Alasdair Macleod
Executive Summary
- Germany is unlikely to break solidarity with the rest of the Eurozone while Merkel remains in charge. But she may not last as long as she'd like.
- France's economy is deteriorating at an alarming rate.
- Most of France's "stability" to date is due to inflows of money fleeing Spain and Italy. That will stop soon – and then what?
- The UK is suffering from many of the same ills as the U.S. However, its banks are too dependent on Eurozone debt for it to take drastic counter-measures, and so it is handcuffed to the future of the Continent.
- All is well as long as no one defaults or no one leaves the Eurozone. With each player's position deteriorating, how long can the status quo last?
If you have not yet read Europe Is Now Sinking Fast, available free to all readers, please click here to read it first.
In previous articles, I have given Peak Prosperity's enrolled members the lowdown on the weak Eurozone governments and looked at the crisis from Germany’s point of view. With respect to Germany, all that can be added is that her political elite is still frozen in inaction and show no signs of snapping out of it. Mrs Merkel, particularly, is still pursuing the out-of-date Euroland ideal. It is as if she has decided that she has no alternative. Come what may, it will have to succeed in the end, and she is not going to be the one who calls “uncle.”
I don’t know how these things work in Germany, but in the UK there comes a point where “the men in grey suits” metaphorically tap the leader on the shoulder and politely instruct him or her to resign. It happened to Mrs Thatcher, and unless she has a change of heart, it could happen to Mrs Merkel before next November’s German elections. And when that happens, the withdrawal of Germany from the euro can be expected to begin.
In this article we will update the deteriorating situation in two other key players on Europe's chessboard: France and the United Kingdom. And we'll reveal why the current system is like a Mexican standoff: Everything is stable until someone makes a move. Then all hell breaks loose…
Europe’s Mexican Standoff
PREVIEWExecutive Summary
- Germany is unlikely to break solidarity with the rest of the Eurozone while Merkel remains in charge. But she may not last as long as she'd like.
- France's economy is deteriorating at an alarming rate.
- Most of France's "stability" to date is due to inflows of money fleeing Spain and Italy. That will stop soon – and then what?
- The UK is suffering from many of the same ills as the U.S. However, its banks are too dependent on Eurozone debt for it to take drastic counter-measures, and so it is handcuffed to the future of the Continent.
- All is well as long as no one defaults or no one leaves the Eurozone. With each player's position deteriorating, how long can the status quo last?
If you have not yet read Europe Is Now Sinking Fast, available free to all readers, please click here to read it first.
In previous articles, I have given Peak Prosperity's enrolled members the lowdown on the weak Eurozone governments and looked at the crisis from Germany’s point of view. With respect to Germany, all that can be added is that her political elite is still frozen in inaction and show no signs of snapping out of it. Mrs Merkel, particularly, is still pursuing the out-of-date Euroland ideal. It is as if she has decided that she has no alternative. Come what may, it will have to succeed in the end, and she is not going to be the one who calls “uncle.”
I don’t know how these things work in Germany, but in the UK there comes a point where “the men in grey suits” metaphorically tap the leader on the shoulder and politely instruct him or her to resign. It happened to Mrs Thatcher, and unless she has a change of heart, it could happen to Mrs Merkel before next November’s German elections. And when that happens, the withdrawal of Germany from the euro can be expected to begin.
In this article we will update the deteriorating situation in two other key players on Europe's chessboard: France and the United Kingdom. And we'll reveal why the current system is like a Mexican standoff: Everything is stable until someone makes a move. Then all hell breaks loose…
Executive Summary
- Why the U.S. and the IMF won't act soon enough to avoid a German exit
- Why Finland will bolt from the Eurozone the moment Germany does (and how many others may soon follow?)
- What a German exit (and a new mark) would really mean
- When will Germany likely announce its departure from the Eurozone?
If you have not yet read Part I, available free to all readers, please click here to read it first.
In Part I, we covered the background to what now appears to be inevitable: Germany has to leave the Eurozone. She, along with the Netherlands and Finland, simply cannot afford to bail out the rest of the Eurozone, so she is standing in the way of a resolution to the crisis. It is therefore only a matter of time before the political classes have to face this reality.
