“We have to keep the British economy safe, to take the British economy through this storm. That means preparing for all eventualities” British prime minister, David Cameron speaking on 10th November in the UK and responding to concerns about the EuroZone
Germany is reportedly doing it, the British prime minister has admitted the UK is doing it, the French are strongly suspected of doing it, but when asked if Ireland is preparing or has prepared a Plan B for dealing with a break-up of the EuroZone, Taoiseach Enda Kenny said last Tuesday 8th November 2011 that “on behalf of our own country he [Enda Kenny] had contributed to that debate [the EU summit last month which addressed Greek debt, European banks’ capital and expanding the EFSF]” and “unlike what happened here in this country a number of years ago, I [Enda Kenny] don’t expect that if a crisis does arise within the EuroZone that it [Plan B] will be took at 2.30 or 3.30 in the morning with nobody present except a very few, I would expect that the leadership of the EuroZone would call a special council meeting if there is to be a special focus on any particular crisis or any particular aspect of a crisis. I expect that European leadership will deal with this politically” You would hope and pray that the Taoiseach avoided confirming the existence of a Plan B in order not to undermine confidence which might lead to the withdrawal of euros from Irish banks and conversion to a more secure currency (I suppose the good old Swiss Franc, but even the US dollar and sterling look strong compared to the euro at present); you would hope the NTMA and the Central Bank of Ireland and the Department of Finance have prepared a Plan B, and hope also that it is never needed.
There seems to be a lot of chatter presently flying through cyberspace about Ireland’s contingency planning for a break-up of the euro. But for the last couple of years there seems to have been periodic rumours about Punt Nuas being secretly printed at the Central Bank of Ireland in Dame Street, with stocks of the new currency all ready to be dispatched to banks once the mushroom cloud rises over the ECB in Frankfurt; normally the rumours are based on whispers by a friend whose boyfriend’s sister’s cousin twice-removed claimed that they’d seen actual evidence of the new currency. Of course there may be a secret store of a new currency but given the size of this small country, the fact that nothing concrete has leaked out suggests gossip and misinformation. The view on here is that there would be a number of future junctions to pass before the euro collapsed, there would at least be an attempt at closer fiscal union involving Ireland, an attempt to expand the ECB’s balance sheet (in other words printing more euros which would help indebted nations, and nations with deficits, but would tend to push up inflation) and a better attempt to recapitalise EuroZone banks, before France and Germany allowed a collapse. But you never know, and next weekend we may find that other EuroZone countries have deployed their long-prepared contingency plans and we are forced to manage our economy with Punt Nuas.
So what would that mean?
For the household, it would mean bank accounts denominated in euros would be converted to Punt Nuas and for the sake of simplicity let’s say EUR 1 = PNTn 1. The banks would also allow you to convert your notes and coins to Punt Nuas. Your borrowings from Irish institutions would be converted to Punt Nuas. So the Central Bank would need have a stock of notes and coins but remember that most money in the economy is in bank accounts.
For businesses, like households, their bank accounts, borrowings from Irish banks and cash on hand would be convertible to Punt Nuas. Sales would be in Punt Nuas so prices in the shops would be in Punt Nuas, your newspaper would in Punt Nuas and your salary and any welfare benefits would be paid in Punt Nuas.
For banks, they’ll need change the currency on their computer systems and ATMs, and they’ll need convert any cash on hand at the Central Bank of Ireland to Punt Nuas.
What about international debts? By default these will still be payable in the currency specified when the debt was incurred in the first place. I note that our bilateral bailout agreement with the UK requires us to repay the maximum of GBP 3.2bn in sterling in the event that the euro collapses. The worrying thing is that the betting is that following the creation of our currency, it will lose value against stronger currencies so these debts will increase. It is unclear how the remainder of our national debt will fare. It is also unclear how the Central Bank would limit the euros which it exchanged, presumably there would be a strict time-limit for exchange but there might need be further restrictions to stop euros in the other 16 countries being exchanged. And it is unclear if foreign currency accounts at Irish banks in Ireland would be affected, for example by a decree that they must be exchanged at a fixed rate.
