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Thursday, November 17, 2011

Last Man Standing

Now that it is clear that the Eurozone is in a free-fall unraveling (see e.g. Wolfgang Münchau in Der Spiegel), with panic enveloping the sovereign debt of every country except Germany (even such paragons of virtue as the Netherlands and Finland), the solution is clear. If Germany will not agree to the ECB acting as lender of last resort, as somebody must to stop a financial panic, then it should leave the Eurozone and let the remaining countries put their house in order themselves.

This is much simpler without Germany than with it:
  1. First, the rump Euro will devalue with respect to the new DM, restoring the rump EZ's competitiveness with respect to Germany (Germany was always the outlier in the unit labor cost ranking);
  2. The remaining EZ members can abandon the masochistic and self-defeating austerity approach (not that this absolves them from other important reforms);
  3. Germany will be left sitting on devalued Euro sovereign debt and will have to massively bail out its banks;
  4. Everyone else will enjoy windfall profits on the appreciating German sovereign debt they own (assuming it is redenominated one-to-one into DM, as it must be for German domestic creditors);
  5. The rump EZ can finally empower the ECB to act as lender of last resort and restore their national creditworthiness. (Greece might still be a problem...)
Hats off to Germany for being the last man standing, but it will be a Pyrrhic victory over its European partners that will only bring it grief. A serious attempt to create a workable, mutually advantageous Eurozone would have been preferable, but too much Borniertheit stood in the way. RIP

Post mortem exam question for economists: why was a domino effect hidden within the governance structure of the Eurozone, but not in the Dollar, Pound, RMB and Yen zones?

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