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Friday, February 28, 2014 2:57 PM


Stiglitz: Leaving the Euro Painful but Staying in More Painful; Eurozone Breakup Recap


Nobel prize winning economist Joseph E. Stiglitz has come to the right conclusion Leaving the Euro Painful but Staying in More Painful.



Partial Transcript

Question: I want to probe you a bit on that small mistake of the euro. UYou seem to suggest there is nothing that cannot be solved with more European solidarity and I agree with that intellectually. But if you are politically realistic, I don't think it is going to be forthcoming. I don't see large checks being written by German politicians to subsidize for example, the Spanish or Greek unemployed. So if you think about that perspective, and put yourself in the shoes of a 30-year old Spaniard or Greek head of household who has no prospect of employment, would it not be better is countries left the eurozone altogether?

Stiglitz: As I said in my talk the reality is, if the reforms I described were made, Germany would not have to write large checks. It more likely to pay a high cost for not making these reforms.  ... But I think your description of the reality of the way the dialog is going in Germany is absolutely correct. And that is one of the reasons I am a little depressed about the future of Europe. It's going to be a hard row to persuade Germany to make these reforms even if they would cost less. And that leaves Spain and Greece with an important debate, a policy question, what should they do if the reality is there won't be these reforms. To me the real risk is the following: Europe is going to dangle out just enough hope that Spain and Greece and the other periphery countries will say, they are going to come to our assistance. .... But they are going to dangle enough hope that people won't want to leave the euro, but in fact, there will be so little reform there will be literally no time soon the countries will emerge from depression. SAo my advice would be along the lines of what you are hinting at: They should probably face the reality that there is not going to be political reform that will make the euro viable for the periphery ... that internal devaluation won't work, that leaving the euro will be painful, but staying in the euro will be more painful.

Among economists, there is an easier solution, that many people have argued, that Germany should leave. If Germany leaves, the value of the euro will go down, the competitiveness of the southern 
countries would become substantially enhanced. They can design a set of economic policies that work for a large group of countries, and owing money in euros they will be able to repay money in euros. Germany is in a better position to absorb the consequences of a breakup in that fashion.

End Transcript

Better if Germany Leaves

I am in total agreement with the unknown questioner regarding the political reality: Germany will not pony up the cash, nor the banking union and fiscal unions required to make the euro work.

On November 9, 2011 in Breakup Inevitable, but How? I offered the following comments.

Eurozone Breakup Inevitable, But How?

The Eurozone is a failed experiment. A breakup is inevitable just as it has been from the beginning. Structural flaws were too great, built up over the years. No currency union in history has ever survived unless there was also a fiscal union.

It would be best for all involved if Germany left the Eurozone and went back to the Deutschmark. Germany would have an immediately credible currency. Should Greece or Spain leave first, those countries might experience hyperinflation or massive inflation.

It's important to remember that Germany suffers regardless. As long as the Eurozone stays intact (it can't and won't over the long haul) German taxpayers have to keep acting bailing out foreign countries, foreign banks, and their own banks.

On the other hand, were Germany to leave, the debts to German banks will not be paid back in Deutschmarks but rather deflated Euros.

On the whole, Germany exiting the Eurozone would be less disruptive, than massive inflation scenarios in Greece, Portugal, and Spain.
Eurozone Math; One Size Fits Germany; Door Number Two

People accuse me of blaming Germany. The blame goes to the architects  of the fatally flawed euro and the politicians who signed up for the mess.

Blame also goes to the ECB. I have written about that on numerous occasions as well. For example, please consider my April 11, 2013 post Eurozone Math; One Size Fits Germany; Door Number Two.
Reader "JB" thinks I am blaming Germany for what is happening. That's not exactly correct, but let's take a look at what "JB" has to say via email.
Hi Mish,

I read your blog daily. We are generally on the same page. We even agree that in all probability the eurozone will break up. However, You cannot blame the Germany, the German government, or the German people for doing the right thing. Germans can accept austerity. The phrase "tightening the belt" is an axiom in the German language. ....
JB
Hello JB, I think you misunderstand my message. I am not biased against Germany, and I am in favor of "austerity".

By "austerity" I mean shrinkage of public sector jobs and pensions, and liberalization of work rules.

I am against tax hikes, especially those imposed on Spain, Greece, and Portugal by the nannycrats in Brussels. What the nannycrats call "austerity" is nothing more than devastating tax hikes coupled with minimal, if any work rule reforms.

My message is primarily a function of math.

