The Euro falling into a recession?
economist.com
economist.com
(Of course there were governments and financial institutes which have behaved badly in the past, no denying there.)
For example, akin to the "Colbert Bump", there is a "Buffett Bump" where position prices rise as Buffett releases his positions. Over the past few weeks a bunch of firms were required to disclose some positions as part of a 13F filing.
But it's not all puffery. Check out the story of David Einhorn and Green Mountain Coffee (GMCR).
- If each country leaves the Euro, debt (including that with the U.S.) will remain as it is (no change in face value),
- If each country has its own currency, the inevitable devaluation will increase the value of the debt, and cost of interest (on local currency terms), making it impossible for many countries to repay that debt (including that with the U.S., which is well over $350bn)
- This will result in the immediate default for a long list of countries.
Food for thought
If each country leaves the Euro, then this will definitely happen. If only some does, then it will be up to the courts to decide what the treaties says.
Overall, who is going to guarantee a contract between states (like money lending)? There is no superpower that watches over them and punishes them if they do wrong, they have to fight it out among themselves somehow.
Also note that most of the contracts is not between states but between citizens, banks and other companies.
As for wars - forcing sovereign nations to pay debts in currencies they cannot pay is also a way to get wars. The post WWI war reparations and how they paved the way for Hitler[] is a good example of this.
[] Godwin, but I do think the example is relevant.
"They can unilaterally declare their debt to be in their new currencies, if they separate." is juts a wrong statement. How is sovereign debt different from corporate debt? Do you have an example?
Example: If Italy goes back to the Lira, the face value of Italian debt that the U.S. Government holds, in dollar terms, will not change, even if that debt is changed to Lira, IT IS NOT re-valued to a price the Italian Govt. sees fit. Should a devaluation of the debt occur, the U.S. would have to write-off billions from its balance sheet (assuming a devaluation of the Lira occurs, which is most certain).
If each country does this, billions will have to be written off, there isn't such thing as "Sovereigns do not play by the same rules as the rest of us.". I suggest you read any debt offering memorandum from any European Government or even the U.S. Government, all terms, clauses, reps/warranties are clearly explained and detailed.
http://blogs.reuters.com/felix-salmon/2011/11/20/cds-conspir...
"Everybody knows that Greece can and should take some kind of tactical advantage of the fact that most of its debt has been issued under Greek domestic law."
Sovereigns entering obligations under laws not their own is a totally different thing though, and cannot be changed this simple though.
As to how the US would react in such a hypothetical scenario, they'd probably send diplomats to Italy to try to bend some arms and influence the terms to be better for them, but it is the Italian government that is the bookkeeper for deals made under their own laws.
This is also why splitting up isn't necessarily going to fix much. Lots of banks are only solvent so long as they can hold many of these bonds on par on their books. Start having credit events, and crystallizing losses, and you get one bank after another falling over.
It's the fear of bank failure dominoes that is keeping credit out of the market; ironically, this fear of insolvency is destroying liquidity, which in turn is increasing insolvency risks - as long as banks are liquid, they can live indefinitely on the money they skim off the rate difference between their assets and liabilities. The ECB is in fact surreptitiously keeping the system afloat by purchasing bonds, but not liking it at all.
There's no simple solution to the whole mess; no matter what happens, I think it's going to be painful.
* recognize the dangers of this crisis and act boldly
* have much stricter controls on Eurozone countries, and have mechanisms to automatically cut expenses/raise taxes when some don't respect the rules (as Greece so blatantly did)
* compensate that making the ECB the lender of last resort of the Eurozone Countries
It's getting late, but there is still time to do this. But our leaders need to stop being timid and worrying so much about their reelection.
That would require some new treaties, and in some countries, require a referendum, i.e. a popular vote. If there's a big financial problem, you don't want that to hang on the popular vote or some small member states.
have mechanisms to automatically cut expenses/raise taxes
EU doesn't have the ability to levy taxes, only member states.
The cynic in me says that with the ECB bailing out & funding several states, that the ECB already has the power to dictate taxation matters to some of those states already. Let's see if that saves the euro.