Time is running out, and the longer Germany delays, the worse her position will be. The yields on Spanish and Italian debt will inevitably head towards and through the 7% "point-of-no-return" threshold and beyond, and Germany will get all the blame. Germany will be seen as a thorn in the side of the ECB, restricting its scope for monetary action and obstructing a solution, partly because of the Bundesbank’s stubborn conservatism and partly because Germany’s Constitutional Court frowns on monetising government debt. She will be unfairly condemned by everyone.
Let’s look at some back-of-the-envelope figures…
The Implications of a German Exit from the Eurozone
PREVIEWExecutive Summary
- Why the U.S. and the IMF won't act soon enough to avoid a German exit
- Why Finland will bolt from the Eurozone the moment Germany does (and how many others may soon follow?)
- What a German exit (and a new mark) would really mean
- When will Germany likely announce its departure from the Eurozone?
If you have not yet read Part I, available free to all readers, please click here to read it first.
In Part I, we covered the background to what now appears to be inevitable: Germany has to leave the Eurozone. She, along with the Netherlands and Finland, simply cannot afford to bail out the rest of the Eurozone, so she is standing in the way of a resolution to the crisis. It is therefore only a matter of time before the political classes have to face this reality.
Time is running out, and the longer Germany delays, the worse her position will be. The yields on Spanish and Italian debt will inevitably head towards and through the 7% "point-of-no-return" threshold and beyond, and Germany will get all the blame. Germany will be seen as a thorn in the side of the ECB, restricting its scope for monetary action and obstructing a solution, partly because of the Bundesbank’s stubborn conservatism and partly because Germany’s Constitutional Court frowns on monetising government debt. She will be unfairly condemned by everyone.
Let’s look at some back-of-the-envelope figures…
There was yet another European Union summit at the end of June, which (like all the others) was little more than bluff. Read the official communiqué and you will discover that there were some fine words and intentions, but not a lot actually happened. However, there are some differences when compared with past meetings that need explaining:
- The European Council is being asked to consider permitting the European Central Bank to have a regulatory role alongside national central banks “as a matter of urgency by the end of 2012.” When this new super-regulator is eventually established, perhaps the ECB might be able to recapitalize banks directly. This was needed three years ago; the Eurozone will be lucky not to have a new banking crisis in the next few months, let alone by the year-end.
- A bail-out for Spain’s banks is agreed in principle, but it is to be funded by the European Financial Stability Facility (EFSF) until the European Stability Mechanism (ESM) is up and running. The EFSF has no money and relies on drawing down funds from all member states including Greece, Spain, Italy, Ireland, and Portugal, and the chances of the ESM being ratified by the individual Eurozone parliaments is very slim. We are told that Spain’s banks need about €100bn, but how much they really need is not known.
- The ESM will not rank as a prior creditor to the disadvantage of bond holders. This is a positive step, but makes it more difficult for national parliaments to authorize the ESM.
The big news in this is the implication the ECB will, in time, be able to stand behind the Eurozone banks because it will accept responsibility for them. This is probably why the markets rallied on the announcement, but it turned out to be another dead cat lacking the elastic potential energy necessary to bounce.
e another dead cat lacking the elastic potential energy necessary to bounce.
The Growing Pressures Likely to Blow the Eurozone Apart
There was yet another European Union summit at the end of June, which (like all the others) was little more than bluff. Read the official communiqué and you will discover that there were some fine words and intentions, but not a lot actually happened. However, there are some differences when compared with past meetings that need explaining:
- The European Council is being asked to consider permitting the European Central Bank to have a regulatory role alongside national central banks “as a matter of urgency by the end of 2012.” When this new super-regulator is eventually established, perhaps the ECB might be able to recapitalize banks directly. This was needed three years ago; the Eurozone will be lucky not to have a new banking crisis in the next few months, let alone by the year-end.
- A bail-out for Spain’s banks is agreed in principle, but it is to be funded by the European Financial Stability Facility (EFSF) until the European Stability Mechanism (ESM) is up and running. The EFSF has no money and relies on drawing down funds from all member states including Greece, Spain, Italy, Ireland, and Portugal, and the chances of the ESM being ratified by the individual Eurozone parliaments is very slim. We are told that Spain’s banks need about €100bn, but how much they really need is not known.
