Understanding the Problem, Understanding the Solution, and Understanding Who is to Blame are Three Different Things

Ambrose Evans-Pritchard speaks of the Self-serving myths of Europe’s neo-Calvinists

In his article he chastises Germany for its role in the Eurozone mess, citing Germany’s Wolfgang Schauble and the northern neo-Calvinists. Pritchard also praises a report by Simon Tilford and Philip Whyte on how stricter rules threaten the eurozone.

There is certainly much in the report that I agree with, primarily a description of the problem. Unfortunately, there is even more I disagree with, notably the solution.

Ideas I agree with:

1. Creditor countries cannot be absolved of all blame.
2. If the eurozone had been a fully-fledged fiscal union, it would not be in its current predicament. (Mish: It would be a different predicament, likely much worse)
3. The current crisis is not simply a tale of fiscal irresponsibility and lost competitiveness in the eurozone’s geographical periphery. It is also about the unsustainable macroeconomic imbalances to which the launch of the euro contributed (in creditor and debtor countries)
4. The challenges presented by Greece were always going to be daunting, given the dysfunctional nature of its political economy.
5. The medicine prescribed to Greece – which was partly motivated by an urge to punish it and to take a stand against moral hazard – was doomed to failure.
6. A year’s worth of punishing austerity and contracting activity has only succeeded in pushing Greece deeper into insolvency.
7. The eurozone will not emerge from the debt crisis without economic growth.
8. It is now clear that a currency shared by fiscally sovereign member states is more vulnerable to losses of confidence than a monetary union that is more fully integrated.
9. A familiar pattern has now set in. Under market duress, leaders hold an emergency summit and announce an agreement designed to restore confidence once and for all.
10. After an initial bout of euphoria, financial markets digest the contents of the agreement, conclude that it does not resolve the underlying problems, and the cycle starts all over again. Each agreement buys less time and the stakes become larger with every summit.

Hopefully we can all agree on those 10 points. The problem is the Euro was fatally flawed from the beginning.

No in Many Languages

No currency union has ever survived without there being a fiscal union at the same time. Is Germany to blame for this?

I say Nein, Non, Ochi, Iie, Nie, Nej, and of course No.

Who is to Blame?

The rules of the Maastricht Treaty were known by everyone at the outset and there were many architects of the Euro idea including Jean-Claude Trichet. In that regard it makes as much sense to blame France as it does Germany.

Moreover, countries could have accepted or rejected the treaty. Every country had a vote (or many votes - as politicians crammed the Euro down their citizens' throats whether they wanted it or not).

The UK chose wisely, other countries did not, including Germany. Every country stupid enough to enter this untenable arrangement can look in the mirror and blame themselves.

The Non-Solutions

Unfortunately, the rest of the report borders on the nonsensical, notably "All eurozone countries should therefore finance debt by issuing bonds which would be jointly guaranteed by all of them."

The authors then proceed to discuss all the inherent problems with the idea including "moral hazards", borrowing targets, etc, stating "A dogmatic target of budgetary balance four years hence, irrespective of a country’s position in the economic cycle, would achieve little."

The authors then have to figure out a way around dogmatic targets, proposing "rules should be set with reference to the cyclically-adjusted fiscal position for each member state."

That of course creates another problem as to how to do that, coming to the conclusion that 17 votes is too many, and a creditor-dominated board would not work, but "A board of nine economists, from the big eurozone economies, the European Commission, the European Central Bank (ECB) and the OECD might form a good basis."

Good grief.

Wait, I am not done yet. The authors freely admit "the issuance of eurobonds will not prevent debt crises in the absence of steps to reduce trade imbalances within the eurozone" then attempt to dream up solutions to that problem.

That idea makes as much sense as attempting to solve a trade disparity between California and Indiana.

We are still not done yet. The authors see a need to "set up a jointly-funded, eurozone-wide deposit protection scheme."

Finally, the authors conclude "The ECB’s mandate is too restrictive. The central bank must guard against excessive inflation. But its fear of inflation blinds it to the much more serious threats confronting the eurozone economy."

