Monday, October 24, 2011

BRICS to the Rescue? Kiss Eurozone Growth Goodbye

In September, when Michael Pettis' private newsletter discussed how destructive a BRICS rescue of the eurozone or any eurozone country by buying bonds would be, his observations and conclusions were too obvious to justify further comment.  Here is a shorter public version of the newsletter.

Bottomline, if China and Brazil were to buy sovereign bonds in the eurozone or EFSF eurobonds (if any are ever approved), it would would mean the eventual shift of financial flows to the BRICS from the eurozone stifling eurozone economic growth, because, as Pettis said, "foreign investment simply replaces domestic savings, undermines the manufacturing sector, and raises unemployment or debt."  As the BRICS bought European bonds, the Europeans would be forced to buy United States bonds, US dollars would be sold to buy euro and the euro would strengthen while trade balances would shift to the BRICS, particularly China.  This is the consequence of foreign investment.  To make matters worse, as Pettis points out, the foreign investment is not needed as Europe is awash  in capital in the surplus countries.

Yet, as the trade surplus nations of the eurozone continue to avoid the trade imbalances within the eurozone, this possible scenario is being floated as the EU Summit  draws out with France and Germany unable to agree and the UK demanding all EU countries participate.  This will only seriously aggravate the eurozone problem as, according to Pettis, "the increase in foreign investment would simply be matched either by an equivalent reduction in domestic savings or an equivalent increase in domestic debt to counteract the rise in unemployment. Rather than ease the burden, in other words, foreign investment simply replaces domestic savings, undermines the manufacturing sector, and raises unemployment or debt."

If the BRICS want to help Europe then they need to invest in infrastructure and manufacturing in the eurozone and, particularly, in the peripheral countries.

If BRICS buy eurozone peripheral sovereign nation bonds through the EFSF or individually, the eurozone can kiss economic growth goodbye and the currency problems of the euro multiply with decreased savings, increased debt, increased unemployment, and loss of trade surplus to non-eurozone countries.

As we indicated in our last post, the eurozone needs to decide if it will be a fiscal European Union or if it needs to break up. 

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