Last week, I asked a northern European friend of mine (he works in the financial field with securities and derivative strategies) what he thinks of the current Euro zone brouhaha. Here's what he came back with:
This is a multifaceted problem -- it is easy to understand the German protests (around bailing out the Mediterranean EU members) but they really should be happy to have Greek and Latin currency involvement since this has provided much needed Euro devaluation for many years now. Had the Germans still been on the Deutschmark, their fighting power in export markets would have been considerably worse. In other words, if you decouple the Latin countries from the Euro, the currency would quickly rise in value, and German exports would fall, domestic German unemployment would rise etc.
Pedagogically, Merkel is challenged since she has to publicly beat up the Latin countries for their lack of fiscal and economic discipline, but behind closed doors she is quite pleased with German export figures. Additionally, we shouldn't forget that both France and Germany broke the fiscal Euro rules only a few years back, yet both countries naturally went unpunished. Merkel definitely doesn't want to lose the Euro advantage; that would be disastrous for Germany -- so she has no choice other than propping up the currency. The chaos that would follow a breakup would likely trigger market panic and unforeseeable costs -- those costs (for the Euro markets as a whole) would exceed the current expense involved in shoring up the situation under politically controlled terms.
The ECB (European Currency Board) will ultimately save the currency in the unlikely situation that the politicians fail since their role is to ensure financial market stability as well as smoothly running banking and payment systems. If pushed, the ECB has no other choice than to de fact print money by buying bonds issued by the ECB member countries.
The ECB challenge is putting pressure on the member countries to gain some form of fiscal balance. Dealing with the Greek and the likes of politicians like Berlusconi will always be a hazardous game. Since member countries don't have their own printing presses yet are independent they act like spoiled children that assume that the daddy (ECB) will come to the rescue if things go seriously wrong. Moral hazard. The banks that are viewed as "too big to fail" can essentially do as they please -- per earlier reasons.
It boils down to finding ways to penalize nations who ignore their fiscal health and blatantly use public funds as a means to win elections.
His prediction is that the Euro will survive, but the longer it takes until the Mediterranean countries get their act together, tighten up their finances and switch to more growth-promoting economies the higher the price to pay to clean up the mess. All financial market players need to wake up to the fact that government bonds are not zero risk papers -- forget what you were told in econ class!
The light at the end of the European tunnel is the long term prospect of reduced public sectors, "as the saying goes, eventually, Socialists run out of other peoples' money (to spend)" -- with an increased opportunity for the private sector to grow with all the structural benefits this would bring.
Right now, no matter what Greece tries to do, they need to realize that reduced purchasing power and increased unemployment is in their immediate future will cause a hard stop shock when they run out of money, or the EU and the IMF will force them to change their ways.
To summarize, my friend predicts a political resolution and renewed commitment to making the Euro work -- or the ECB will come in at the brink of the abyss to save the day. But the uncertainties of the alternatives will be either too costly and/or too politically unacceptable to be allowed to occur.
- Thomas Kase