Six Weeks to Save the Euro? It was Dead on Arrival

Do we have six weeks to save the Euro?

From the Guardian:

George Osborne warned on Friday that the leaders of the eurozone had six weeks to end their political wrangling and resolve the continent’s crippling debt crisis.

Speaking in Washington, the chancellor said that the turmoil in the world’s financial markets meant there was now “a far greater sense of urgency” and mounting pressure on Europe from the G20 group of developed and developing nations.

“There is a sense from across the leading lights of the eurozone that time is running out for them. There is a clear deadline at the Cannes summit [G20] in six weeks time”, Osborne said. “The eurozone has six weeks to resolve this political crisis.”

 I don’t think so. I think the Euro was effectively dead on arrival. A fundamentally broken system; and that fundamental discord has now been transmitted around the world in the form of European sovereign debt, infecting the balance sheets of nations and institutions, creating huge counterparty risk, and raising the possibility of a tsunami of defaults.

And why was it fundamentally broken?

Niall Ferguson explains why:

Crisis—from the Greek “krisis,” for a turning point in a disease—is one of many English words we owe to the ancient Athenians. Now their modern descendants are reminding us what it really means.Just when it seemed safe to start using the word “recovery,” a Greek crisis is threatening the world economy, and the very existence of the world’s second-biggest currency.

The euro seemed like such a good idea just 10 years ago. Europe had already achieved remarkable levels of integration as a trading bloc, to say nothing of its consolidation as a legal community. Monetary union offered all kinds of alluring benefits. It would end forever the exchange-rate volatility that had bedeviled the continent since the breakdown of the Bretton Woods system of fixed rates in the 1970s. No more annoying and costly currency conversions for travelers and businesses. And greater price transparency would improve the flow of intra-European trade.

A single European currency also seemed to offer a sweet trade. European countries with problems of excessive public debt would get German-style low inflation and interest rates. And the Germans could quietly hope that the euro would be a little weaker than their own super-strong Deutsche mark.

Monetary union had geopolitical appeal, too. In the wake of German reunification, the French worried that Europe was heading for a new kind of domination by its biggest member state. Getting the Germans to pool monetary sovereignty would increase the power of the other members over a potential Fourth Reich. And, best of all, it would create an alternative reserve currency to challenge the mighty U.S. dollar.

Still, when European Commission president Jacques Delors first proposed monetary union, it seemed a wildly ambitious project. Even when it was formally adopted as the third pillar of the European Union in the Maastricht Treaty of 1992, many economists—myself included—remained skeptical.

It was far from clear that the 11 countries that initially joined up constituted an “optimal currency area.” A single monetary policy would likely amplify, rather than diminish, the fundamental differentials between highly productive Germany and the less efficient periphery.

But the worst defect in the design of the EMU, we argued, was that it was uniting Europe’s currencies but leaving its fiscal policies completely uncoordinated. There were, to be sure, “convergence criteria,” which specified that a country could join only if its deficit was less than 3 percent of gross domestic product and its public debt was less than 60 percent. But even when these were turned into a permanent set of fiscal rules in the Stability and Growth Pact, there was no obvious way they could be enforced.

The design of the EMU illustrates a profoundly important truth about human institutions. Just because you don’t create a formal procedure for something you would rather didn’t happen, that doesn’t mean it won’t happen. This was one of the reasons Britaindecided not to join the single currency. A confidential Bank of England paper circulated in 1998 speculated about what would happen if a country—referred to only as “Country I”—ran much larger deficits than were allowed. The result, the bank warned, would be a colossal mess.

10 thoughts on “Six Weeks to Save the Euro? It was Dead on Arrival

  1. Was the Euro necessarily “dead on arrival?”. To me the error was the assumption that all sovereign debt was equal and therefore wasn’t priced to properly to reflect individual country risks. Italy and others are still raising funds now and paying big premia over Euroland base rate. Companies issue bonds in their domicile country and again often have a significant premia so the concept isn’t new. Why was it necessary for the Euro base rate to be the effective base rate in all Euroland countries? Consider in the US where a number of US counties have been bankrupt – they sure didn’t get loans at base thereafter. Maybe the Euro should be worked through – would lenders be so daft as to make the same assumptions of equal creditworthiness again? Looking at USTs, perhaps don’t answer that!

    • To me the error was the assumption that all sovereign debt was equal and therefore wasn’t priced to properly to reflect individual country risks.