Protecting your savings. Now this might be the subject which is soooo dangerous to talk about that Taoiseach Kenny gave the anodyne “it’ll be all okay” response when asked about Plan B in the Dail during the week. If the Punt Nua is to depreciate against established currencies then should businesses and households be converting euros now to a stronger currency? Notwithstanding the fact that exchange will carry a cost and commission, you’ll need find a foreign currency account, you may need access to the funds now to pay day-to-day expenses and you may find that you have exchanged your euros into a currency which loses value. So there’s no clear answer.
During the week it was claimed in the Irish media that there had been some 39 currency unions across the globe in the last century which failed but that subsequently “the sun rose in the morning” meaning that life went on after the break-up. Looking at the Wiki list of currency unions they all appear to be based on the gold standard or else a pegged to a traditionally strong currency like the US dollar or pound sterling. A break-up of the euro currency union between 17 developed countries, where the currency is not pegged to any external currency or standard, seems like a completely new proposition. The sun may well rise in the morning but a sudden euro collapse looks very messy indeed.
NAMA Wine Lake 
Cardiff was asked back in July
http://debates.oireachtas.ie/ACC/2011/07/21/00004.asp
Deputy Shane Ross: I want to come back to the banks, to what Deputy Kieran O’Donnell talked about and the negotiations in Europe today. I know Mr. Cardiff cannot say very much about them and I thank him for offering to provide various scenarios as to what would happen in various situations.
Mr. Kevin Cardiff: I think I said various non-scenarios.
Deputy Shane Ross: Possible scenarios or various theoretical equations or formula which might arise in certain situations. That is okay as far as it goes. What plans has the Department made, or has it made plans, for plan B?
Mr. Kevin Cardiff: We think a lot about the way things are going and how they might go but the principal focus of all our work is on making our current situation work for us. That means getting the fiscal situation back on track, getting control of the banking situation and improving it to the point where we become a party to which the private market as well as the public market can continue to lend. That is the principal focus of all the work we are doing.
Deputy Shane Ross: What I am specifically talking about – I know what the Department’s current focus is on – is that there is a very large body of opinion that the preparations being made at the moment will not end here and that Ireland will either be forced to, or will voluntarily in a structured way, default. Does the Department have contingency plans in the event of a default?
Mr. Kevin Cardiff: The Deputy says that as if a default is something that just happens to you. What we are planning for and working on is meeting the Government’s policy which is to ensure we do not have to default on our debts.
Deputy Shane Ross: Information on Shane Peter Nathaniel Ross Zoom on Shane Peter Nathaniel Ross In the event of that happening, does the Department have any plans at all? Is there any thought going into this in the Department?
Mr. Kevin Cardiff: Is the Deputy asking if there is a plan in a bottom drawer somewhere if we default?
Deputy Shane Ross: No, I am not. Mr. Cardiff knows what I am asking him. I am asking—–
Mr. Kevin Cardiff: The Deputy knows why, even if we had such a plan, I would not say we had a plan.
Deputy Shane Ross: I do not want to know the plan but whether the Department is giving thought to that particular scenario.
Mr. Kevin Cardiff: Let us put it this way, being 100% honest, we give thought to a lot of scenarios and we do work around scenarios but all our focus is on not being at the default stage. Frankly, that is a much more likely scenario, so it is the one we have to work on.
When one looks at what is going on around Europe, people naturally look at our Greek friends and others and say certain things are inevitable but they are not inevitable. We have the great advantage over our Greek friends of being wealthier as a country and better prepared as a country with better institutions. In fact, we are so good, one would wonder how we got into this mess in the first place, but that is a different matter.
It is a very real question. How can good institutions end up in the situation in which they are? We have good institutions and we can prepare for dealing with the situation in a way that does not lead us into any of that kind of area.
We have strong European partners who are also very anxious that those kinds of things should not happen and we have strong partners in the IMF who are anxious to avoid those kinds of situations occurring. The Government of Ireland pays its debts, always has and plans to do so.
Deputy Shane Ross: I take that as a “Yes”.
