Thoughts on the EU & Euro

TUMBLR REPOST.

While the regular doom and gloom vultures are circling the EU, Greece, Spain and the Globe right now, sometimes you have to flip an argument over and look at it from another angle. I’m sure it’s been said before, but last week Jahncke’s (President of Townsend Group Intrn’l) suggestion for Germany to exit from the Euro does make some sense.

A single, powerful nation would have the best shot at executing a relatively swift exit that would be over before anyone could panic. No agonizing over who exits and who doesn’t. Stripped of its German export powerhouse, the euro would depreciate sharply, but would not become a virtually worthless currency, as, for example, any re-issued Greek drachma surely would. With the euro devalued, a Greek exit and devaluation would be relatively pointless. So, no contagion or bank runs. With new exchange rates making all the non-euro financial havens prohibitively expensive, and with the threat of forced conversion into devalued national currencies removed, depositors in southern Europe would lose their impetus to run. –Bloomberg 6/12/2012 (Red Jahncke is president of the Townsend Group International LLC, a business consulting firm in Greenwich, Connecticut. The opinions expressed are his own.)

The next question is why would Germany want to do this? The value of their currency would jump up. Would this price them out of the export market or would the quality of their goods justify higher relative prices? Is it worth a chance? Maybe this is the way for Merkel to frame the argument to Germans who’ve been benefiting from a lower Euro currency.

While polls suggest that most Germans would be happy to have their old currency back, Germany would not escape unscathed. Its exports would contract as the new exchange rate made German goods much more expensive abroad. It would be vilified for violating the orthodoxy of Europe’s post-World War II drive toward integration. –Bloomberg 6/12/2012

George Soros’ talk in Trento Italy (June 2, 2012) was interesting, he seems to be pointing out a bigger-than-previously-thought fire under Germany’s b-u-t-t. He gives them three months to do something before all hell breaks loose:

In my judgment the authorities have a three months’ window during which they could still correct their mistakes and reverse the current trends. By the authorities I mean mainly the German government and the Bundesbank because in a crisis the creditors are in the driver’s seat and nothing can be done without German support.

The more things change, the more they stay the same…

Or as Henry Kissinger succinctly put it: “Poor old Germany. Too big for Europe, too small for the world.” (source: NYTimes opinion piece)

In an economic crisis with a lot of possible solutions, the question ends up being “what will work?” How will the “system” and it’s “participants” react to a new set of incentives? For Greece, Spain, Italy (etc), many are pushing for austerity. But how does austerity work? How does a whole country and economy tighten its belt and cut back? Here are some potential scenarios:

1. Cut back on Gov’t spending without monetary loosening -> GDP decreases as a result (economy may even shrink) -> unemployment will increase to the point where people will eventually begin lowering their wage expectations (hopefully before resorting to crime) -> labor costs decrease for businesses, investment picks up as economy becomes more globally competitive -> GDP growth resumes
2. Cut back on Gov’t spending WITH monetary loosening -> GDP decreases UNLESS banks lend to businesses and get some liquidity into the private economy (takes time, big question mark here: Will the banks lend?), so lending restrictions must be loosened (..remembers 2008..) -> IF banks lend heavily, Euro devalues, this creates a nice cycle where products made in the Euro become relatively cheaper globally (as long as everyone else doesn’t devalue at the same time) -> demand for Euro-zone products increases -> businesses invest in production capacity increases -> employment rises -> consumption rises -> tax receipts rise -> Gov’t pays off debt -> growth resumes
3. Gov’t spending without monetary loosening -> The really important thing here is that GDP start growing much faster, although it’s hard to imagine how it will, without GDP growth, the Gov’t will be further in the hole. This seems to be the consensus for Greece, which needs to stimulate their economy without the ability (alone) to increase the supply of Euro.
4. Gov’t spending with monetary loosening -> This is Keynes’s bread-and-butter, which claims that a depression caused by a lack of demand requires gov’t intervention and monetary loosening. Here the G (of CIGX) drives GDP growth in the beginning, puts cash in consumers hands -> Note: this isn’t supposed to cause much inflation because more money is chasing an already too high level of supply -> in the process, C grows and stabilizes the economy (for the short to mid-term)

It looks like the New Democracy party has taken the lead in the Greece elections last weekend. Good news, because they don’t want to leave the Euro, so the “Lehman moment” risks have subsided for the moment. Still, it’s time for Greece to get to work:

Greece is mired in a fifth year of recession, with unemployment spiraling above 22 percent and tens of thousands of businesses shutting down. (source)

12-month Outlook: Short Euro, due to monetary loosening but look out for other currencies setting up to devalue as well.