      Not quite equal, but certainly less unequal. And certainly corporate/state bondholders of debt from the United States have many of those problems. But at least the United States has a unified budget, so you don’t get the crazy monetary-fiscal divergences you do with Europe.

      The problem is that nobody is really in charge, and no real mechanisms were created to handle a situation like this. Romano Prodi admitted at the start that the entire Euro project requires a whole new set of policy tools. At the time there wasn’t the political will to create them, but they decided to cross that bridge when they came to it. Well now they’re not just at the river. They’ve waded into the mud — and there’s no way the Germans and Scandinavians are happy to create the necessary institutions and policy tools to make Europe work. And some of us recognised at the very start of the EMU that there would never be the political will on the streets and outside of Brussels, really.

      Dominique Strauss-Kahn noted at the start that “monetary union is like a marriage”. They problem is, in most marriages, you don’t have fifteen different nations writhing around, struggling for power, none of whom is really in charge.

    • On the physical side, a lot of bullion dealers seem to be totally sold out at these price levels, which adds weight to the idea it was a hedge fund or a central bank liquidating a (most probably paper) position to raise collateral.

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  3. Slovakia has never had such an important decision. I am sure the Alpha male ego of Richard Sulik will ensure he get’s his 15 minutes of fame on the world stage and history. I agree with his views, but I am sure he’ll dither to the end (causing a huge short opportunity), then finally accept when the EU Pupeteers convince him (Cash, whores or threats) to accept the EFSF 2.0 from:

    Sept. 15 (Bloomberg) — Greece should default on its debt and abandon the euro as further loans won’t solve its crisis, a Slovak lawmaker whose vote in parliament may decide whether the country backs a bailout package for the currency area said.

    The Freedom and Solidarity party, a member of Slovakia’s coalition government, will vote in parliament against the European bailout system, founder and parliamentary speaker Richard Sulik said in an interview. His party, known as the SaS, wants member states to “keep to the rules” guiding the euro and “start saving money.”

    “The first step is, Greece has to go bankrupt,” he said at his office in the Slovak parliament in Bratislava. “There is no possibility that” Greece “not now, not in the future, not in 50 years, will” pay back “the loans. My personal opinion is it would be better for Greece to leave the eurozone.”

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  5. Please find EFSF press release: EFSF’s top credit rating affirmed

    If you would like any further information, please contact:

    Christof Roche

    Chief Press Officer

    Tel: +352 621 368 923

    29 October 2011

    EFSF’s top credit rating affirmed

    Luxembourg – Following the official entry into force of the Amendments to the EFSF Framework Agreement on 18 October 2011, all three credit rating agencies affirmed the best possible credit rating – Standard & Poor’s “AAA”, Moody’s “(P)Aaa” and Fitch Ratings “AAA” – to the EFSF.

    All three agencies have also assigned the highest quality short term rating to the EFSF – Standard & Poor’s “A-1+”, Moody’s “(P)P-1” and Fitch Ratings “F1+”.

    In reaction to the potential increase funding volumes that could arise to take into account the new tasks assigned to the EFSF, its funding strategy will consequently become more flexible and diversified. It is expected that the EFSF will implement a short-term funding strategy which could be structured around a Bill programme.

    Klaus Regling, CEO of EFSF stated “confirmation of the highest possible credit rating shows the confidence in the strategy of the euro area to restore financial stability. The amendments to the EFSF will allow it to contribute in more ways to implement this strategy”.

    Under the amended EFSF, the guarantee commitments have been increased to €780 billion and effective lending capacity is now be €440 billion. The scope of activity of the EFSF has also been enlarged and it is now authorised to:

    Intervene in the debt primary and secondary markets.
    act on the basis of precautionary programmes
    finance recapitalisations of financial institutions through loans to governments including in non-programme countries
    All assistance to Member States would be linked to appropriate conditionality.

    EFSF has placed 3 benchmark issues this year for a total of €13 billion in support of the programmes for Ireland and Portugal which total €43.7 billion (€17.7 billion for Ireland; €26 billion for Portugal). Christophe Frankel, EFSF Deputy CEO and CFO commented “EFSF is fully operational and stands ready to perform all duties to which it is assigned”.

    EFSF intends to issue a €3 billion benchmark bond for Ireland in the near future market conditions permitting.

    • What was that Warren Buffet said about interconnectedness making systems weaker by mingling the bad with the good? The bad weakens the good, not vice verse. The EFSF (Moody’s would do well to heed their owner’s rationale) is a case-in-point.

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