Mr. Kevin Cardiff: I have lost the question but it is certainly a “Yes” to one of the Deputy’s questions.
Deputy Shane Ross: It would be most extraordinary if the Department was not making those plans because it is a possible scenario.
@OR, thanks for that. The hope is that Taoiseach Kenny would have been able to truthfilly say what the British prime minister said just substituting “British” with “Irish” –
“We have to keep the British economy safe, to take the British economy through this storm. That means preparing for all eventualities”
And that the only reason Taoiseach Kenny didn’t say this was to avoid bank-runs and unintended consequences of people abandoning euros in favour of more established currencies or stores of value.
[…] https://namawinelake.wordpress.com/2011/11/13/ireland%E2%80%99s-plan-b-for-the-possibility-of-the-bre… […]
The sun may well rise in the morning but a sudden euro collapse looks very messy indeed…..
Really NWL…. as opposed to the current ‘neat’ system that has Anglo bond holders et al getting paid in full.
@John, messy compared to the present where money has a certain value in households and businesses. How will a new currency fare against established currencies, what will that mean for inflation and international debt, for wages and for the economy generally.
I think the “what have you done for me lately?” argument regarding the whole EU currency is missing.
And so is the “why is Ireland not in bed with Britain?” argument.
Pride and prejudice aside, small groupings with strong identity work well in many facets of life. But politics of course, is different.
I wonder if masochistic austerity is preferable over dissolution of a dream, perhaps it is.
@sfca, yes a return to some tie-in with sterling might be one of the scenarios being explored. If EUR 1 = GBP 0.86 then there might even be some pegging like PNTn 1 = GBP 0.75 so as to attempt to maintain the value of a new currency within a turbulent EU and also to steady the ship, both directly with our largest trading partner and indirectly with the rest of the world outside the EU.
@WSTT, I can’t help but notice that both scenarios offered by you would make investing in property (!) and other safe-haven assets more attractive. If the ECB prints more money inflation should increase, and perhaps housing will start increasing in nominal terms. If we leave the euro and adopt the Punt Nua then the betting is the new currency will depreciate against other currencies and domestic inflation will spike up, again making it a likelihood that people will turn to the sanctuary of safe assets to protect their wealth, which if in cash would be set to lose value through inflation.
There are only two outcomes to the mess that is the euro and the bankrupt european banks.
1. Europe hits the printing presses.
or
2. Punt Nua
That’s it. Just two alternatives. The rest is wishful thinking.
In the language of ( my kind of) politicians at least Punt Nua
“would send a positive message about Ireland proudly and boldly grabbing its destiny by the scruff of the neck and taking a first brave step toward a new and better Ireland”…i made that up of course.
Printing press, well proud and brave and better don’t come into it do they?
Collapse and resurgence, anyone?
I hear a poem coming on.
My 2 “Shillings”
The Punt Nua will be “Pegged” to Sterling just as the old “Pound” was.
Has anyone got Sterling?
All a bit early yet… we’ll have to get through a ‘brady bond’ type solution first, not to mention a few rounds of Quantitative tEasing….
The position of sterling in the medium let alone long-term is in many ways far riskier than that of the Euro.
The UK is running a very high Government borrowing requirement, has a poor balance of payments and high household debt compared to most Eurozone countries (though not Ireland). It also has a serious inflation problem, partially caused by its substantial managed devaluation against the Euro. Inflation appears to embedded into its economy as we will see when it publishes its October figures tomorrow. Dependence on devaluation is not a viable long-term strategy.
It’s economy seems to be moving back into recession with little or no growth forecast.
It has a a capital city which has sucked in huge amounts of foreign cash for property deals. Central London property prices are being driven upwards by this foreign cash as they make up most of the demand for high end housing. Foreign cash as we should know in this country is a fickle thing.
As the Financial Times and other newspapers have pointed out, the UK only has one real political leader who a) can lead & b) knows what he is doing, Alex Salmond, and he wants out of the UK and into the Eurozone.
Whether we like it or not, we are tied to the Euro for the long haul. The Frau Dr. is our new matron. Just get used to calling her Mutti!
