[OPE] The Crisis of the Euro

Futronomics: contrarian analysis of global macro trends, commodities, currencies, equities: The Crisis of the EuroFrom the 'Futronomics' blog:
Futronomics: contrarian analysis of global macro trends, commodities, currencies, equities
Topics typically covered include: intermediate and long-term prices of major asset classes, political policy implications for the macroeconomy, socionomic and demographic influences on markets, deflationary vs. hyperinflationary influences, wealth preservation techniques, and more. Analysis is typically done with Austrian Economic Principles in mind... This is currently a not-for-profit beta version.

                            Sunday, January 18, 2009

                            The Crisis of the Euro

Ambrose Evans-Pritchard writes in the Daily Telegraph, "Monetary Union Has Left Half of Europe Trapped In Depression"

  Events are moving fast in Europe. The worst riots since the fall of Communism have swept the Baltics and the south Balkans. An incipient crisis is taking shape in the Club Med bond markets. S&P has cut Greek debt to near junk. Spanish, Portuguese, and Irish bonds are on negative watch.

  Dublin has nationalised Anglo Irish Bank with its half-built folly on North Wall Quay and €73bn (£65bn) of liabilities, moving a step nearer the line where markets probe the solvency of the Irish state.

  A great ring of EU states stretching from Eastern Europe down across Mare Nostrum to the Celtic fringe are either in a 1930s depression already or soon will be. Greece's social fabric is unravelling before the pain begins, which bodes ill.

Evans-Pritchard is one of the few mainstream writers who manages to get things right on occasion. With this article he is bang on. The euro is in disastrous shape. Back to the article:

  This week, Riga's cobbled streets became a war zone. Protesters armed with blocks of ice smashed up Latvia's finance ministry. Hundreds tried to force their way into the legislature, enraged by austerity cuts.
  "Trust in the state's authority and officials has fallen catastrophically," said President Valdis Zatlers,
  who called for the dissolution of parliament.

  In Lithuania, riot police fired rubber-bullets on a trade union march. Dogs chased stragglers into the Vilnia river. A demonstration outside Bulgaria's parliament in Sofia turned violent on Wednesday.

While American news has been transfixed on Barack Obama's coming inauguration and spends countless hours on pundit roundtables debating how long his "honeymoon" will last, the real world is still turning. Nearly every night on German television I see the riot footage. It is not just a few benign rabble-rousers. These riots are displays of society-wide malcontent with the results of the worldwide depression. Many of these countries were goaded into joining the EU with promises of greater economic stability. All they got was an enormous influx of foreign capital causing huge asset inflation - which has now subsequently fled and is leaving a path of destruction in it's wake. The Latvians, Greeks, Bulgarians, Irish and many others are now finding that they are worse off than they were before the EU, yet their own governments are toothless to do anything because of the many international treaties they signed.

The European Union itself is a representation of positive social mood. Now that many of the other symptoms of that high social mood are coming undone (rising prices, low unemployment, rapid growth) the logical conclusion is for the EU and by extension the Euro to come under increasing attack as well.

  These three states are all members of the Exchange Rate Mechanism (ERM2), the euro's pre-detention cell. They must join. It is written into their EU contracts.

  The result of subjecting ex-Soviet catch-up economies to the monetary regime of the leaden West has been massive overheating. Latvia's current account deficit hit 26pc of GDP. Riga property prices surpassed Berlin.

  The inevitable bust is proving epic. Latvia's property group Balsts says Riga flat prices have fallen 56pc since mid-2007. The economy contracted 18pc annualised over the last six months.

  Leaked documents reveal – despite a blizzard of lies by EU and Latvian officials – that the International Monetary Fund called for devaluation as part of a €7.5bn joint rescue for Latvia. Such adjustments are crucial in IMF deals. They allow countries to claw their way back to health without suffering perma-slump.

  This was blocked by Brussels – purportedly because mortgage debt in euros and Swiss francs precluded that option. IMF documents dispute this. A society is being sacrificed on the altar of the EMU project.

Nobody thought to question these contradictions on the way up. Just as nobody really thought to question the trillions worth of promises made to the newly retired and the elderly in the form of Social Security and Medical Insurance. All of the economic "models" made by Harvard graduates suggested that everything would be just fine. All they needed to do was take the last 10 or 20 years of data and extrapolate that over the future. Presto! You're all going to be rich!

Oh. What's that? The models were filled with faulty assumptions? That can't be right. My Harvard PhD advisor says it's okay to make assumptions. He's wrong? Uh oh.

Many of Europe's economies and most of the world's financial system has been having an "uh oh" moment for the last year. As a result, small countries (ones we've been schooled to believe only exist in geography class) are erupting into anger and chaos.

Yet somehow, there is still a vast consensus that President Obama will fix everything. That some policy change in Washington will all of a sudden cause Europeans to start speculating on condos in Riga again. That MBS will be repackaged with new derivatives and home prices will bounce back. Does anyone else see how this common logic is absolutely insane? At least try to tell me that some science experiment will change the world. Or we'll find a miracle drug. Don't try to tell me we'll just go back to making the same stupid mistakes. More from the article:

  Italy's treasury awaits each bond auction with dread, wondering if can offload €200bn of debt this year. Spreads reached a fresh post-EMU high of 149 last week. The debt compound noose is tightening around Rome's throat. Italian journalists have begun to talk of Europe's "Tequila Crisis" – a new twist.

  They mean that capital flight from Club Med could set off an unstoppable process.

  Mexico's Tequila drama in 1994 was triggered by a combination of the Chiapas uprising, a current account haemorrhage, and bond jitters. The dollar-peso peg snapped when elites began moving money to US banks. The game was up within days.

  Fixed exchange systems – and EMU is just a glorified version – rupture suddenly. Things can seem eerily calm for a long time. Politicians swear by the parity. Remember John Major's "soft-option" defiance days before the ERM blew apart in 1992? Or Philip Snowden's defence of sterling before a Royal Navy mutiny forced Britain off the Gold Standard in 1931.

  Don't expect tremors before an earthquake – and there is no fault line of greater historic violence than the crunching plates where Latin Europe meets Teutonia.

  Greece no longer dares sell long bonds to fund its debt. It sold €2.5bn last week at short rates, mostly 3-months and 6-months. This is a dangerous game. It stores up "roll-over risk" for later in the year. Hedge funds are circling.
  Traders suspect that investors are dumping their Club Med and Irish debt immediately on the European Central Bank in "repo" actions.

  In other words, the ECB is already providing a stealth bail-out for Europe's governments – though secrecy veils all.
  An EU debt union is being created, in breach of EU law. Liabilities are being shifted quietly on to German taxpayers. What happens when Germany's hard-working citizens find out?

Indeed. The German people are not stupid. They know they were being swindled by the south. But as long as unemployment kept falling, nobody had any reason to speak out. As I pointed out in Manufacturing Weakness Spreads to Germany, that is no longer the case. People are being thrown out of work here too.

Germany has a general election later on this year. I fully expect that at some point, the issue of Germany's ties with the rest of Europe will become front and centre. The euro cannot survive without Germany's support.

Those betting on the imminent collapse of the US Dollar are missing the boat entirely. The euro is the real problem child. And when it falls, US Dollars rise. Paper money is still the medium of exchange, and as long as it is mandated so by law, demand for that medium will continue. Conventional wisdom has it that the US Dollar is on the verge of an inflationary nightmare due to the exploding Fed balance sheet. Conventional wisdom is not generally correct.
Posted by Matt Stiles at 3:13 AM
Labels: euro crisis

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Received on Wed Jan 21 12:55:24 2009