Eurozone Math

  • Germany was the primary beneficiary of the ECB's "one size fits Germany" interest rate policy.
  • It is mathematically impossible for every country to be an exporter like Germany
  • It is mathematically impossible for one interest rate to work when there is a multitude of fiscal policies
  • It is mathematically impossible for the euro to survive without a transfer mechanism of some sort from Germany to peripheral Europe, and Germany will not allow any transfer mechanisms
  • It is mathematically impossible within the realm of the euro for Spain to be more like Germany, unless Germany is less like Germany
  • Germany has ruled out everything that could possibly make the eurozone work.

Euro Architects and Politicians to Blame

I do not blame Germany. I blame all the architects of the euro. I also blame all the politicians making matters worse by trying to force their will on the markets. In that sense, I do blame Merkel, but I also blame Hollande, Sarkozy, Trichet, Draghi, and everyone else involved in this mess, past or present.

One Size Fits Germany (Until it Doesn't)

The math of the matter is Germany benefited from the Euro and from the ECB's "one size fits Germany" interest rate policy more than any other country.

As a direct result of the unstable eurozone treaty, sovereign interest rate imbalances, Target II imbalance, and trade imbalances are out of control. Germany and the other European creditor countries are owed money that cannot be paid back.

Door Number Two

The eurozone cannot work as is, and Germany is going to pay the price in one of two ways.

  1. Germany Forgives Loans to European Debtor Nations
  2. The debtor nations exit the eurozone and default

German taxpayers do not want to bail out the rest of Europe. And if I was a German taxpayer I would have the same stance. Without assigning blame to Germany, the math is what it is: unsustainable.

Pick your poison. Is it door number one or door number two? Odds overwhelmingly favor door number two.

Even diehard supporters of the eurozone now see it cannot work. For example, please see Eurointelligence Founder Wolfgang Münchau, Once a Staunch Euro Supporter, Now Welcomes the Anti-Euro Party "Alternative for Germany".

Soros On Board

George Soros is still a eurozone supporter, but he understands it cannot work without eurobonds. I do not believe the eurozone can work with eurobonds as I expect tensions will be high. Soros' second-best alternative is for Germany to exit the eurozone.

That has been my #1 idea for a long time. I explained it recently in Illusions of Stabilization.
Failed Experiment

The Eurozone is a failed experiment. Structural flaws were too great initially, and they have increased over the years. No currency union in history has ever survived unless there was also a fiscal union. Current politics says it cannot happen, on meaningful terms.

Breakup Inevitable, But How?

A breakup is inevitable, just as it has been from the beginning. The key is to manage a breakup in the least destructive manner.

Breakup Options

Option 1: If Germany (and the northern states) left the eurozone, the Deutschmark (and respective currencies) would immediately be credible. The downside to Germany (and the northern states) is debts to German banks would not be paid back in Deutschmarks but rather deflated (but not worthless) Euros.

Option 2: The second option is a piecemeal, destructive breakup. Should Greece and Spain leave first, those countries might experience a complete loss of faith in currency resulting in hyperinflation. The Northern states would be paid back in worthless notes, if they were paid back at all.

Germany Suffers Regardless

Note that Germany and the Northern creditor nations suffer regardless. Either they keep ponying up bailout money, there is a managed breakup, or a piecemeal destructive breakup. It would be best for all involved if Germany left the eurozone and went back to the Deutschmark.

There are no other options, and no other choices. Meanwhile, imbalances grow and German taxpayers keep funneling tax dollars to the Southern states to keep them afloat.
Merkel Not a Savior

Many Germans view Merkel as a hero for her tough stance on Cyprus.

However, Merkel is neither a savior nor a hero. Her stance is always one of political necessity. Every step of the crisis she has made politically expedient decisions such as caving in to Sarkozy and providing funds for Greece but not for Cyprus.

Sentiment in Germany in favor of holding the eurozone together is strong provided German taxpayers do not have to pony up another dime. The irony is Germany was the main beneficiary of the ECB's "one size fits Germany" interest rate policy that destroyed Spain and peripheral Europe.

Sentiment Does Not Change the Math

Sentiment does not change the eurozone math, but it does impact the way the eurozone breaks apart.

Expect a piecemeal, destructive breakup.

Some will blame Germany. I blame a mathematically unworkable treaty that was flawed from the beginning. I also blame all the politicians who supported the idea even though it was fatally flawed.
Late to the Party

Those just now coming to the conclusion the euro cannot possibly work are late to the party.  Yet, many, if not most, still have not figured this out.

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

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