@Niall, which of us has a crystal ball but the EU Autumn forecast for the UK produced by Olli Rehn’s department
http://ec.europa.eu/economy_finance/eu/forecasts/2011_autumn_forecast_en.htm
and which is pretty consistent with projections from the UK’s own Office of Budget Responsibility shows that the projection is for
(1) weak growth, but positive growth
(2) inflation at 4-5% in 2011 but thereafter falling to 3% and 2%, in Ireland we’re running at close to 3%
(3) unemployment to rise slightly from about 7.5% today to peak of 8.6% which is elevated for the UK but compare that with 14.4% here
(4) the deficit which is, as you say, similar to Ireland’s to come slowly down
(5) debt:GDP to peak at 89% which is elevated but nothing near our 120% (or 150%+ of GN)
The UK has a rocky road ahead and I see there is likely to be a 2m+ general strike later this month and their commentators are talking about a repeat of the “winter of discontent” in 1978 when there was widespread strike action – in the UK they’re unhappy with the erosion of pension rights and the general standard of living; that has come about through cutting the deficit and reducing costs on one hand and managing deflation on the other hand where they have printed GBP 295bn (20% of GDP) in Quantitative Easing to help deal with the financial crisis and the subsequent recession.
But if you were to tie your 4.6m, €155bn GDP economy to any currency, wouldn’t sterling the currency of our biggest trading partner be one of the first options to explore. The UK is by no means perfect and seem to be battling their public sector to reduce the deficit and their banks to ease credit into the economy, but at least they know what their notes and coins in circulation will look like from one week to the next. With the ongoing clowns’ performance in Europe with our own Taoiseach contributing where he can, can we say as much here?
@ NWL The inflation figure quoted in the report is for HICP. While the Irish rate is no longer the lowest in Europe, it is the second lowest @ 1.5%. UK HICP Inflation for September was 5.2% and for their version of our CPI called RPI, 5.2%
While the UK are a major partner, for the first seven months Belgium was our second largest market for exports, with the UK for imports. I would suggest that neither figure actually represent the real position as both countries.act as a conduit for movement of goods and services. The US is our largest trading partner, See Table 4 http://www.cso.ie/releasespublications/documents/external_trade/2011/extrade_jul2011.pdf
I think whatever option we choose, it will not be easy, but the UK option seems worse to me. However hard it will be to live with the Frau Dr., linking with the UK ties you to a Government & opposition bereft of ideas or a vision of where they are going. This is first and foremost a question of political economy, with a capital P and a small e.
@ NWL The UK inflation figures were published yesterday and show a slight movement down.
The Irish HICP rate of 1.5% compares favourably for the present against the similar UK index CPI of 5%.
The Irish CPI rate of 2.8% again compares favourably for the present against the UK index RPI of 5.4%.
The differentials are down considerably since September with the HICP measurement down from 3.9% to just 3.5%, while the Irish CPI/UK RPI differential is down from 2.8% to 2.4%
There are a number of categories which seem to explain most of the differential. Transport, Restaurant & Hotels are two that have increased at a much higher in the UK than here. On the other side housing and education costs have increased more here. UK figures are available here http://www.ons.gov.uk/ons/dcp171778_242409.pdf
It is assumed that inflation will fall both here and in the UK over the next year and it will be interesting to see which falls more or do they converge.
Any inflation pressures in the two states are likely to be driven by Government actions, e.g education charges.
The re-print below is extracted from the excellent John Mauldin’s recent article on the eurozone crisis. Says it all really:
Where is the ECB Printing Press?
By John Mauldin | November 12, 2011
Where Can I Find €3 Trillion?
When Leverage Comes Back to Haunt You
The German Dilemma
So How Do We Solve the Eurozone Problem?
Where Is the ECB Printing Press?
Europe remains the focus of markets, and rightly so. But the picture is not as clear as one would like. Different analysts point to different problems – if only this one problem could be solved, then all this would go away, they tend to say. Sadly, it is not one problem but three that must be solved, and none of them is easy. In today’s letter I try and offer a basic primer on the problems facing Europe. My challenge to myself is to do it in a short piece rather than the book-length tome it could easily become. Thus, in the pursuit of brevity, we will not be as in-depth as usual, but I think it helps us to step back a few feet and look at the larger picture before we focus on minutiae.