As for taxes to levy, I didn't mean that they would be levied by the EU, but that the member state would have to do that automatically to keep the imbalance in check. Not easy to enforce, but I'm pretty sure a way can be found if there is the political will.
And Germany would still not acquiesce to letting ECB become a lender of last resort. FWIW, Germany didn't want Italy joining the Euro, much less Greece.
To get there, (mostly) the German and European leadership would have needed/need to reassure (mostly) the German public with different rules that would make a new Greek case impossible, and to make it understand that the more timid you are, the more you're going to pay for the crisis, Germany included.
Having said that, the Euro is a great project. It will trigger a common European economic policy and that will push Europe to the next level.
What national currencies will Euros be exchanged for? What rates will they be exchanged at? Will other markets recognise those new currencies (and they will be =new= currencies, since all the Eurozone currencies ceased to exist when they changed to the Euro), and what rates will they be traded at on the markets as opposed to the fixed exchange rate they'll swapped for Euros at.
It took 10 years to get from the establishment of the Euro (then ECU) as a currency to the point where all the Eurozone nations switched to it as the only official currency - there will not be 10 years to switch the other way, and it's going to be very very messy.
The Euro is the 2nd most traded currency after the US dollar, is the 2nd largest reserve currency after the dollar, it's used as part of currency baskets for setting FX rates of numerous other currencies. Were the Euro to dissolve, the second order effects in markets around the world would be extremely turbulent, and likely highly damaging to the world economy.
Claiming that it would be 'Nothing special' is naivety at it's most dangerous.
What is the route from point A to point B here? An economic crisis that forces tighter Eurozone policies? Military enforcement of economic policies?
Anyhow, short term, there will be a lot of fallout where exchange rates for contracts and loans stop being predictable leading to a drop of trade, and quite possible a lot of failed banks and other big institutions (probably saved by their respective governments, but it will still be a shaky time).
Long term (assuming the sovereign debt is made into national currency and not kept in Euro[]), the increased flexibility will make the economic status of the different Euro members a lot sounder. There will be consequences of less trade though, since it is not free for the companies to protect themselves against currency effects.
[] If they keep the debt in Euros while not being on the Euro themselves, then I expect hyperinflation. Thankfully for them (but not necessarily for the creditors) they will be able to do such a transition by a stroke of a pen. Sovereigns play by their own rules after all.
Why should it? The troubles we see now are NOT caused by the Euro but by overspending. Or are you saying the US economic problems are caused by the US dollar?
The economic problems of US are a lot less severe than those in the Euro area, precisely because US has a different way of equalizing bad balance between regions - namely taxes and federal spending. There are also no danger of default, since US can fulfill the obligations it has by printing money. That is also not on the table in the Euro area.
It tried to combine strong exporting nations like Germany with weaker tourist nations like Greece. Were the Deutschemark a separate currency, it would be stronger than the current Euro (and likewise, the drachma would be weaker than the Euro). Germany benefited greatly from this (net exporters benefit from a weaker currency -- see China) and Greece and other nations were hurt.
If you want to see a pure example, check out what happened with Nintendo. Thanks to the relative strengthening of the yen, they posted a loss: http://www.bbc.co.uk/news/business-15473961
Overspending is intrinsically not problematic if the currencies are separate. The governments of overspending nations would just print more money, devaluing their currencies in the process.
You've got it backwards.
Germans worked hard producing goods which they turn around and send to people outside Germany. This is a net loss for the Germans. In contrast, the Greeks received a bunch of goods and services they didn't need to work as hard for. This was good for them.
A weaker currency may be good for companies with domestic liabilities and foreign customers, but it's very bad for consumers with domestic customers (their employer) and foreign liabilities.
"Germans worked hard producing goods which they turn around and send to people outside Germany." <-- agreed
"This is a net loss for the Germans." <-- not so simple.
It is a net loss for Germans if you presume that they would sell the same number of goods with a stronger currency. However, that is not how it works. If the currency were stronger, they would actually export less, and as a whole would be worse off.
