What is going on in the Eurozone?
The always sane Martin Wolf writes in the FT:
“Perhaps future historians will consider Maastricht a decisive step towards the emergence of a stable, European-wide power. Yet there is another, darker possibility … The effort to bind states together may lead, instead, to a huge increase in frictions among them. If so, the event would meet the classical definition of tragedy: hubris (arrogance), ate (folly); nemesis (destruction).”
I wrote the above in the Financial Times almost 20 years ago. My fears are coming true. This crisis has done more than demonstrate that the initial design of the eurozone was defective, as most intelligent analysts then knew; it has also revealed – and, in the process, exacerbated – a fundamental lack of trust, let alone sense of shared identity, among the peoples locked together in what has become a marriage of inconvenience.
Elsewhere, on the highly recommended Project Syndicate, Barry Eichengreen, Professor of Economics and Political Science at Cal-Berkeley, has this to say:
“Europe is again on the precipice. The most recent Greek rescue, put in place barely six weeks ago, is on the brink of collapse. The crisis of confidence has infected the eurozone’s big countries. The euro’s survival and, indeed, that of the European Union hang in the balance.”
As with any debt crisis, the real questions are (a) whether it’s a crisis of solvency or of liquidity; and (b) if the former–which it assuredly seems to be–whether there’s a believable plan for restoring solvency.
Wolf lays out the three questions which immediately follow:
- How big is the required restructuring?
- Who will pay? and
- Will that be enough?
Needless to say, if the answer to #3 is “no,” it’s difficult to envision the eurozone surviving in its current form. Here’s how bad it is in some of the worst-hit countries:
As you can see, it’s ugly.
Wolf does the numbers, with help from Citigroup, and estimates that if all the losses from restructuring were to fall on private creditors, they would lose:
- 97% of their holdings of Greek debt;
- 63% for Ireland, and
- 60% for Portugal.
Assuming this is not plausible–among other things, it could cause some marquee banks in “core Europe” to fail–the governments of those core Europe countries would have to bail out the banks. In other words, the EU “would be revealed as a transfer union.” And this is even assuming the super-debtor nations make very courageous strides towards austerity.
Ultimately, of course, there is no choice but to write down the debt to more or less what its true value, as reflected in its market pricing, is. Yes, this would “crystallize losses,” as Martin delicately puts it, but what choice do we have? This is reality because “the chances of success with denial are close to zero,” and history shows that the sooner such losses are recognized and booked, the better.
But this only stops the patients’ bleeding.
The next challenge is restoring growth, and here the statistics are not encouraging either.
Look at the spreads on these debt instruments–not just the Eurozone “periphery” debtors but the major bank spreads.
I think Germany faces a very unhappy choice: Either they can support the ECB in ensuring liquidy for governments and financial institutions which are solvent, or they cannot.
I don’t foresee a way for this to end through any other measures.
And if Germany says no to such an investment in the ECB?
Unless the ECB steps in anyway and props up liquidity far and wide, a snowballing financial collapse seems utterly plausible, indeed probable.
The ECB might be prudent to call Germany’s bluff, as it were, and support liquidity anyway.
This basically leaves Germany with the choice whether to walk out of the Eurozone, accompanied perhaps by whoever else would come along. (Martin suggests Austria, the Netherlands, and/or Finland.)
The consequences, then, of that?
I dare not even think about them right now. Tomorrow is another day.
(Of course, that last paragraph was meant facetiously: I’m stealing a page from the evident thought processes of the alleged leaders in Europe at the moment.)