Where Can I Find €3 Trillion?
First, for the record, the European issue is not a crisis of confidence, as Merkel and Sarkozy, et al., keep telling us. It is structural. And until the structural issues are dealt with, the problems will not be solved.
The first problem facing Europe is the glaring sore thumb: there is simply too much sovereign debt in Greece, Ireland, Spain, Italy, Portugal, and Belgium. That is not news. What has yet to be absorbed by the markets is that the cost of bailouts, present and potential, is likely to be in the €3 trillion range, talking an average of the estimates I have seen (with the Boston Consulting Group suggesting €6 trillion). €3 trillion is not pocket change. Indeed, it is a number that is inconceivable in scope.
Greece has been told that they can write off 50% of their debt held by private entities, but not that owed to the IMF, ECB, or other public entities. This means something more like a 20-30% haircut on total debt. Sean Egan suggests that eventually Greece will write off closer to 90%. That is a number that cannot be contemplated in polite European circles, as it is plenty enough to cause a serious banking crisis.
And that is before we get to the rest of the problem children. Portugal will need at least a 40% write-off (probably more!). The Irish are going to walk away from the bank debt they assumed in the banking crisis. While on paper Spain looks like it may survive, in reality it has significant problems in its banking sector. If they move to insure the solvency of their banks, their debts become unmanageable, not to mention that their debt grows each and every month from the rather large deficits they run and seem totally unwilling to try to reduce. The Spanish government deficit is likely to be at least 7% next year, well above their target of 6%. The “semi-autonomous regions” are in deep trouble, and their citizens are leveraged due to excessive real estate exuberance. Unemployment across Spain is 21%, and for the young it is over 40%.
The Spanish government has adopted the rather novel idea that if it doesn’t pay its bills then its deficit will not be as large and therefore they can get closer to meeting their targets. Yields on Spanish debt are about 1% lower than on Italian debt, but give them time.
And then there is Italy. Italy is simply too big to save. Yes, it looks like Berlusconi is leaving, but he is not the real problem. The problem is a 10-year bond yield at 7%, when your debt is 120% of GDP and growing. Italy is likely to be in recession soon, which will only make the problem worse. A drop in GDP while deficits rise means that debt-to-GDP rises faster. That means interest-rate costs are rising faster than (the lack of) growth in the economy. The deficit is a reported 4.6%. By contrast, Germany’s is 4.3%. But the difference is the debt. The market realizes that if you grow debt by 5% a year, it will not be but a few years until Italy is at 150%. There is no retreat without default from such a number, and the markets are saying, “We’ve seen this movie before and the ending is not a happy one. We think we’ll leave at intermission.”
The ONLY reason that Italian yields have dropped below 7% is that the European Central Bank has been buying Italian debt “in size.” Any retreat by the ECB from buying Italian debt and Italian yields shoot to the moon. Italy will need to raise close to €350 this year, including new debt and rollover debt. The higher rates will put even more pressure on the deficit.
Debt, whether it is with an individual, a family, a city, or a country, always has a limit. Debt cannot grow beyond the ability to service the debt. That is the clear lesson of Rogoff and Reinhardt’s epic work, This Time Is Different. When that limit is reached, the debt must be restructured in some way, either with better terms or through some sort of default.
Mediterranean Europe simply borrowed more than it could pay, given the cash flows of the various countries. And now we are at the Endgame. How can one deal with the debt?
The best solution is to figure out how to grow your economy faster than the growth of debt. Over time, debt service becomes a smaller part of the economy. But Southern Europe does not seemingly have that option. Certainly not Greece, Portugal, or Spain; and this week we learned that Italian production was off 4.8%. Europe, even Germany, is slipping into recession.
