The inevitable eurozone breakup
September 2nd, 2011
Though the global stock swoon is reported in the U.S. as a response to domestic economic fears, we presume the real issue is fear that that the eurozone may fail, leading to cascading failures of financial firms along the lines of the Lehman collapse in 2008. The “tell” for this is the parabolic rise in the Swiss franc (until the Swiss central bank threatened August 11 to peg to the euro).
Readers may notice I am writing about eurozone breakup as a certainty; for at least 16 months I have considered it inevitable, based on this reasoning:
- Europe can be considered to exist in three potential states of economic integration: trade union (no tariffs), currency union (common currency and central bank), or fiscal union (common treasury and taxation).
- It is currently in the second state, monetary union without fiscal union.
- This is an inherently unstable transitional state between trade union to fiscal union. With a common currency, members cannot devalue vs other members, so persistent uncompetitiveness or financial shocks cause big current-account imbalances; without fiscal union, these imbalances are not easily corrected by transfusions from other members, and so instead become ever-increasing debts. Since these debts cannot be inflated away by devaluation, they must end in either rescue or default.
- This appears to have been understood from the outset by at least some EU framers. The intent, or at least the hope, was always to move forward to fiscal union.
- But EU-wide fiscal union is politically impossible. Differences in culture and legal systems prevent uniform taxation. Popular majorities rejected the euro currency (Maastricht Treaty) — a far less drastic measure.
- The benefits of a common currency are lower than in the past, and falling. The original political goal of the EU – to guard against postwar threats like fascism and communism — is no longer relevant. The information revolution makes foreign currency transactions fast and cheap. So the EU today captures most of the economic benefits of total integration by its trade union alone, without resorting to the extremes and risks of monetary and fiscal union.
- Because there are so many risks and so few benefits, it stands to reason that the parts of the EU that cannot go forward to fiscal union must, then, go back to mere trade union.
- Sovereign nations eventually act on self-interest, and the current euro area is no longer in the self-interest of some member states. Greece’s main benefits from the euro — greater buying power and cheaper credit — are waning fast. Germany’s main benefit from the euro — artificially depressing the cost of its exports to other EU countries by preventing devaluation against the mark — is increasingly counterbalanced by the cost of ever-larger bailouts, with no end in sight.
The above argues that breakup is only a question of when, not whether. Franco-German talks last month on the subject of common taxation suggest they hope to lay groundwork for a common currency between them, advancing to fiscal union, albeit over a smaller region. The others then may regress to trade union. Though a short-run financial shock, this is actually a stabilizing outcome in the long run, in my view.
But what are the implications for investors, other than the prospect of insanely cheap holidays in Santorini? See next post.
(Above photo by Nesster.)