is a cruel month in international monetary history, when regimes that once seemed inviolate have shattered. In 1931 it was the month when Britain went off the gold standard. In September 1992 the same country was booted out of the European Exchange Rate Mechanism. This month will not see the end of the euro, but could go a long way to deciding its fate.

With the concept of Eurobonds becoming increasingly unpopular, the richer nations getting cold feet over the endless bailouts, and the poorer ones having no face for austerity, is it possible that the European system is just too fractured to mend? The Economist thinks not:

Barry Eichengreen, a monetary historian at the University of California, Berkeley, says that the economic costs of disintegration would be catastrophic for Europe and beyond. In the case of Greece, he fears the result would be a 1930s-style Depression brought about in particular by the collapse of the financial system. If Germany were to leave, its export-based manufacturing economy would take a body blow as the new currency soared. Other costs are incalculable because much would depend on responses that cannot readily be modelled: a Greek exit, say, could spark bank runs in other peripheral countries.

Not everyone accepts these dire warnings. Daniel Gros of CEPS, a think-tank in Belgium, thinks that the impact on other vulnerable countries of a Greek exit could be contained as long as European leaders made clear that they would be protected. Charles Calomiris of Columbia Business School argues that Greece could ultimately benefit by leaving because it would bring about both the harsh default needed to restore debt sustainability and the big devaluation needed to restore the country’s competitiveness. As for Germany, it has a knack of coping with a high exchange rate.

So far, Europe has bungled through the crisis playing it by ear and crossing bridges as it reaches them, all with the implication that the end-goal (i.e., the thing that would solve the problems) is fiscal union. But the reality is that this muddle may well have driven Europe — and the global economy — off a cliff, because the “policy instruments”, i.e. fiscal integration, are politically untenable. Global fear is up.

From Business Insider:

Look at the following graph from the St. Louis Fed. It is the amount of deposits at the US Fed from foreign official and international accounts, at rates that are next to nothing. It is higher now than in 2008. What do they know that you don’t?

I predict that Europe will continue to muddle through, instead of taking firm and concerted action. That’s because the federal European government is an incoherent muddle — and the centralised policies and systems it has adopted require coherence. And I predict that this continued muddle will make the crash — whether it happens this week, in three months, in three years, or later — much, much worse.

18 thoughts on “Big Change For Europe?

  1. That graph scares me.

    I have my cash tied up. And although a Bank run is a possibility, governments can step in and guarantee (upto to a limit say 1 million)

    The Australian government guarantee ends in a few weeks. I hope they say it will be continued, as my 6.5% cash rate, seems awfully high!!!!

  2. Hi Aziz,

    Stumbled upon you by following a recommendation on zerohedge. Great blog – keep it up.

    I just read a series of articles on about the situation (I think it’s serious enough that we can just call it ‘the situation’ now!) by Glen Neely, the Elliot Wave analyst. To summarise, he argues that money printing will stop, because the public won’t allow it to continue beyond a certain point, and because politicians and the Fed will realise anyway that printing is powerless against the massive force of debt deflation. When that happens (soon), the price of gold will crash and the price of all other assets in indebted Western nations will follow, albeit more slowly, as we enter a 10-20 year period of deflationary stagnation.

    You have argued that further increases in the price of gold don’t depend on more printing. What do you think he’s missing?

    (PS. I know this piece is about Europe, but I hope you’ll agree that these issues are totally interdependent.)

    • Hi there,

      Because politicians and the Fed will realise anyway that printing is powerless against the massive force of debt deflation.

      Evidence shows that the money-printing does stave off debt-deflation. It massages figures without addressing the underlying problems, but it does buy time and keep the system floating along. And there is no way that the Keynesian establishment will back-track on their entire academic careers. They don’t see it as money printing. They see it as “raising aggregate demand”. And they see mild-to-moderate inflation as somewhat beneficial because of its net effect on debt.

      You have argued that further increases in the price of gold don’t depend on more printing. What do you think he’s missing?

      First I think he’s missing the fact that when you look at the world from the perspective of a different currency, the inflationary picture is completely different. From the perspective of the fiat dollar, we are experiencing a weird and confusing wave of biflation (inflation in food, fuel and “necessities”, deflation in everything else). When we look at the world from the perspective of gold (as Exter’s inverted pyramid puts it: the ultimate money), it is obvious that the real phenomenon is a gold-denominated deflationary depression — the world is in a depressive spiral (conveniently hidden under a tidal wave of fiat printing to “raise aggregate demand”) and will be increasingly coveting and hoarding the ultimate currency (look at net yields on gold and silver vs other asset classes and tell me the mutual funds won’t be increasing their holdings) instead of investing in productive assets/ infrastructure/ output. I think the Keynesians will realise this, and the final throw of the Keynesian dice will be QE Gold (3-5 years away), attempting to get investment back into productive ventures by lowering net-gold yields and reversing gold-denominated inflation.

      Second I think he’s missing the fact that a lot of the global demand for gold (caused in part by fear regarding the global economic slowdown) is being driven by non-US actors, particularly developing world central banks.

      Third I think he’s missing the fact that printing has a small net effect on the amount of money circulating in the US. QE increased bank reserves, but it didn’t actually increase M2 (very much) or M3 (at all). A huge factor is other nation’s FX holdings. If that money is returning to the US to buy American productive assets and gold (in the absence of a global recovery and the presence of a depreciating/dying dollar, this is a dead cert) then that’s a tidal wave of cash to reverse any fiat-denominated deflation.

      Fourth, I think he’s missing that if a 10-20 year fiat-deflationary depression began to bite, the riots and ensuing civil disorder would oust any government, trigger the nationalisation of banking, and bring in a corporatist-militarist regime that would forcefully build America out of any depression. Although central planning does lead inexorably to the misallocation of capital, there is no doubt in my mind that in spite of that problem, a massive centrally-controlled infrastructure/ energy independence/ manufacturing program would end the depression. This might cause other problems (like, for example, if that manufacturing drive is in the name of winning a conflict with China), though.

      NB: For those among us who believe the elite want a deflationary depression so that they can buy up assets, well I don’t deny that possibility. But for the “buy when there’s blood on the streets” adage to work, you need a recovery eventually. And the more forceful the better.

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