Let's take Mercedes-Benz cars as an example. Daimler pegs a price in Euros (the home currency) and the US price is driven by the euro price (plus some adjustments, but those are small relative to the product price). If the euro is weakened relative to the dollar, then they can sell cars at a lower price for US consumers. In the US market, then, they would sell even more cars. MB actually cut the price a bit for the E class lineup due to this effect.
As another example, consider China. If China's currency were allowed to appreciate against the dollar, then chinese goods would cost more to the US customers, making US-produced goods more appealing. In the extreme, if the dollar was severely weakened (for example, if the fed printed a ton of money without a similar action by china), then US products would actually be cheaper than the corresponding Chinese products.
No, it's a net loss for the Germans because they don't get to enjoy the product of their labor.
Consider your Mercedes example. Some Germans work very hard building this car, and do they get to enjoy driving this car? No. They put it on a boat and send it to the US. In return they receive some colored pieces of paper which they can't buy very much with.
A strong currency means your citizens have access to many goods and services worldwide. The USD is strong relative to the INR - that means I could buy all the dosas I wanted without caring about the price. In contrast, the strong GBP meant that I had to think twice before buying a sandwich in London.
I'm discussing the balance sheets of consumers. Maybe I'm just crazy, but I care more about consumers than I do about Mercedes-Benz Inc.
Suppose that mercedes benz is only able to sell half as many cars as normal. What will happen? Will they keep the same number of employees? If the US is any example, the answer is clearly no. And once families lose their incomes, they have less income to deal with.
If you presuppose that they magically earned the same number of euros without concern for the demand, then yes. However, that's not how it works. You have to look at Mercedes Benz and other companies because they are the ones who are paying most of the consumers.
Put simply, a consumer with no income in a world with a stronger Euro is worse off than a consumer with an income in a world with a weaker Euro (something is better than nothing :)
Consider the second order effects of a stronger currency. Germans can now purchase big screen TVs, food and non-German cars for less money than before. They still have money left over which can be spent on personal trainers, pedicures, restaurant meals, etc. Or conversely, they can work fewer hours.
In this world, Germans have the same number of Mercedes-Benz cars as before, and they also consume more restaurant meals and leisure.
Except that they did get paid for said goods, and if their currency had been independent and stronger, they would not have sold so many of them in the first place, since they would have been more expensive.
I think veyron has it right.
There is a lot of truth to that. It's important to keep in mind that Germany as a whole is doing that voluntarily, though. It is a (more or less) conscious political choice to be a net exporting nation, and it was achieved by (among other things) systematically depressing the real wage development in Germany by political means.
So the German position is really schizophrenic (and I'm saying that as a German). On the one hand, Germany has for the last ten years given presents (in real terms) to the rest of the world. But now Germans are saying that they don't want to give presents (aka bail outs) to other European countries, even while they insist on continuing to give presents (aka net exports) to other countries.
It is a self-contradicting policy.
The problem is that Germany - at least the German elite - benefited in the sense that accumulating financial assets against the rest of the world implicitly increases the power that Germany has over the rest of the world. So Germany is in this very powerful position right now, where nobody can effectively challenge the insanity of their self-contradicting policies, at least from the outside.
From the inside it is very hard work as well, because unfortunately the media campaigns in favor of net exports have been so effective that most regular people believe in their benefits.
One of the key planks of economics is that people respond to incentives, so is it really suprising that when incentivized to borrow (whether it's southern european governments, or low income earners with sub prime mortgages), people borrow?
AFAIK Italy's deficit has been more or less stable for the last twenty years while debt has gone down for the first few years of the euro presence and has only risen again after 2008.
As far as i can tell italy's problem has been and continue to be a de facto stagnation with growth rate around 1%, which surely is not the case for others e.g. spain.
A lot of planks of economics have failed lately, and it's not all government fault.
If you look at the rankings in "World Bank Ease of Doing Business" and "Heritage Economic Freedom" the picture is very clear:
"AAA Euro Countries": (Ranking WorldBank - Heritage) Finland: 11 // 17 Germany: 19 // 23 Netherlands 31 // 15 Austria 32 // 21 Luxembourg 50 // 13
Portugal: 30 // 69 Spain: 44 // 31 Italy: 87 // 87 Greece: 100 // 88
1)Forced conversions of savings from euros to pesetas, liras, francs, and in the process devaluating their purchasing power 50% or more(somebody have to pay for the excesses in financing industry and history says it is always the people as the people that have money will fly or ask expert advice to not being touched)..