- The ESM will not rank as a prior creditor to the disadvantage of bond holders. This is a positive step, but makes it more difficult for national parliaments to authorize the ESM.
The big news in this is the implication the ECB will, in time, be able to stand behind the Eurozone banks because it will accept responsibility for them. This is probably why the markets rallied on the announcement, but it turned out to be another dead cat lacking the elastic potential energy necessary to bounce.
e another dead cat lacking the elastic potential energy necessary to bounce.
Executive Summary
- European banks have shifted their priority from supporting national governments to combating captial flight
- Hollande's policies are accelerating France's path to insolvency, thus advancing the date of the Eurozone collapse
- The euro can fall MUCH farther from here
- We are currently at a stalemate being forced by Germany, but it will soon end and downward momentum will quickly build
If you have not yet read Part I, available free to all readers, please click here to read it first.
In Part I, we examined the economic pressures likely to blow the Eurozone apart and concluded that there is increasing disquiet in Germany over the cost of supporting stricken economies and her increasing reluctance to write open-ended cheques. The first creditor country to leave will probably be Finland, or perhaps one of the other smaller members less committed to the Eurozone project. Let's now explore how this might come about, along with the consequences for the rest of the world.
Sovereign Debt Markets
It is obviously not possible to anticipate tomorrow’s events with any certainly, but we can lay down some pointers, the most obvious of which is changing yield levels in sovereign debt markets. Let's focus on Spain because she currently causes the most concern.
Before mid-November last year, Spain’s ten-year bond yield had run up to 6.58%, up from the 4% level that prevailed before her debt crisis became an issue (see chart below). At end-November, the yield fell in anticipation of the ECB’s first long-term refinancing operation (LTRO), because Eurozone banks used some of the money to arbitrage between Spanish bond yields and the considerably lower cost of funding from the ECB. This way of making money is encouraged by Basel 3 rules, which define short-term sovereign debt as being the highest quality, so no haircut is applied. This regulatory quirk has been conspiratorially used by the ECB, commercial banks, and governments themselves to ignore fundamental lending realities…
The Consequences of a Eurozone Breakup
PREVIEWExecutive Summary
- European banks have shifted their priority from supporting national governments to combating captial flight
- Hollande's policies are accelerating France's path to insolvency, thus advancing the date of the Eurozone collapse
- The euro can fall MUCH farther from here
- We are currently at a stalemate being forced by Germany, but it will soon end and downward momentum will quickly build
If you have not yet read Part I, available free to all readers, please click here to read it first.
In Part I, we examined the economic pressures likely to blow the Eurozone apart and concluded that there is increasing disquiet in Germany over the cost of supporting stricken economies and her increasing reluctance to write open-ended cheques. The first creditor country to leave will probably be Finland, or perhaps one of the other smaller members less committed to the Eurozone project. Let's now explore how this might come about, along with the consequences for the rest of the world.
Sovereign Debt Markets
It is obviously not possible to anticipate tomorrow’s events with any certainly, but we can lay down some pointers, the most obvious of which is changing yield levels in sovereign debt markets. Let's focus on Spain because she currently causes the most concern.
Before mid-November last year, Spain’s ten-year bond yield had run up to 6.58%, up from the 4% level that prevailed before her debt crisis became an issue (see chart below). At end-November, the yield fell in anticipation of the ECB’s first long-term refinancing operation (LTRO), because Eurozone banks used some of the money to arbitrage between Spanish bond yields and the considerably lower cost of funding from the ECB. This way of making money is encouraged by Basel 3 rules, which define short-term sovereign debt as being the highest quality, so no haircut is applied. This regulatory quirk has been conspiratorially used by the ECB, commercial banks, and governments themselves to ignore fundamental lending realities…
Executive Summary
- Why Greece is unlikely to release a new drachma
- Why globally-coordinated money printing is the most likely resolution to the Greek & Spanish crises
- Why the magnitude of derivative risk makes a Eurozone collapse much more frightening
- Why capital flight will get worse, and why gold will benefit from this
- Why Germany's odds for leaving the Eurozone are lower than most assume
- Why the time left before extreme action must be taken is than a few months – possibly only weeks
If you have not yet read Part I: Abandoning Ship, available free to all readers, please click here to read it first.
Here are some key points to bear in mind as the crisis progresses:
Greece: new drachma?
