Kleinwort Benson: Three ways to save the euro
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AS the EU and IMF conclude their second European bailout of the year (should there be an award for Best Bailout of 2010 one wonders), the markets are focussing their attention on Portugal and Spain as the next recipients of such assistance, and on whether the euro can survive. It is helped by the deliberate non-existence of an exit process. This was for two reasons; the first being that if there were such a process, its very existence would make it more likely that it would be used and it would thus be counter-productive and the second that in the event of the sort of disaster now striking the eurozone, then the euro’s designers assumed and indeed desired that it would force a move towards greater political union in order to enforce and save the monetary union. Thus the EU would demand much stricter budgetary control over the offender in exchange for the money necessary to get them out of their problems. In terms of economic theory, the eurozone is a very sub-optimal single currency area. Single currencies work best when there is considerable mobility of labour within the area and where there is an over-arching political system that can transfer monies from the successful parts of the single currency area to the struggling parts. Currently the eurozone has neither of these (apart from bankers and sportsmen). As a single-currency area it needs change. The first way to save the euro is very straightforward – extend the monetary union into a fully-fledged political union with a European government and a Treasury to go with the Central Bank. In this way transfer payments can go from rich to poor areas (for which read from Germany to the Med) to boost demand in the poorer regions as is done today within individual countries. This would work if the peoples of the countries concerned could be persuaded to vote for it by their politicians. Unfortunately the German population have a clear understanding that this would involve passing a great deal of their tax payments to Greek ex-government employees who have been allowed to retire at 50. Equally the Greek and other populations would fear that their countries would be ruled by German politicians or at least German-designed laws. In addition, the German Constitutional Court has ruled that if the financial regime associated with the euro no longer offered “stability”, then Germany would have to leave the euro. This “stability” involves not only a relentless desire to avoid inflation but also that each country should be responsible for its own debts and no other country should be forced to support it. The fundamental problem with the eurozone though is the trade and competitiveness imbalance between Germany and the Mediterranean countries. Average unit labour costs show Germany to be about 25% more competitive than these other countries, which results in huge German trade surpluses with Portugal, Italy, Spain and Greece. By exporting far more than they import from these countries, Germany effectively sucks the euros out of these countries, which until the banking crisis they sent back by buying the government debt of these countries. This financial recycling has now come to an end, forcing the crises we have seen this year as governments cannot find the buyers for the debt they need to raise to finance their budget deficits, and banks cannot obtain the wholesale deposits they used to rely on from the German banks.. There are two solutions to this competitiveness issue. The first is German inflation, which would raise German labour costs and also boost German consumption levels. Five years of 5% inflation in Germany and 0% inflation in the other countries would do the trick here. Sadly, again, Germany does not accept this as a desirable solution, though it would be very attractive for the rest of the eurozone. The second solution to this competitiveness issue is Mediterranean depression The relentlessness of economic logic means that in the absence of progress in the direction of either of the first two solutions to save the Euro, there is left only the third solution of Mediterranean depression. It is easy to see how today this is being forced onto many of these countries by public sector austerity and private sector bankruptcy. None of these three are attractive or possibly even achievable political solutions. In their absence, the euro is not sustainable and some countries will be forced to exit and effectively default on their debt. The risk then is the resulting losses in the financial sector which could trigger a banking crisis in Europe every bit as bad as was seen in 2008. This note is intended to give an insight into the thought processes that lie behind our investment views and our investment strategy. They do not necessarily reflect the current investment policy of Kleinwort Benson. This note is intended for information purposes only and does not take into account the investment objective, the financial situation, or the individual needs of any particular person. Investors should obtain independent advice based on their own particular circumstances before making investment decisions. More articles in
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