2) Increment cost in commerce between Europeans as you will have to convert pesetas, escudos or liras to francs witch takes a hight commission and bureaucracy(time and money) cost.
3) If you go to other European country you will need to change money(and pay) and if you don't use it all you need to convert it again.
4) Debt is denominated in euros, so when countries start printing money for paying their obligations (pensions, functionaries) debt will be more impossible to pay than already is.
If the Euro breaks up it will break up into two. The currency of the top half will skyrocket and those countries will quickly become uncompetitive and so their economies will crash. The bottom half will find that they earn is some useless currency but that their debts are denominated in Euros. They will find themselves crushed under an impossible debt burden. Think negative equity on a national scale which last decades.
I know which half I would rather be in, but it's gonna be horrible for everyone.
Weeks ?! Wow... that's a very short time frame.
A country doesn't have to continue using the Euro. It would be... painful were they to switch, but it's by no means impossible.
Why can't it happen overnight? A government wouldn't want to announce it in advance, as that would lead to everyone withdrawing their money from the country and keeping it in (relatively safe) Euro, rather than the chosen local currentcy.
I don't see the strong euro economies having any reason to leave, right?
The problem with the Euro comes from the fact that all countries are locked in to the euro and that some countries (those with lots of debt) would benefit from the inflation that would be caused by printing Euros and some countries who saved money (Germany) would loose if inflation was prevalent.
The quickest way to understand the Euro crisis is to understand the concept of inflation and what it will do to each country.
*Alternative solutions that were proposed weeks ago include germany lending to greece or all of europe lending to weaker countries, but those loans required the countries borrowing to adopt tighter monetary policy.
That tighter monetary policy caused riots in greece because they didn't want to loose their entitlements.
The problem is escalating and will likely result in the fall of the European union.
Or you can just default ( http://en.wikipedia.org/wiki/Argentine_economic_crisis_%2819... ).
Does anybody read history? Is there any good example in the past of this actually working out well? I can only think of disasters when this was tried (usually by desperate politicians) in the past.
Greece is currently at least suffering from the inability to do #2: it would be ideal for Greece for the Eurozone to be running higher inflation rates, which, if nominal pay was held constant (as it currently has to be under their agreements), would in effect cut the pay of Greek employees (and their pensions) without having to cut it in nominal terms, as well as bring down the real prices of all sorts of other things like housing. The only alternative way of accomplishing that is significant, sustained domestic deflation in the form of actual nominal price/wage cuts, which is more difficult to pull off in a way that doesn't completely wreck the economy.
There is a lesson here about taking systems of people and trying to mash them together without acknowledging the necessary pain. I'm concerned that now we're in the end game, and more and more complex strategies are just going to make things worse. I would never advocate any kind of violence, but there's a good reason why Napoleon was the one person who did the most to modernize Europe.
The general consensus seems to be that a recession is already under way, and the contraction will continue until this all gets straightened out.
if you mean centralized government of the Empire - i'd not agree, there were other big Empires in the Europe which preserved, instead of solved/improved, the problems. If you mean Napoleonic wars, when i'd agree and add WWI and WWII.
But that kind of thing hardly seems to be the problem of mixing too many people together, it is simply a flaw in the system.
Of course the initial problem might have been that the system could only be some lowest common denominator of all the systems it tries to combine, making it almost impossible to create something good.
I find it interesting that there are therefore two interesting problems: how to set up a stable currency, and more importantly, how to set up a decision process that produces good results and doesn't alienate everybody.
I suppose even the US has different parts with different economic cycles and different economic strength.
Your point about the US is valid. However as their national debt is $15 trillion they aren't exactly a model economy.
That is one reason why people had high hopes for Europe: today it seems unthinkable to have a war between states of Germany (they don't have their own military either). Perhaps one day it could be as unthinkable to have war between European states.
