[Updated below – GP]
________
Thanks to
Paul Krugman, we learn from Martin Wolf in the
Financial Times that we can
put "paid" to the eurozone as currently constructed:
The eurozone, as designed, has failed. It was based on a set of principles that have proved unworkable at the first contact with a financial and fiscal crisis. It has only two options: to go forwards towards a closer union or backwards towards at least partial dissolution. This is what is at stake.
From here it gets a little complicated for non-economists, so I'll save that explanation until last. What isn't complicated is this: The eurozone — the collection of countries all using the euro — works internally like the old gold standard. When external financing dries up, banks in strong country make up the shortfall in banks of weak countries. (The technically correct explanation is
paragraph two of Wolf's column.)
The source financier of all this, the go-to pocketbook, is the ESCB, the European System of Central Banks. Wolf again (my emphasis here and elsewhere):
At last month’s Munich economic summit, Hans-Werner Sinn, president of the Ifo Institute for Economic Research, brilliantly elucidated the implications of the response to this threat of the European System of Central Banks (ESCB). The latter has acted as lender of last resort to troubled banks. But, because these banks belonged to countries with external deficits, the ESCB has been indirectly financing those deficits, too. Moreover, because national central banks have lent against discounted public debt, they have been financing their governments. Let us call a spade a spade: this is central bank finance of the state.
But not all central banks are created equal. Some are better-funded than others; some are net borrowers and others net lenders.
Now
click this link and look at the chart. Notice the degree to which Germany is a net
lender: 325.5 billion euros, the long bar in the chart. The top-right chart in
this set of four (from Wolf's column) matches up German lending against the combined borrowing of Greece, Ireland, Portugal and Spain. A pretty good match.
You can see the problem. German banks want to be repaid, so they want austerity, not debt restructuring (forgiveness or default). But austerity is
killing the economies that are trying it. And that means, as Krugman has
pointed out elsewhere, "Greece, Ireland and Portugal can’t and won’t repay their debts in full."
The German banks may get their austerity, but they're not going to get their money back. And as countries leave the euro, its value will collapse, at least in the intermediate term.
[But see the Update below.] Not a great trade for the German banks, but perhaps that's the price of an addiction to chest-thumping demands that other people be "moral" for your benefit.
Krugman bottom-lines Wolf's main point:
One way to summarize [Martin Wolf's] argument is to say that slow-motion bank runs are already in progress in the European periphery, and that these countries’ banking systems are being sustained only by a process in which, say, Ireland’s central bank borrows from the Bundesbank and then lends the funds on to Irish private banks to replace the fleeing deposits. ...
You can see why we’re now at the panic stage. The Bundesbank is already very upset about its large claims on troubled debtors, which are backed by sovereign debt as collateral. Yet if financing stops in the wake of a debt restructuring, the result will be to collapse the debtor nations’ banking systems, a process Martin believes would lead to their ejection from the euro.
Click through for the rest of Krugman's summary, it's clear and easily understood. He concludes that the metaphorical fuel rods are exposed, and we "really are in meltdown territory."
Remember what we said earlier about Greece
exiting the euro — doing so would trigger a monster bank run. (Think about it; your money is in euros in a Greek bank and the government declares it will convert all euros to New Drachmas in five days. If you think New Drachmas will plummet on the FOREX exchange on the first day they can be traded, you and the whole rest of the world will pull your euros out of Greek banks.)
But if a bank run is in effect anyway, there's a much lower penalty for leaving the euro. What's to stop them?
Wolf on the choices that Europe faces:
The eurozone confronts a choice between two intolerable options: either default and partial dissolution or open-ended official support. The existence of this choice proves that an enduring union will at the very least need deeper financial integration and greater fiscal support than was originally envisaged. How will the politics of these choices now play out? I truly have no idea. I wonder whether anybody does.
I think it's pretty obvious where most bets will fall; seems like bankers will take down any system that asks them to take a haircut, and open financing of weaker economies (free money for the immoral) is not a choice I've seen anyone make lately. So get ready. (And if you're looking to buy euros for whatever reason and can wait this out, you may want to sit back and watch. Just a thought.)
Update: About euro strength and my parenthetical comment above, Krugman thinks that if Greece
et al. abandon the euro, its value won't necessarily fall.
See here for his reasoning.
GP
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