Germany is in the position of wanting the problem countries to cut their deficits through something called austerity. And living within your means is hardly a novel idea. It makes a great deal of sense. But when you are a country in recession and have to cut back, it only makes the recession worse for a period of time. Asking Greece to cuts its deficit by 4% a year for 4 years to get to something closer to balance means that the Greek economy will shrink by at least 10%, if not more. Tax revenues, never on solid footing, will shrink, making the deficit worse. How do you ask people to willingly enter into a pepression for a rather long time in order to pay back the banks, even if the debts were freely taken on by the government and the money spent on the populace, and even if the haircuts are 50%?
Yes, if Greece leaves the euro that means they will also have a depression. No one will lend them money for at least three years. Their banks will be insolvent, their pension funds destroyed. Their ability to buy needed materials (like oil, medicines, etc.) will be limited to the amount of goods they can produce and sell. Government employees will be forced to leave jobs, as there will be no money to pay them. Those on government pensions will get a fraction of what they were promised. Going back to the drachma will be painful in the extreme. Just as staying in the euro will be painful. Greece has no good choices.
There are those who suggest that Europe is demonstrating the failure of the socialist welfare state. And there is some reason to say that. But I don’t think the socialist welfare state is the cause of the debt crisis. One can have a welfare state without debt, if you are willing to run a sensible budget. Think of the Scandinavian countries.
And you can have countries without much social welfare get into debt problems. There are plenty of examples in history. Amassing large amounts of debt is a national problem that has as much to do with character as anything else. That is true for families or for countries. It is wanting to spend for goods and services today and pay for them in the future.
Debt has its uses. Properly used, it can be of great benefit to societies and families. People can buy homes and tools that can be used for the production of goods, build roads and other infrastructure, etc. But debt cannot be allowed to become the master of the budget or the source for current spending, again whether for families or countries. And Greece and its fellow countries have used debt to fund current spending and now have run up against the inability to borrow more at sustainable levels.
The easy answer is to cut spending. But when you cut back spending, even borrowed spending, it is going to affect GDP. It is something that may have to be done, but it is not without consequence. Ireland, a small country of 4.2 million people, just paid close to €1 billion to service debt that it owes for taking on the debts of its banks that went bankrupt. That is hugely unpopular in Ireland, and it will not be long before the Irish government simply says no. If the current one does not, then there will be a new one that does. Unless the Irish renegotiate their debt, they will be paying on it for decades. Debt that was private debt and paid to European banks (who lent to Irish banks) is now public debt. And it is a punitive and crushing debt.
We can go to each problem country and home in on its own particular situation, and the answer almost always seems to be that the debt must be dealt with in some manner that either directly or indirectly amounts to default. (Even if the Eurozone leaders say that a 50% haircut by a bank is “voluntary.” Yeah, right. European leaders have a different understanding of voluntary than I learned in school.)
But that is the problem. The European Commission is trying to figure out how to find €1 trillion to use to bail out southern Europe and Ireland. They so far cannot, and the market recognizes that fact and that the needs are actually much higher. European leaders cannot (at least publicly) fathom how to find €3 trillion. But whether or not they can “find” another few trillion, that debt will have to be restructured or defaulted. Once you go down that path, as they have with Greece, it is just a matter of time before you have to do the same for Portugal and Ireland; and are Spain and Italy close on their heels?
When Leverage Comes Back to Haunt You
European regulators allowed their banks to leverage up to 450 to 1 on their capital, on the theory that sovereign nations in an enlightened Europe could not default, and therefore no reserves need to be kept for “investing” in government debt. And with those rules, banks borrowed massively and invested it in government debt, making the spread. It was an awesome free profit machine. Until Greece became a road bump. Now it is a nightmare. Even if you only invested 4% of your bank’s assets in Greek debt, if that is more than your capital then you are bankrupt.
Irish banks were foolish and invested in Irish real estate that was in a bubble. They went bankrupt. Spanish banks were even more heavily leveraged to real estate, but have yet to write down their debt. They assume that houses will only lose about 15%, rather than the 50% that the real world is suggesting. And you can get away with that for a time if you own the agencies that rate the real estate debt, as the Spanish banks do. But most of the rest of European banks are going to go bankrupt the old-fashioned, tried-and-true, proven-over-the-centuries way: by buying government debt. Somehow they want to be seen as rational in leveraging up government debt.
