June 24, 2012

The Euro: Going….Going….G… – Is Anyone Listening?

by Hal Gershowitz

Comments Below


We aren’t so presumptuous as to predict (let alone declare) the demise of the Euro.  Not quite yet anyway.  We do think, however, that the late Milton Friedman was on to something when, a dozen years ago, he gave the Euro a life of about a decade.  The legendary University of Chicago economist saw this train wreck coming long before the locomotive chugged out of the station in Brussels.  The Euro was (and is) the world’s first international reserve currency divined out of thin air.  It is backed by nothing.

Our dollar, while no longer tied to a precious metal, is still backed by the full faith and credit of the United States of America. And while we are recklessly compromising that on which our full faith and credit rests, we are still viewed as the world’s safest harbor (perhaps, testament to how unsafe are all the other harbors). By contrast, the Euro was (and still is) backed by nothing more than the non-binding, fiscal-discipline agreements of the Eurozone states, many of which never had any intention of honoring those agreements – and they haven’t.  One can only cringe at the folly of entrusting the stability of an international currency to so flimsy a foundation.

The United States by, contrast, is a politically united and economically homogeneous country, while the European Union is a collection of different and heterogeneous sovereign countries.  The Eurozone countries have had two things in common: (1) an agreement between them to limit budget deficits to three percent of GDP, and public debt to 60% of GDP; and (2) absolutely no intention of honoring those agreements.

The European financial family rejoiced for about an hour last week when Greece voted, in effect, to stay with the Euro family. Then reality set in. Nothing had really changed.  The irresponsible, high-spending, debt‑ridden cousin chose not to run away from his Euro family.  He decided to stay with the family.  Now, what to do?  He is still heavily in debt, barely has enough income on which to live (let alone repay what he owes), he prepared bogus financial statements, has little to no prospect of earning more, and wants nothing to interfere with his citizens’ plans to retire at a fairly young age.  Oh yes, one other thing.  As a condition of his decision not to run away, he requires substantially more assistance (and with better terms) than the last couple of times he reneged on his promises to live more responsibly.

So in the days and weeks ahead we will hear and read a lot about the MoU (Memorandum of Understanding) between Greece, the EU and the IMF.  Think of the 51-page MoU on “Specific Economic Policy Conditionality” as a loan covenant.  Loan covenants are conditions that borrowers agree to up front with the clear understanding that violating those conditions constitutes a type of default that can trigger penalties and even an obligation for immediate repayment of a loan.  Greece is already in substantial violation of the MoU upon which its second bailout was predicated, and wants the agreement modified so that Athens can receive the second installment of the bailout, which it desperately needs.

While Germany, Europe’s lender of last resort, has insisted on compliance with the MoU, the document will, of course, be modified. According to the existing memorandum of understanding, Greece can seek more time for fiscal consolidation if recession is deeper than thought (thought being in short supply in Greece) and first quarter data showed that the contraction was likely to be bigger than forecast.  Given the very predictable straits in which Greece now finds itself, the original MoU was somewhat farcical to begin with.  Under the current MoU, Greece was to have reduced its budget deficit to slightly more than 2 percent of GDP in 2014 from 9.3 percent in 2011.  Did anyone in the EU or the IMF really believe that was even remotely possible?

We are not unsympathetic to the plight in which the people of Greece find themselves, especially those who are now coming of age facing a very bleak future for which they bear no responsibility.  A year-and-a-half ago we referred to Greece as the canary in the coal mine.  Europe’s leaders and central bankers all called for measures to contain the crises.  Avoiding contagion became the agenda of countless meetings and the focus of endless public pronouncements.  But just how is the crisis to be contained?

The Eurozone consists of seventeen different sovereign states with diverse cultures, varying work ethics, widely differing levels of productivity, different tax structures and different budget and spending priorities.  To make matters even more confusing, Europe’s leading economists and bankers noodled an initial one-time rate of exchange by which each Eurozone country abandoned their own currency for the new Euro.  Floating exchange rates between participating European countries, which once reflected value based on countless daily market judgments came to an end across the entire Eurozone.

It all seemed to be working pretty well during the salad days of the new century’s first decade.  Tourism was strong, America, and to a lesser extent, Germany and other emerging economies were buying what Europe had to sell, and no one seemed to notice (or care) that many Eurozone countries had left caution to the wind and had begun running up deficits and debt far in excess of the limits they had pledged to honor.

