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Bild Zeitung populism has prevailed. Germany is pushing Greece towards a hard default, risking the uncontrollable chain reaction so long feared by markets.
– Germany and Greece flirt with mutual assured destruction (Telegraph, Sep. 11, 2011):
First we learn from planted leaks that Germany is activating “Plan B”, telling banks and insurance companies to prepare for 50pc haircuts on Greek debt; then that Germany is “studying” options that include Greece’s return to the drachma.
German finance minister Wolfgang Schauble has chosen to do this at a moment when the global economy is already flirting with double-dip recession, bank shares are crashing, and global credit strains are testing Lehman levels. The recklessness is breath-taking.
If it is a pressure tactic to force Greece to submit to EU-IMF demands of yet further austerity, it may instead bring mutual assured destruction.
“Whoever thinks that Greece is an easy scapegoat, will find that this eventually turns against them, against the hard core of the eurozone,” said Greek finance minister Evangelos Venizelos.
Greece can, if provoked, pull the pin on the European banking system and inflict huge damage on Germany itself, and Greece has certainly been provoked.
Germany’s EU commissioner Günther Oettinger said Europe should send blue helmets to take control of Greek tax collection and liquidate state assets. They had better be well armed. The headlines in the Greek press have been “Unconditional Capitulation”, and “Terrorization of Greeks”, and even “Fourth Reich”.
Mr Schauble said there would be no more money for Athens under the EU-IMF rescue package until the Greeks “do what they agreed to do” and comply with every demand of `Troika’ inspectors.
Yet to push Greece over the edge risks instant contagion to Portugal, which has higher levels of total debt, and an equally bad current account deficit near 9pc of GDP, and is just as unable to comply with Germany’s austerity dictates in the long run. From there the chain-reaction into EMU’s soft-core would be fast and furious.
Let us be clear, the chief reason why Greece cannot meet its deficit targets is because the EU has imposed the most violent fiscal deflation ever inflicted on a modern developed economy – 16pc of GDP of net tightening in three years – without offsetting monetary stimulus, debt relief, or devaluation.
This has sent the economy into a self-feeding downward spiral, crushing tax revenues. The policy is obscurantist, a replay of the Gold Standard in 1931. It has self-evidently failed. As the Greek parliament said, the debt dynamic is “out of control”.
We all know that Greece behaved badly for a decade. The time for tough love was long ago, when the mistakes were made and all sides were seduced by the allure of EMU.
Even if the Papandreou government met every Troika demand at this point, it would not make any material difference. Greek citizens already understand this, and they understand that EU loan packages are merely being recycled to northern banks.
Instead of recognizing the collective EU failure at every stage of this debacle, the creditor powers are taking out their fury on what is now a victim.
We have never been so close to EMU rupture. Friday’s resignation of Jurgen Stark at the European Central Bank is literally a kataklysmos, a German vote of no confidence in EMU management. Dr Stark is not just an ECB board member. He is the keeper of the Bundesbank’s monetary flame.
The vehemence of his protest against ECB bond purchases confirm what markets suspect: that the ECB cannot shore up Italian and Spanish debt markets for long without losing Germany.
“I look at what is happening in EMU and the words that spring to mind are total and utter disaster”, said Andrew Roberts, credit chief at RBS. He thinks German Bund yields could break below 1pc in the flight to safety.
Citigroup and UBS both issued reports last week on the mechanics of EMU break-up, both concluding with touching faith that EU leaders cannot and will not allow it to happen.
“The euro should not exist,” said Stephane Deo from UBS. It creates more costs than benefits for the weak. Its “dysfunctional nature” was disguised by a credit bubble. The error is now “painfully obvious”.
Yet Mr Deo warns that EMU exit would not be as painless as departing the ERM in 1992. Monetary unions do not break up lightly. The denouement usually entails civil disorder, even war.
If a debtor such as Greece left, the new drachma would crash by 60pc. Its banks would collapse. Switching sovereign debt into drachma would be a default, shutting the country out of capital markets. Exit would cost 50pc of GDP in the first year.
If creditors such as Germany left, the new mark would jump 40pc to 50pc against the rump euro. Banks would face big haircuts on euro debt, and would need recapitalization. Trade would shrink by a fifth. Exit would cost 20pc to 25pc of GDP.
UBS concludes that the only course is a “fiscal confederation”, a la Suisse.
Well, perhaps, but Germany’s top court chilled such hopes when it ruled that the Bundestag’s budgetary powers may not be alienated to “supra-national bodies”. Nor do I believe that German society is willing to undertake such a burden for Greco-Latins in regions equal to six times East Germany.
Citigroup’s Willem Buiter disputes the “federalism or bust” dichotomy, saying Anglo-Saxon commentators are trapped in the mental world of the Peace of Westaphalia in 1648, which established the sovereign state as pillar of international order.
“There is no recent, close analogue to the EU,” he says. As a blend of national and supra-national, the EU resembles the Holy Roman Empire, which united central Europe from the 10th Century until Luther (technically until 1806).
Dr Buiter says the two “canonical models” for EMU break-up – that debtors walk out, or the German-led core walks out – are both are fraught with perils.
The weak would sell their souls for a mess of potage, discovering that devaluation can be an “uncontrollable process” with little lasting gain for exports.
If the German bloc left to create a “Thaler”, the costs would be less. However, the rump euro would fall apart, with massive dislocations. “It would not be pretty,” he says.
Ultimately, political investment in the EU project is by now too great to entertain such thoughts. The eurozone will muddle through along a third way, with spasms of debt restructuring kept within the euro-family. It will fall short of a transfer union or a debt pool, he said.
Each of these reports is a terrific read, but as an unreconstructed Westpahlian – and having covered a lot of NO votes to EU referendums – I don’t accept that Europe has a teleological destiny towards closer union.
It has already pushed its ambitions beyond the tolerance of Europe’s historic states and cannot be made democratically accountable.
The new fact of recent months is that German society has begun to discern a clash between its own democracy and the fiscal drift of EMU. The two are seen to be in conflict for the first time. Germans may be forced to choose. The outcome to that is far from clear.
Nor do I accept the headline figures of UBS. Every Treasury official and every voice of orthodoxy warned in 1931 that British exit from the Gold Standard would unleash the seven plagues. It proved a liberation. The UK, the Empire, and allied states broke free from a system that had become an engine of deflationary Hell. It cleared the way for monetary stimulus and recovery.
There is a close parallel between 1930s Gold and EMU, both in destructive effect and totemic sanctity. The Gold Standard was more than a currency system. It was the anchor of an international order and way of life.
My solution – like that of Hans-Olaf Henkel, the ex-head of Germany’s industry federation (BDI) – is to split EMU into two blocs, with France leading a Latin Union that keeps the euro. This bloc would devalue but not by 60pc, yet uphold its euro debts intact. The risk of default and banking crises would decrease, not increase.
The German bloc could launch their Thaler, recapitalizing banks to cover losses from rump euro debt. Disruptions could be contained by capital controls at first. None of this is beyond the wit of man. My bet is that aggregate losses would be lower than the status quo, and the long term outcome much healthier. The EU might even carry on, unruffled.
The status quo, however, is not acceptable. EMU’s debt-deflation strategy has trapped half of Europe in depression, with youth unemployment reaching 46pc in Spain and no way out for years.
Perhaps a global coalition of the G20, IMF, China, and the oil powers will combine to rescue Euroland, as some now hope. But how would that bridge the gap between EMU’s North and South? It solves nothing.