As I told the Irish crowd last week, don’t worry about your bank debt; all you have to do is wait a little while. When French and Italian banks (and most of the other banks in Europe) are publicly insolvent and have to go to their respective countries and the ECB for capital, the relatively small amount (by comparison) of Irish bank debt will not even be noticed when you default. I was trying for a little humor, but there is a core of truth in that glib remark.
France cannot afford to bail out its banks. As we have seen this week, they are already in danger of losing their AAA rating, as a false (premature?) press release from S&P suggested. (Someone is in trouble for that one! Seriously, you think S&P is not ready for this? There is reason to believe, I hear, that this was a draft for use later. We’ll see.) France will want the Eurozone to bail out their banks, and that means the ECB. If France gets such a deal, Ireland will certainly demand – and get – one, too.
The German Dilemma
And that brings us to the third problem, which has two parts: (1) the massive trade imbalances in Europe, where Germany and a few others export and the rest of Europe buys, And (2) the fact that German labor is far cheaper on a relative basis than Greek or Portugal labor (or that of most of the rest of the Eurozone). German workers have seen very little rise in their incomes, while Southern Europe labor costs have risen to over 30% higher.
I won’t go into the details (I have written about this before), but there is a basic rule in economics. You can reduce private debt and you can reduce public debt and you can run a trade deficit. But you can only do two of the three at the same time. The total of the three must balance.
Greece runs a massive trade deficit. They are also attempting to reduce their government debt, and private debt (that borrowed by business and consumers) is being forcibly reduced, as the banks are in full retreat.
Greece must therefore endure a large reduction in its labor costs if it wants to reduce its government deficit. Sell that one to the unions. (By the way, Irish public unions took a large reduction, as did pensioners. Different political climate and country.) Germany seemingly wants the rest of Europe to behave like Germans, except that they also want them to continue to buy German products and run trade deficits, while Germany exports its way to prosperity.
In the “old days” of a decade ago, a European country could simply devalue its currency and adjust the relative value of labor that way. But with a fixed currency there is no adjustment mechanism other than reduced pay or large unemployment numbers, which eventually translates into lower wages.
Essentially, the southern part of Europe is on an odd sort of “gold standard,” with the euro being the fixed standard. And the adjustments are painful. There are no easy answers if you stay with the euro. And leaving is its own nightmare.
So How Do We Solve the Eurozone Problem?
Let’s quickly look at options for solving this.
1. The Germans (and the Dutch and Finns, et al.) can simply take their export surplus and taxes and savings and pay for the deficits in the southern zone until such time as they can be brought under control. Or they can bail out all the banks. Not just their own but throughout Europe, as a customer without a banking system cannot buy your products. That seems to be a political non-starter.
2. The problem countries can make the extremely painful adjustments, cut their deficits, and enter into a lengthy pepression. That also seems to be a political non-starter.
3. The Eurozone can forgive enough debt to get the various countries back to a place where they can function, nationalizing the banks that hold the debt, which would lead to a Europe-wide deep recession. Possible if the Eurozone leaders can sell it, but it is a tough sell.
4. A few countries (2? 3? 4?) can leave the Eurozone. If this is not done in an orderly fashion, the chaos will reverberate around the world.
All of the above paths (or some combination of them) mean a banking crisis and chaos and long-term recessions. These are not pretty paths. But the above options assume that the ECB remains true to its Bundesbank core. Which brings us to the next “solution.”
Where Is the ECB Printing Press?
It is hard for us in the US to understand, but the commitment of European leaders to a united Europe is amazingly strong. They will do whatever they think they must do (and/or can sell to the voters) to maintain the European Union.
As a way to think about it, the US fought its most bloody war over the question of whether or not to remain a union. I think you have to call that commitment. While I am not suggesting that Europe is getting ready to start a civil war, I think it is helpful to remember that commitments to an ideal can drive people into situations that others have a hard time understanding.
Let’s summarize. There is too much debt in many southern countries; and while I have not yet mentioned it, France is not far from having its own crisis if they do not get back into balance. And if they lose their AAA rating, then any EFSF solution is just so much bad paper.
