Eurotrash & Fragility

I haven’t covered the nascent European Financial Stabilisation Fund (EFSF) much lately, in spite of all the bureaucratic & ministerial scrabbling and wrangling to rescue the European status quo.

That’s mainly because I have grown (or shrunk?) to see most developments as irrelevant can-kicking.

At best, they can muster an American-style response: kick the can far into the future. But unless the underlying problems are solved (clue: they won’t be) then the system remains fundamentally broken.

That’s because monetary integration without integrated budgeting is a recipe for insolvency. Banana Republics can print money to pay their debts because they control their currency. Nations who don’t control their currency can’t devalue to pay their debts. They have to default, or hope for a bailout from the powers-that-be. And the problem at the heart of Europe is that fiscal integration is politically impossible (sorry Frau Merkel), for a myriad of reasons including (among others) nationalism, incompatibility, and the perception that the Mediterranean nations will leech off the more productive northern nations.

Of course, most of these constraints wouldn’t be there if the system was less fragile. In a fractional reserve banking system where (and this is crucial) the money supply (M2) is determined by private lending, a number of situations can lead to Irving Fisher’s debt deflation problem — with a shrinking money supply, debts become unrepayable, triggering a default cascade. These situations include bank failures, bank runs, credit contractions, price deflation and sovereign default — five phenomena that history teaches us are quite common. The scale of indebtedness makes systemic reform very difficult — creditors will demand that debts are honoured, so central banks continue with the instruments they have — competitive debasement, low-rates, expansionary monetary policy.

All that the sovereign debt crisis in Europe is revealing is the fragility in the systems — the fragility of the European political union, and the fragility of the fractional reserve banking system.

And if a fragile system isn’t allowed to collapse (or is not effectively reformed) when the problems are comparatively small (insert nonsensical rubbish about “systemic importance“, “economic infrastructure” and “too-big-to-fail” here) it will rumble on through many bailout-crisis-bailout-crisis cycles until it becomes too-fucked-to-bail, at which point the entire system collapses, and the debt is razed (either by default of hyperinflation or both).

The problem is that such climactic events usually have geopolitical implications: war, famine, upheaval, etc.

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Eurocide

Angela Merkel says that Europe won’t issue Eurobonds, presumably heeding the warning that handing over 133% of German GDP to bailing out PIGS may not go down so very well with the German taxpayer. From Bloomberg:

German Chancellor Angela Merkel attempted to shut the door on common euro-area bonds as a means to solve the debt crisis, saying that she won’t let financial markets dictate policy.

Joint euro bonds would require European Union treaty changes that would “take years” and might run afoul of Germany’s constitution, Merkel said. While common borrowing might arrive at some point in the “distant future,” bringing in euro bonds at this time would further undermine economic stability and so they “are not the answer right now.”

“At this time — we’re in a dramatic crisis — euro bonds are precisely the wrong answer,” Merkel said in an interview with ZDF television in Berlin yesterday. “They lead us into a debt union, not a stability union. Each country has to take its own steps to reduce its debt.”

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