The Greeks would be crazy to embrace a new drachma, as recommended by neoclassical economists. A new drachma would be backed by nothing, unless it comes with full convertibility into Greece’s 111.6 tonnes of gold, assuming that actually exists. The complete lack of faith in any Greek government’s economic credentials would mean a new drachma in the absence of gold convertibility would rapidly descend towards its intrinsic value, which is zero. Interestingly, recent polls suggest that the Greek people understand this and prefer to remain with the euro.
The legality of changing deposits from euros to drachmas is highly questionable. Assuming the Greek government can force this through on domestic deposits that will leave an open question over loans, likely to be challenged through the courts. And in the past non-Greek banks lending money to Greek businesses have as a matter of course stipulated contracts to be governed by the laws of another jurisdiction.
Message: do not buy into the siren attractions of an independent drachma…
The Most Predictable Next Events
PREVIEWExecutive Summary
- Why Greece is unlikely to release a new drachma
- Why globally-coordinated money printing is the most likely resolution to the Greek & Spanish crises
- Why the magnitude of derivative risk makes a Eurozone collapse much more frightening
- Why capital flight will get worse, and why gold will benefit from this
- Why Germany's odds for leaving the Eurozone are lower than most assume
- Why the time left before extreme action must be taken is than a few months – possibly only weeks
If you have not yet read Part I: Abandoning Ship, available free to all readers, please click here to read it first.
Here are some key points to bear in mind as the crisis progresses:
Greece: new drachma?
The Greeks would be crazy to embrace a new drachma, as recommended by neoclassical economists. A new drachma would be backed by nothing, unless it comes with full convertibility into Greece’s 111.6 tonnes of gold, assuming that actually exists. The complete lack of faith in any Greek government’s economic credentials would mean a new drachma in the absence of gold convertibility would rapidly descend towards its intrinsic value, which is zero. Interestingly, recent polls suggest that the Greek people understand this and prefer to remain with the euro.
The legality of changing deposits from euros to drachmas is highly questionable. Assuming the Greek government can force this through on domestic deposits that will leave an open question over loans, likely to be challenged through the courts. And in the past non-Greek banks lending money to Greek businesses have as a matter of course stipulated contracts to be governed by the laws of another jurisdiction.
Message: do not buy into the siren attractions of an independent drachma…
Executive Summary
- The political and economic reasons why Europe's leaders will not change their behaviour until forced to by further crisis
- The reasons Europe's future is in the hands of Germany and the ECB
- How risk has spread from the periphery: What's next for Spain, Italy, and France
- The sure bet for investors to consider
Part I: The Europe Crisis from a European Perspective
If you have not yet read Part I, available free to all readers, please click here to read it first.
Part II: What Lies in Store for Europe
In Part I of this article, we looked at the background to the Eurozone crisis and made the point that there are substantial extra government liabilities that were hidden by most member nations to meet the joining criteria in the target year for proof of convergence, 1997. And the only reason that capital flight from Greece, Ireland, Portugal, Spain, and Italy has not led to a banking and economic collapse already is that it has been accommodated by a build-up of imbalances between the accounts of national central banks of the individual Eurozone members.
The End of the Keynesian Experiment
In truth, all advanced Western democracies face the same crisis. It is the end of the Keynesian experiment, marked by the collapse of various credit-fueled bubbles four years ago, mostly involving property. This event threatened a global systemic banking collapse, which was only averted by sovereign nations guaranteeing the solvency of their banks by shifting the risk to government bond markets. The answer for the US, UK, and Japan has been to flood the system with dollars, pounds, and yen respectively, partly to give banks breathing space, and partly so that governments could fund their ballooning deficits.
The individual states in the Eurozone gave away that facility to the ECB, so they are only the first of the advanced nations to face collapse. This is because printing money is the principal means by which governments survive financial crises.
In that sense it is wrong to blame our financial ills on Europe; that would be like sinners casting stones. Like the rest of us, by agreeing to underwrite their banks, Eurozone governments have multiplied their potential debts three, four, or even five-fold (Ireland by eight!). Unfortunately, there is nothing, frankly, that the politicians can do to stop a Eurozone meltdown; they are in a bind of their own making, and they do not understand, nor can they explain to their increasingly angry electorates, how to get out of it.
