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,Hello JB, I think you misunderstand my message. I am not biased against Germany, and I am in favor of "austerity".
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. ....
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.
- 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 one two ways.
- Germany Forgives Loans to European Debtor Nations
- 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 supporter 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.
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.
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 done the politically expedient 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.