Why are people so obsessed about the debt of sovereign governments these days?
Think about it like this: there is (virtual) money in MMO games. Gold in World of Warcraft, ISK in Eve Online, or whatever. In an in-world accounting sense, this money is a debt (liability) of whoever runs the system. But it is ridiculous on the fact of it to worry about the total amount of money in those systems.
So why is their this obsession with the debt?
The most immediate reason is this gut reflex of "it needs to be paid back". But what one has to realize is that, for a monetary sovereign, paying back the debt is just exchanging one type of liability against another. The debt is money that has already been spent. Paying it back does not create new financial assets, it is just an asset swap. Why on earth would that be problematic?
The other objection is that the interest paid on debt causes an undue redistribution of wealth. That point is one of ignorance: a monetary sovereign effectively sets the interest rate that it pays on its outstanding debt - that is what the monetary policy of the central bank is about.
Seeing the true nature of money is initially scary, and perhaps this is what stops many from a deeper understanding. I can only hope that future generation will make fun of us for the way we are thinking about money.
Countries which tie their domestic currency directly to the US's include Panama, Ecuador, and El Salvador. Namibia ties its currency to South Africa's (or rather, to the Multilateral Monetary Area).
Other monetary unions exist. The CFA franc has been around for 60+ years and the East Caribbean dollar has been around for 45+ years.
Those seem like counter-arguments to the idea that monetary policy should be "set on a country by country basis."
Since countries do yield domestic currency in favor of a shared currency, it's apparent that there are advantages to doing so. Why do none of those apply to the EU?
I know that I like how I can use the same currency in Germany, France, Spain, and Ireland without having to change money each trip. While I don't like stopping in Denmark, which has their own domestic currency.
The idea of for a country to appear credible by using a golden straightjacket. It's usually used by countries coming out of hyperinflation phases. And that policy has badly failed before in Argentina.
Of course, I'm just relating what I've been reading. I can tell you it's been quite alarming and yet strangely placid. Like watching a slow-motion train wreck.
I didn't mean the number of people. I meant the idea of smashing up lots of different systems of government and cultures through byzantine layers of bureaucracy instead of just replacing them with a centralized government (which would have worked very well, probably, but it was politically unfeasible)
Apart from going to these countries and open a bank account or have actual money under the mattress, how would this work?
My bank allows me to have accounts in USD and GBP (I actually have some money on each) but if the euro blows, and there is a bank freeze and mandatory 'exchange' of euros to whatever your local coin is, I would think these accounts would also be affected (something like exchanging the USD to EUR at current rate, and then changing the EUR to escudo or dracma)
I looked at forex but I'm in no way qualified to understand how the hell that works.
I'd consider the Canadian and Australian dollars, but they're both way over valued right now because of their political and economic stability. They have no where to go but down I think.
To a first order approximation, every country is printing money in a beggar-thy-neighbour approach to increasing competitiveness. But when the malaise is global, that doesn't exactly work well.
This is just not true. Didn't we have Gold and Silver for a common currency for a very very long time? Didn't countries just default back then?
The problem is not the currency the problem is implicit (now explicit) agreemand that countries cant default in the eurozone. Greek could of have defaulted just as Island did. The only loosers would have been the people holding the debt. There would no Euro-Crisis just a crisis of the countries that do really have a fical crisis.
2. Various types of gold standards have failed many times in history, including pegs to gold. The reason is almost always the same: countries will overspend no matter what currency they use - wars/militarism are often the excuse. Notable failures include:
- helping worsen, if not cause, the US Great Depression (US Fed decided to defend the peg to gold);
- helping cause the Weimar German hyperinflation (due to the victors taking almost all the German gold reserves for WWI reparations).
3. Free floating, market-traded fiat currencies solved the core problem of a physical fixed currency like gold. But like gold, they do not, nor can they, prevent governments continuing to overspend. However, they do allow a mechanism to punish them for doing so, i.e. the capital markets!
Unfortunately, the capital markets are unable to enforce their own brand of spanking and consolation in this case because there are no individual currencies per government in the Eurozone. So, it has to whip them using the main stick it has left which are the separate sovereign debts, but cannot console them with lower currencies.
