Saturday, October 22, 2011

Has Germany Castrated the Euro?

The German Bundestag now has the legal authority to require the German government to submit all EU proposals which will have budgetary effect to the Bundestag for approval prior to negotiation committing Germany to any agreement.  This virtually prevents the German executive from negotiating any substantive EFSF or other economic support for the eurozone as a whole, or particular member countries, through the EU, ECB, or EFSF.

Despite early French-German discord, there was some renewed hope that a 3 trillion euro package could be put together for the EFSF only to have the German Finance minister quickly and very publicly state that no miracle cure will emerge from tomorrow's EU Summit on the eurozone's sovereign debt crisis and further stating that the process for resolution will take much longer into next year, which has again placed focus and pressures on bank credit and liquidity rather than the more centrally important issue of sovereign risk in a monetary union without any fiscal transfer mechanism.

The EU Summit tomorrow will not only be a disappointment, but it could well be the ultimate stone thrown on the victim of European union.  The 3 trillion euro package has been reduced to 2 trillion and now they are again talking of 1.3 trillion with no additional public sector haircuts beyond 50%, when it is obvious is needs to be much larger if not 80% or more, at the insistence of the ECB, although that would only amount to a 22% writedown of Greek debt and far too little money to provide bank recapitalization and sovereign credit support.  European banks alone face a potential 7 trillion loan contraction.  A conservative economic stabilization fund would need at least 10 trillion if bond buying to support sovereign credit is included to provide some (this is an off the cuff figure and would only be a temporary solution as the political problems will lengthen the process) time to politically provide either the necessary treaty changes with democratic approval for fiscal union or a planned orderly default and withdrawal of Greece from the eurozone.

Already France is being threatened with a ratings downgrade by Moody's and the S&P is warning of an EMU downgrade blitz.  European officials and economists have lost focus on the big picture in attempts to defend cherished political and economic policies which defy real economic data.  While Munchau has maintained the optimal fix would be a democratic fiscal union with the alternative an unacceptable public recapitalization of European banks, this, in my opinion, would only further the depth of sovereign risk and potentially endanger democratic rule.  Munchau has asserted that the choice will be between fiscal union or break up.  Martin Wolf has essentially agreed in the need for fiscal union as first aid will not remedy the eurozone internal balance of payments crisis which is at the heart of the euro currency crisis, as Michael Pettis has clearly described as an economic imperial and colonial relationship.

The European Commission's assessment report has been leaked which shows the total unsustainability of current program and proposals and further discloses the ECB does not agree with the private sector involvement scenarios.  The full leaked version can be found here.   As Rob Parenteau and Marshall Auerback have asserted in private email communications (of which I was a copied recipient), this document substantially documents not only the unsustainability of current programs but refutes current austerity economic polices as indefensible.  In another private email to them from Martin Wolf, he has indicated that Greece's present problem is one of economic flows, which is correct for the current situation in which Greece's debts are denominated in a foreign currency (euro) and default would gain Greece little.

However, any planned, orderly default by Greece would require an immediate take it or leave it redenomination of all Greek debt, public and private, into the new Greek currency.  This would establish an economic stock in which the economic flows are secondary as a fiat currency sovereign nation which taxes cannot become insolvent. The market would decide the haircuts and devaluation.  Most economic speculation has assumed any Greek default would be within the euro which would be suicidal sacrifice on the alter of European union on the part of the Greece, whose citizens do not appear to want to slink into the darkness of slavery quietly.

The EU Summit tomorrow will not only be a disappointment, it may well be a defining moment of existential despair.  In that despair, what choices will the different people of Europe make?


Here is a post by Rob Parenteau entitled "Leaked Greek bailout document: Expansionary fiscal consolidation has failed" which can be found at Credit Writedowns here.

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