EU Superstate and Lisbon Treaty

Will the Euro Disintegrate?

Generating an oil price shock will solve the debt problems of the US economy, inflation will cure the current recession, and Wall Street desperately needs to bomb Iran.

February 15, 2010

Michael Kotov - The question that is on everyone's minds right now is whether the EU's common currency, the Euro, will withstand the shocks posed by the defaulting peripheral states.

This reminds me of the passage in Soros' Alchemy of Finance in which he described just such a scenario. Although the book had been written almost 30 years ago, the ideas discussed are as relevant today as there are ever.

Now Soros believed that the recession in the early 1990s would prove to be an economic calamity, much like we are witnessing today. In fact, there are many parallels between the two downturns: both involved credit crunches, subprime mortgages, CDOs and bank defaults.

The reason why Soros proved to be wrong last time is because the bankers had found a new way to keep expanding credit -- through issuing loans outside of the banking system. With the help of credit derivative products, new loans could be created by start-up mortgage brokers, hedge funds, and other market based financial intermediaries. In fact the proportion of the loans generated through the traditional banking practice has been on a steady decline ever since (for more information, please refer to Staff Report No. 360, Money Liquidity and Monetary Policy, by the New York Fed). Thanks to that, the calamity was avoided in 1990.

Soros also predicted that in the 1990s the European Monetary Union would, in fact, disintegrate; however, was proven wrong last time. Given that what he had believed was about to happen then, is happening now, could his late 1980s prediction come true this time?

If we look at it rationally, then we can see that the common currency for the EU is in fact an unstable system to start up with.

Having a single interest rate set for the entire European economy, with its great differences is bound to lead up to unstable scenarios. Then, without tight fiscal policy coordination, large deficits were allowed to build up by the peripheral countries. Now they are on a brink of default, leaving only Germany and France to bail them out.

Given the fact that the European economy has just dipped back into recession, the bailout for the PIIGS nations seems very unlikely, at least not for all of them. This of course leaves the IMF; but, at the same time, the PIIGS may find themselves in a situation where a default is, in fact, in their own best interest, a so-called strategic default.

Many corporations find themselves in just such a scenario. In fact, the UK defaulted in just such a way in 1931 and the US in 1933 by devaluing the value of their currency against the gold. True, it was a hidden default, yet both had an effect of diminishing creditor wealth whilst at the same time generating a strong recovery thereafter.

Thus the peripheral nations may very well choose to default and thus benefit at the expense of everyone else in the union.

The collapse of the Euro is therefore a very real possibility.

Collapse of the Euro is 'Inevitable': Bailing Out the Greek Economy Futile

February 13, 2010

Daily Mail - The European single currency is facing an 'inevitable break-up,' a leading French bank claimed yesterday.

Strategists at Paris-based Société Générale said that any bailout of the stricken Greek economy would only provide 'sticking plasters' to cover the deep- seated flaws in the eurozone bloc.

The stark warning came as the euro slipped further on the currency markets and dire growth figures raised the prospect of a 'double-dip' recession in the embattled zone.

Claims that the euro could be headed for total collapse are particularly striking when they come from one of the oldest and largest banks in France - a core founder-member.

In a note to investors, SocGen strategist Albert Edwards said:

'My own view is that there is little "help" that can be offered by the other eurozone nations other than temporary, confidence-giving "sticking plasters" before the ultimate denouement: the break-up of the eurozone.'

He added: 'Any "help" given to Greece merely delays the inevitable break-up of the eurozone.'

The alarming claim came a day after European Union leaders promised 'determined and co-ordinated' action to shore up Greece's tattered public finances, but disappointed traders by failing to provide specifics.

Further details are expected early next week, but markets were in high anxiety yesterday amid fears political divisions among rich eurozone members could derail any rescue. The euro slid almost 1 per cent to $1.357 yesterday, meaning it has lost 10 per cent of its value since November. The pound rose to 1.14 euros.

Earlier this week Business Secretary Lord Mandelson's claimed that the single currency had been a 'remarkable success' and that it remained in Britain's interests to join.

David Cameron ridiculed that claim yesterday. He told the Tories' Scottish conference:

'Are this Government the only people in the country who still think that would be a good idea? Our deficit and debt are bad enough without the straightjacket of the euro.

'If I am elected, for as long as I am prime minister, the United Kingdom will never join the euro.'

The French bank's warning was echoed by Mats Persson, Director of the Open Europe think-tank, which campaigns for reforms in Brussels. He said:

'The eurozone is facing a fully-fledged crisis. The Greece episode has made it painfully clear how flawed the euro project was from the very beginning.

'Even if Greece receives a one-off bailout it would not solve the real problem, which is the huge differences in competitiveness between the eurozone's richest and poorest members.

'If these differences are to be evened out, the EU would need a single budget and common taxes so it can redistribute resources.

'One thing is clear, Britain made the right choice in staying out.'

Mr Edwards argued that Portugal, Ireland, Greece and Spain are too economically weak to withstand the rigours of eurozone membership.

Countries that are highly uncompetitive are normally able to slash interest rates and devalue their currencies to prop up their economies. But this is not possible within the euro, given its one-size-fits-all economic governance.

The implication is that weak, peripheral eurozone members will have to suffer years of painful deflation and tumbling living standards, as well as draconian budget cuts, in order to adjust.

Harvard University Professor Martin Feldstein, a long-standing sceptic on the euro, yesterday said the single currency 'isn't working' because member governments have no incentive to keep their public debts under control.

'There's too much incentive for countries to run up big deficits as there's no feedback until a crisis,' he said.