After leaving these individual sovereign debt markets in droves and therefore causing government borrowing costs for EZ countries to soar to unsustainable levels, everyone in the markets is finally starting to realise there is no upside in being involved in a common currency which is killing its members.
Locked in a sub-optimal currency area, unable to raise affordable funds, unable to devalue currency, forced to reduce debt levels by austerity, no ability to import inflation (which would reduce real level of debts) because the world economy is entering a downturn, no fiscal union therefore no fiscal transfers, uncompetitive industries and low productivity due to decades of binge spending, therefore low or negative growth outlook...
This is a painful way for any sovereign to live and at some point something has to give!
Why are there still people trying to convince us that the mere existence of more lenders is a solution to debt?
The ECB has broken that rule because they realized that if they stick too tightly to it, they risk a breakup of the Eurozone, and that would eliminate their power base. By giving the least possible amount of support to troubled countries, they hope to stay in power - at the cost of the real living standards of the peoples of those countries, of course, as you can see with a quick look at the double-digit unemployment rates there.
The Euro could become a tragedy of the commons, but it isn't one at this point in time. It is more an example of Wile E. Coyote running into the air since 2000 until, around 2008-2009, he realized that there is no longer any ground beneath his feet. Since then, he's falling.
Which looking at Britains trade deficit it does. Bugger that.
I believe Sweden and the UK are the only two non-recent EU members with fully independent, floating currencies.
I find it surprising how just 3 years ago the euro was becoming a safe-haven, with Jay-Z flaunting them in his videos.
the problem, i think, is that there is a core contradiction at the heart of the euro system:
1) you can't have a currency union, without a fiscal union;
2) you can't have a fiscal union, without a true political union;
3) the euro area is a currency union with neither a fiscal or a political union.
in other words, for a currency union to work well, you need to shuffle money around. but you can't do that without political legitimacy, or if people feel like the money is going to "them", as opposed to "us".
The leaders who created the euro were trying to go about it the other way around: currency union would lead to fiscal union, which would lead to political union. but now, in a recession, with things going bad, they are finding that, in fact, they would need all three for any part to work correctly.
why are the Germans refusing to let the ECB be the lender of last resort? the core reason is that they see, correctly, that this would put them on the hook for the past and likely future mismanagement of the Greeks and Italians. of course, they can't say this publicly, so instead you hear all sorts of nonsense, hyperinflation this and weimar that.
or, to put it another way, would the Germans let this kind of thing happen to other Germans? I don't think so! Greeks and Italians are "them", and in bad times people feel less generous and fall back to the "us".
but at the same time, of course, their refusing to let the ECB, as it were, bail out the Greeks and Italians will inevitably lead to their default, exit from the Euro, and who knows what after that. at the very least, expect nationalist parties everywhere to rise in the polls.
let's just hope that we're not rebooting to the early 20th century.
1) you can't have a currency union, without a fiscal union; - correct.
2) you can't have a fiscal union, without a true political union; - unknown, but history is on your side.
3) the euro area is a currency union with neither a fiscal or a political union. - correct.
There may be a way to incentivise independent states to act in their collective interest and thus create a fiscal union without a true political union. However, if there is such a way, it has certainly never been applied to date for the Eurozone. This is the grand experiment ongoing in the EMU.
In a sense, the experiment not only already failed, but failed from the outset due to states choosing to ignore leverage rules in the 1997 Stability and Growth Pact, including even Germany.
The probability of this ending well, or without Germans paying in some shape or form and potentially severely against their long-term interests, is low.
If Germany had any sense, they will be making preparations to leave at any time, possibly taking the few remaining Germanic (+Switzerland) and Scandinavian creditor nations with them too.
So, it isn't a matter of self interest vs. generosity: it is a matter of understanding that it would be MUCH less costly to make the ECB lender of last resort now than to wait and just hope that things will fix themselves. Moreover, in Italy the only real risk is that of interest rates on its massive debt going too high: Italy already has a primary budget surplus, with "normal" rates the debt would already be shrinking.
1) Question mark. Recession already starting.
2) Not falling, pushed.