Euro debt saga faced with five likely outcomes
THE SAGA of the euro crisis can’t go on forever. Here are the five most likely outcomes:
Armageddon. Deep down, this is the one everyone expects and even wishes for. In this outcome, Germany does nothing but block the European Central Bank from creating the inflation Europe needs to wheedle its way out of its debt woes. The weak countries default and bail out of the euro, setting off a tidal wave of contagion that breaks the back of economically stronger countries. A rupture in financial trust creates a lenders’ strike, in which most of the western world is unable to finance state deficits. Austerity goes out of control, becoming a black hole of deleveraging. Rolling, global defaults and general bank failures create a complete economic collapse throwing everyone back to a financial version of the Stone Age. Recession, depression, and wars follow. All this because, once again, Germany got a bee in its bonnet.
The weak leave Faced with austerity and no democratic platform to enforce it, the Piigs (Portugal, Italy, Ireland, Greece, Spain) countries simply default on their euro bonds and reintroduce home currencies. This is drastic but at least they can then get back to business, borrowing large but manageable amounts with the chronic tool of inflation to right-size the resultant mountain over time. The market lends at a high rate to a margin perceived as sustainable, while financial repression does the rest. New, local currencies crash and local lifestyles return to older patterns and prices. A period of local dislocation is replaced after about three years with an economic performance resembling something normal. When it comes to defaults, lenders have short memories. Russia defaulted in 1998, so what? Perhaps in 10 years, re-entry to the euro occurs. This is the model euro currency levels suggest is most likely. If the weak leave, the euro will remain strong and get stronger.
The strong leave Europe wants inflation, Germany does not. Germany loved its Deutschmark and is not quite so keen on the euro. Why not leave the euro and leave the rest of Europe to have the inflation? Strangely, just as the French believe their 18th century bread prices invented social revolution, so the Germans think their inflation invented fascism. Germany is, in effect, creating the euro-rupture that would lead to only Germany, Holland, the Finns and the Pope remaining in the euro currency. Why not simply bow out of the euro and let the economic rabble print their way out of obligations. Germany gets its beloved Deutschmark back, and the rest get the inflation they want, which is equivalent to the haircut bond holders are going to take in any event. The fly in the ointment of this outcome is that if it was a significant likelihood, the euro’s value would have already gone off a cliff by now. But, the euro remains strong.
Tighter euro integration. Germany and France somehow get everyone around the table. They then explain why each country should give up their central spending authority, undertake central supervision by Brussels meanwhile convincing every premier there is no need to get a referendum passed by their population. As the economies of Europe are all looking into the fires of hell and the prospect of losing their jobs, they see sense in this “Merkosy” steamroller of tighter EU integration, a long hop towards the US of Europe. Any such head lock on dodgy countries such as Greece has to be enforceable while somehow not violating democracy or creating peaceshattering nationalistic movements. Germany then effectively guarantees the debt of the whole of Europe. In return, it would receive a vice-like grip around the throats of the Piigs or, put politely, influence control over their spending policies.
Return to normality Maybe interest rates are simply returning to long-term normality. If politicians can keep talking, they will have their budgets in better shape, have sneaked in sufficient inflation to start grinding away at debt levels and have been working hard enough on balancing cheque books to reassure borrowers. By then, lenders will have realised they can’t keep all their money in gold and tinned food, especially when the US is probably in worse shape.