Sadly, the crisis probably cannot be contained, nor can contagion be avoided.  That’s why European banks are hemorrhaging deposits and the cost of sovereign borrowing in Europe is moving up precipitously.  The Eurozone’s spendthrifts have hoisted themselves on their own petards.  Lenders have been treated to one haircut after another in Greece, and considering the escalating yields being demanded in Spain, Italy, Portugal, France, Ireland and elsewhere in Europe, the efforts to avoid contagion may be futile.  Everyone, it seems, has begun to wheeze and sneeze.

So, what does all of this portend for America?  Is, or will, this contagion be confined to the other side of the Atlantic. We don’t think so.  Not as long as policy makers in Washington continue to believe we can spend, borrow and print our way to recovery, let alone prosperity, and not as long as we keep pretending that slowing the rate at which the government increases spending is the same as reducing spending.  Ironically, it was Mexican President Felipe Calderon who, at last week’s G‑20 economic summit in Los Cabos, lectured the EU suits and our own President Obama that “expanding deficits to stimulate growth is like diving into a cave at the bottom of the sea.” Viva Calderon!

President Obama’s failed economic policies on which he has doubled down for this election cycle is, as even the President of Mexico understands, antithetical to economic growth. The Federal Reserve and the CBO have cut their estimates for economic growth for the balance of 2012.  Employment, the Fed tells us, will see little to no improvement for the balance of the year, remaining above 8.0%. Kathleen Stephansen, senior investment strategist and global head of sovereign research at AIG Management this week declared, “Financial conditions are becoming somewhat more adverse for the economy.”  Daily package volume on the FedEx fleet, an excellent indicator of current economic activity in the U.S., plunged nearly 5.0% in the quarter ending May 31st.  We are not looking at a pretty picture.

The nation’s deficits and debt have gone through the roof.  Not so much as a dime has been trimmed from real government spending in 3½ years.  Contrary to advice from leaders of his own party, President Obama is determined to raise tax rates on taxpayers who already pay over 90% of all federal income taxes, while maintaining the highest corporate tax rate in the developed world.  As we view the changes in direction which candidate Obama once described as change we can believe in we are reminded of what John Jacob Astor is reported to have mumbled to no one in particular while leaning against one of the Titanic’s bars after disaster struck, “I asked for ice but this is ridiculous.”

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2 responses to “The Euro: Going….Going….G… – Is Anyone Listening?”

  1. Mark J Levick says:

    You have susinctly presented the facts which lead to the obvious conclusion that the Western World’s economy is living on borrowed time. The problem is that neither the electorate nor the politicians they elect care. Sadly we are a self absorbed society with little intellectual curiosity and a short term attention span. The sound bites of “fairness”, “justice” and “equality” play well when the audience has no property, no business experience, no legal standing, no moral compass and pent up resentments. That is how leaders instruct their followers to vote for legislation they have not read such as Obamacare, focus on the rights of the minorities they have failed to economically integrate, foment resentment against those who have amassed wealth, extoll “hard working” public sectors union members whose job skill seems to be saying “no” or “just following orders,” and to focus on “Women’s issues”, income equality, the use of the word “God” in public places, green jobs (which they define to include driving a natural gas powered bus), saving the environment, global warming, globalization etc. Thus the beat goes on and on and on while the printing presses roll, the number of jobs created languishes, bureaucratic rules and regulations are expanded to encompass everything we do, the trillions of dollars of unfunded Federal Government obligations are ignored as they tower over the bloated Federal deficit and the can of honesty and responsibility gets kicked down the road while billions are spent to re- elect the can kickers. Where have all the leaders gone? Do we really want the primary role of our President to be an ombudsman or a campaigner in chief? Beats me. Must be the fault of either Herbert Hoover or George Bush as the blame game is all that seems to be working.

  2. Gentlemen: Thanks again for an excellent essay! One extension of criticism that occurs to me dates back to Margaret Thatcher’s unyielding opposition to the call for surrendering Britain’s soveriegn decisions to Internationalist bodies such as the EU, EC, or International Criminal Court, et., al. She instinctively understood that ALL renderings of soveriegn authority, even in the putative name of “justice”, “equality” or whatever would in the long run eliminate the people’s ability to influence governance, enforce accountability by ballot or otherwise, and ultimately enfeeble each country and their citizenry. I’m sure She’s laughing. . .or certainly crying!

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