The banks and banking system are effectively insolvent. There are large trade imbalances that make it almost impossible for the weaker Eurozone countries to grow their way out of the problem.
The path of least resistance, and I use that term guardedly, is for the ECB to find its printing press. Perhaps they can borrow one from Bernanke. Yes, I know they are buying sovereign debt now, but they are “sterilizing” it, meaning they sell euro paper to offset the monetary base effects (large oversimplification, I know).
But the money to solve the crisis does not exist. The only way to find it is for the ECB to print money and print in size, enough to lower the value of the euro and make exports cheaper (which gives southern Europe a chance to grow out of its problems). Which is of course something the Germans vehemently oppose, as it goes against their core DNA coding.
But the choice is print or let the euro perish. I see no other realistic solution, aside from massive austerity, willingly accepted by Europeans everywhere, along with the nationalization of their banks, etc., as described above. I think there is even less willingness to endure all that.
It is a hard choice, I know. If you held a gun to my head and asked, “What do you think they will do?” I would have to say, “I think the ECB prints.” But not without a lot of rancor and solemn pledges and maybe a rewriting of the treaty in order to get Germany to go along.
The choice is between a much lower euro or one that is far different from today’s, with a number of countries having left it. There are no good or easy choices.
As a closing aside, a lower euro means lower US and emerging-market exports (Europe is China’s biggest customer!) to Europe and more competition from Europeans in what the rest of the world sells to each other. It will be the beginning of serious trade issues and when coupled with the collapse of the Japanese yen, circa 2013, will usher in currency wars and protectionism. This will be a decade we will be glad to leave in 2020.
John Mauldin
John@FrontlineThoughts.com
I think the name Blackrock might ring a few bells around Ireland.
http://www.zerohedge.com/news/italy-pregnant-blackrock-sees-write-downs-75-80-greece-portugal-and-ireland
@Jake, amazing that BlackRock didn’t think to stress test the banks’ holdings of PIIGS sovereign debt holdings with 75-80% haircuts when they were doing the stress tests earlier this year. Instead there was practically no haircut assumed to €10bn + of sovereign debt.
Now I know why they said “fuhgeddaboudit” when I mentioned investing in Ireland to them!
oh but they did very very subtly…… Ireland’s green energy play was/is much admired and so are the executives.
‘BlackRock said in a statement yesterday that a dozen power principals from NTR will be joining BlackRock Alternative Investors, the unit launched nine months ago and which manages more than $110bn in assets.’
http://www.efinancialnews.com/story/2011-03-01/blackrock-ntr-renewables
@NWL
They also forgot to stress test themselves for Italian sovereign.
@JG
How about solar panels in Ireland? Maybe only in Skibbereen.
@JW they are highly regarded team part of the ‘new brain drain’ all future profits they generate now going to another Us Co. depressing watching from afar whats going on.
‘
‘GE Energy Financial Services announced it is acquiring a diverse pool of nearly $1 billion in senior secured energy project finance assets located in more than a dozen countries. GE Energy Financial Services is acquiring the portfolio from the Bank of Ireland, which is selling non-core loans as part of its deleveraging plan.’
This was highly regarded loan book too.
http://www.monitordaily.com/ge-energy-financial-acquires-1b-portfolio-bank-ireland/
There is no plan B.
There isn’t even a plan A.
Anyone with evidence to the contrary can step forward.
@OMF
I think there is a plan C. What the hell is my pension going to be worth in punts.
I wonder what changes will have to be made to obtain greater integration in Europe?
For the periphery to be absolved of their sins (debt) what will they have to surrender to the core?
Truly some enormous dice are being rolled around the European floor at the moment.
In relation to Ireland, for the next 100 years, would we be better off in or out of a more integrated Europe? Who can we trust, our own politicians or those of a different nationality?
@ObsessiveMathsFreak
Plan B?
Here’s a sneak peek!
http://www.japlandic.com/2011/11/irelands-plan-b.html
A simple solution here: http://twitpic.com/7mrdgj