Tuesday, November 22, 2011

The Slippery Slope or, Is There Method in This Madness?

Why is the Eurozone like a bunch of mountaineers, roped together in a line, dangerously ascending an icy precipice overlooking a chasm, and not a group of solid economies, pooling their resources and reserves to create, via the laws of diversification and scale, a more stable and robust economic entity? After all, EZ indebtedness and deficits are lower than those of the US, the UK or Japan. The way things now work, one climber after another is slipping off the ledge and falling into the chasm, pulling the next candidate with him by the rope, the Euro, that was originally meant as a safety device. As more and more climbers slip off the precipice, the weight on the remaining climbers only increases, accelerating the tragedy and making a mockery of the rope.

But the situation is even worse than this. Well before the first climber started slipping, the lead climber was surreptitiously loading the other climbers' backpacks with stones (otherwise known as current account deficits). And a helicopter to whisk the climbers off the mountain and land them on flatter terrain was not available because the pilot did not consider it to be his job.

The Eurozone is in free fall because markets, rightly, have woken up to the fact that sovereign debt issued by countries that do not possess a central bank is almost worthless, even more worthless than the debt of emerging market countries issued in hard currency. The latter can at least devalue their national currencies to increase their export competitiveness, and adjust their central bank discount rates, while the former are locked into a currency they do not control and cannot defend.

The ECB has shown itself to be the central bank, not of the Eurozone as a whole, but in essence of Germany and the Bundesbank, the lead climber. Thus as the crisis has unfolded, yields on German Bunds have fallen while spreads on other EZ debt have soared, even on AAA rated ones like France, the Netherlands and Austria.

So today, once again, the Bundesbank's Jens Weidmann says that Italy and Spain should be able to solve the crisis by their own efforts, without ECB intervention. The only thing we have to fear is fear itself, i.e., a crisis of confidence. And Merkel reiterates that austerity, austerity, austerity is the only solution. How can they fail to see that the absence of a central bank backstopping (not financing) periphery EZ debt, and periphery austerity, are leading inexorably to exactly the crisis of confidence they think they can exorcise with incantations of more austerity?

Or is there method in this madness that we mere mortals are unable to perceive? A darker plot to impose a (Brussels/Paris/Berlin based?) Eurocratic dictatorship over recalcitrant peripheral, and with the increasing unpopularity of the bailouts, also core democracies, as intimated by former EU official Bernard Connolly (see Milken Institute 2011 panel and his 2002 Dark Vision document)?

I'm not much of a fan of conspiracy theories, but one is forced by the Euro crisis to make a choice between two incredibly difficult assessments. Either the German government and Bundesbank are being unbelievably obtuse, acting against their own long-term interests, and are just 'unbelehrbar' (German for incorrigible). Or they are complicit in some darker antidemocratic project that we mortals can only faintly adumbrate, a project that has already brought down the democratically elected governments of five EZ countries (Portugal, Ireland, Greece, Italy and now Spain), with two of them now being governed by Eurocratic unelected governments. The peripheral countries' governments are now essentially impotent to carry out any policy except that dictated to them by Germany. That's why the election of a new conservative government in Spain, and the consolidation of the Monti government in Italy, have brought them no relief on the interest rate front. The future of the Eurozone is being decided exclusively in Frankfurt and Berlin, and my impression is that these people do not have the faintest idea what they are doing. But I could be wrong, which might just be even worse.

The self-destruction of the Eurozone will be one of the signal events of modern European (and world) history. But whether it was the result of method or of madness will be a matter for future historians to decide.

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