There is a remedy, and it is deeply un-Keynesian.
What Lies in Store for Europe
PREVIEWExecutive Summary
- The political and economic reasons why Europe's leaders will not change their behaviour until forced to by further crisis
- The reasons Europe's future is in the hands of Germany and the ECB
- How risk has spread from the periphery: What's next for Spain, Italy, and France
- The sure bet for investors to consider
Part I: The Europe Crisis from a European Perspective
If you have not yet read Part I, available free to all readers, please click here to read it first.
Part II: What Lies in Store for Europe
In Part I of this article, we looked at the background to the Eurozone crisis and made the point that there are substantial extra government liabilities that were hidden by most member nations to meet the joining criteria in the target year for proof of convergence, 1997. And the only reason that capital flight from Greece, Ireland, Portugal, Spain, and Italy has not led to a banking and economic collapse already is that it has been accommodated by a build-up of imbalances between the accounts of national central banks of the individual Eurozone members.
The End of the Keynesian Experiment
In truth, all advanced Western democracies face the same crisis. It is the end of the Keynesian experiment, marked by the collapse of various credit-fueled bubbles four years ago, mostly involving property. This event threatened a global systemic banking collapse, which was only averted by sovereign nations guaranteeing the solvency of their banks by shifting the risk to government bond markets. The answer for the US, UK, and Japan has been to flood the system with dollars, pounds, and yen respectively, partly to give banks breathing space, and partly so that governments could fund their ballooning deficits.
The individual states in the Eurozone gave away that facility to the ECB, so they are only the first of the advanced nations to face collapse. This is because printing money is the principal means by which governments survive financial crises.
In that sense it is wrong to blame our financial ills on Europe; that would be like sinners casting stones. Like the rest of us, by agreeing to underwrite their banks, Eurozone governments have multiplied their potential debts three, four, or even five-fold (Ireland by eight!). Unfortunately, there is nothing, frankly, that the politicians can do to stop a Eurozone meltdown; they are in a bind of their own making, and they do not understand, nor can they explain to their increasingly angry electorates, how to get out of it.
There is a remedy, and it is deeply un-Keynesian.
[This week, we introduce a new contributing editor to PeakProsperity.com, Alasdair Macleod. He will mostly be contributing commentary focused on the situation in Europe, where he's located. The credit crisis underway there is not Europe's problem alone; it has the potential to send crippling financial shockwaves to the US and elsewhere around the world. Please join us in extending a warm CM.com welcome to Alasdair. — Adam]
The purpose of this report is to give readers the essential background to the economic problems in Europe and to bring you up-to-date in what has become a fast-moving situation. At the time of writing, there has been a lull in the news flow, but that does not mean the problems are under control. Far from it.
Flawed from the Start
When we talk about Europe today in an economic context, we really mean the Eurozone, whose seventeen members are the core of Europe and share a common currency, the euro. The euro first came into existence thirteen years ago, on January 1, 1999, replacing national currencies for eleven states; Greece joined two years later. In theory, the idea of a common currency for European nations with common borders is logical, and it was Canadian economist Robert Mundell's work on optimum currency areas that provided much of the theoretical cover.
However, the concept was flawed from the start.
The Europe Crisis from a European Perspective
[This week, we introduce a new contributing editor to PeakProsperity.com, Alasdair Macleod. He will mostly be contributing commentary focused on the situation in Europe, where he's located. The credit crisis underway there is not Europe's problem alone; it has the potential to send crippling financial shockwaves to the US and elsewhere around the world. Please join us in extending a warm CM.com welcome to Alasdair. — Adam]
The purpose of this report is to give readers the essential background to the economic problems in Europe and to bring you up-to-date in what has become a fast-moving situation. At the time of writing, there has been a lull in the news flow, but that does not mean the problems are under control. Far from it.
Flawed from the Start
When we talk about Europe today in an economic context, we really mean the Eurozone, whose seventeen members are the core of Europe and share a common currency, the euro. The euro first came into existence thirteen years ago, on January 1, 1999, replacing national currencies for eleven states; Greece joined two years later. In theory, the idea of a common currency for European nations with common borders is logical, and it was Canadian economist Robert Mundell's work on optimum currency areas that provided much of the theoretical cover.
However, the concept was flawed from the start.
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