Apparently Europe needs a "mandate" but one that is meaningless, and allows the central bank to print at will.

Conclusion


The authors ramble on about various problems, real and imagined, then conclude with ...

Eurozone leaders now face a choice between two unpalatable alternatives. Either they accept that the eurozone is institutionally flawed and do what is necessary to turn it into a more stable arrangement. This will require some of them to go beyond what their voters seem prepared to allow, and to accept that a certain amount of ‘rule-breaking’ is necessary in the short term if the eurozone is to survive intact. Or they can stick to the fiction that confidence can be restored by the adoption (and enforcement) of tougher rules. This option will condemn the eurozone to self-defeating policies that hasten defaults, contagion and eventual break-up.

Indeed, Not

Pritchard, cited the above paragraph and finished with "Indeed. Read it all"

I did read it all and nearly threw up at the self-serving myth there are only two options.

1. Break the rules
2. Stick to self-defeating policies

There is a third option and Pritchard should know it well: Plan for a breakup of the Eurozone and make banks write down bad investments. Bondholders will take a hit, but they deserve to. It is time to stop bailing out banks at the expense of taxpayers.

The report by Simon Tilford and Philip Whyte with all their convoluted solutions culminating in the creation of a "fiscal nanny-zone" should be enough to convince anyone the Euro is not worth saving.

Countries that disagree can keep the damn thing. If France wants a fiscal nanny-state and unlimited printing by the ECB, fine. Let France have it.

True Solution

The best solution and the one I propose is for Germany to leave the Eurozone. I am quite sure other countries in Northern Europe would follow. The Euro will still survive in my proposal, and France can be king of the nanny-hill if it elects to stay in.

Yes this would be disruptive. However, it would give the Euro-fools what they want and Northern European voters (not politicians) what they want.

Michael Pettis outlined a compelling case why Germany exiting the Eurozone is the best option. Please see Eurozone Breakup Logistics (Never Believe Anything Until It's Officially Denied) for details.

The Euroskeptics Were Right

The Euroskeptics were right, straight from the beginning. Pritchard was among those skeptics. He was right then. He was also correct in a major way when he stated the German supreme court would not allow Eurobonds or ECB printing.

Please see Germany's Top Judge Throws Major Monkey Wrench Into Leveraged EFSF Machinery, Demands New Constitution and Popular Referendum for Further Powers for details.

Unfortunately he is wrong now. In more ways than one.

1. Pritchard is wrong on who to blame
2. Pritchard is wrong to perpetrate the myth the euro can be saved
3. Pritchard is wrong about fearing deflation (a natural state of affairs actually, it is only fractional reserve lending and mountains of debt that bring upon such fears. The solution is to get rid of central bankers and end fractional reserve lending)
4. Pritchard is wrong to not fear inflation in the scenario proposed by Tilford and Whyte.

Eurobond, Unlimited Printing Foolishness

I am not the only one who thinks the eurobond, unlimited printing idea is beyond foolish. John Hussman had an excellent writeup on Monday Why the ECB Won't (and Shouldn't) Just Print

Over the past week, we've heard all sorts of propositions that the European Central Bank (ECB) "must" begin printing money to bail out Italy and other countries, because "there is no other option." There are three basic difficulties with this idea.

The first is that ECB buying might help to address immediate liquidity issues of distressed European countries, but it would not address long-term solvency issues, and would in fact make them worse.

The second is that the ECB, under existing European treaties, has no such authority, and the prohibitions against it are very explicit. Changing that would be far more difficult than many market participants seem to believe, because it would require an explicit and unanimous change in the EU Treaties that AAA rated countries such as Germany and Finland vehemently oppose.

The third difficulty is that even if the ECB was to buy the debt of distressed European countries with printed money, the inflationary effects would likely be far more swift than anything we've seen in the United States. This would not "save" the euro, but would simply destroy it by other means.

Hussman builds an excellent case.

I will conclude the way Pritchard did: "Indeed. Read it all".

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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