The Eurozone Endgame: Four Scenarios

By Peter Boone and Simon Johnson

In the aftermath of the Irish bailout, the German proposal for a future sovereign and/or senior bank debt restructuring mechanism within the eurozone makes complete political sense to the electorate in stronger European countries.  They do not want to write “blank checks” to weaker countries and to out-of-control financial institutions going forward; creditors to countries that run into trouble will face likely losses.

While the details of this “burden sharing” approach remain to be hammered out (after Sunday’s announcements), there is no way for German or other politicians to backtrack on the broad strategic principles.  But once this arrangement is in place, say in 2013 or thereabouts, all eurozone countries will (a) be able to sustain less debt than has recently been regarded as the norm, and (b) become vulnerable to the kinds of speculative attacks in debt markets that we have seen in recent weeks – to reduce funding rollover dangers, they will all need to lengthen the maturity of their outstanding debt. 

The end point is clear.  Last week the markets began to work backwards to today’s debt profiles; major disruptions still lie ahead.

Ultimately, there will be a eurozone will greater shared fiscal authority, a common cross-border resolution authority for failed banks, and likely greater economic integration.  But there are four scenarios regarding who ends up in that eurozone – and how we get there.

First, as officials hope, the IMF bailouts for Greece and Ireland may work – by stopping the panic and reassuring the investors that there will be enough growth to make even those debt burdens sustainable.  This seems most unlikely, particularly given what we have seen of the IMF package for Ireland so far.

In this scenario, everyone can continue to stay inside the eurozone.  The debt profiles of Greece and Ireland would remain vulnerable, as would slow growth in Portugal and whatever Spanish banks are hiding in their so-called “stress tests.”  Germany agrees to foot an open ended bill because its leadership becomes scared of the consequences.  The ECB buys a lot of bonds, one way or another.

Second, there is the current market consensus that a package of IMF-European Union support for Portugal and perhaps Spain would truly stabilize the situation.  This consensus is fragile – and perhaps more wishful thinking than anything else – but likely to motivate official efforts in the week ahead.  But this is what we call the Maginot Line Illusion, i.e., an idea that ignores the potential for trouble to jump to other potentially weaker eurozone countries, such as Italy, France or Belgium.

In this scenario, Greece probably leaves the eurozone and restructures its debt.  The Germans say “Greece should never have been admitted; this was the original and only mistake.”  Ireland stays in the eurozone but many of its citizens emigrate.  There could be significant grants from Germany and even from outside the eurozone, depending on how much fear spreads around the globe.

Third, there is the thoughtful view of Willem Buiter – currently chief economist at Citigroup and still a brilliant critic of the global financial system.  In a presentation circulating last week (not publicly available), he predicts “three or more sovereign defaults in the next five years.”  His logic is impeccable – once it is easier to restructure debts, the temptation is to do exactly that; the market knows this and so brings everything forward in time.

Fourth, we have the unthinkable – nicely articulated by the Financial Times’ Lex column on Friday.  Divide the eurozone into “relatively prudent” and “relatively imprudent”, in terms of fiscal policy.  Adjust that for the forward-looking ability to run a primary surplus (i.e., can a country run a budget surplus on a pre-interest basis, needed to pay down the government debt if under pressure.)  Adjust this further for off-balance sheet losses incurred by a country’s banks in the “extreme stress” scenario that begins with the default on senior Irish debt guaranteed by the sovereign – another “Lehman moment”.

Now the eurozone (more likely, some kind of Neue Deutsche Mark, NDM) becomes Germany, the Netherlands, Austria, Finland, and a few smaller countries.  Italy is out – even though northern Italy should remain, two currency zones within one country probably does not make sense (sorry Catalonia).

In this scenario, France is the interesting case.  Does France leaving the eurozone break the Franco-German alliance that has underpinned European integration since its inception? 

Even this extreme scenario is not so bad for political stability and economic recovery.  The weaker peripheral countries will be damaged for a generation, but European integration is about more than attempting to share a currency between countries with divergent fiscal policies and no convergence in productivity.

The NDM area will do well; in fact, growth there is already strong – they will probably want to raise interest rates soon.  The rump eurozone will flounder but the positive effects of exchange rate depreciation will be rediscovered, at least for those without too much debt.

83 thoughts on “The Eurozone Endgame: Four Scenarios

  1. There are only two real “endgames” for the Eurozone.

    1. Dissolution.

    2. The establishment of a European Treasury, with full tax and spend authority, and the ceding of a tremendous amount of sovereignty by all members.

    #2 is far more likely, but I wouldn’t rule #1 out.

    In the meantime, they will try all sorts of half measures and kludges to avoid either.

  2. The problem is that the financial euro was created to solve a political problem ie the french fear of a reunited dominant germany. Now i looks like they have caused this to happen.

    There is a growing % of the voters in the stronger countries who are tired of brussels, tired of the “eu demands” line. While Ruetheday is right, option 2 is more likely, it will not happen without a fight as attempts by the commission to levy their own taxes have proven

  3. Yes, #2 and strong countries like Germany will have disproportionately larger control over he new financial system.

  4. Politically, I don’t think it doesn’t make any sense to join EU unless you can enjoy the benefit of german’s low cost of funding. So, no EUR is equal to no EU. Why would the Spain or Italy join EU knowing fully that they cannot compete with german’s industrial might. Yes, they can export lots of fuits and vegetables but I don’t think this is enough of a bargain to entice them to join EU in the first place. Actually, if one looks carefully, EUR problem is primarily an EU internal problem since the region enjoy neither positive or negative current account against the rest of the world. So, this is definitely an internal family dispute. Unfortunately, like many other family disputes, I think this one will end badly as well if the richer norther countries’ politicians keep blaming the med club countries.

  5. Number 1 and 2 won’t work; number three will happen anyway; number 4 will destroy the “weak ones” with the “strong ones” and vice versa, while it will be easier for the weak ones to get back on some kind of track – over time. Ahhh, and France will declare themselves a weak one!

    Can you not do any better, Peter, Simon?


  6. In #4, won’t the NDM appreciate as money flows in from the “imprudent” countries, thus undermining export-based growth in the “prudent” countries?

  7. there is something of silly in the 4th scenario that would be comical if it weren’t unfathomable in its consequences…the splitting of italy and “sorry catalonia” even if tempered by writng that it probably does not make any sense, it gives forage to those in italy that are dead set on splitting the country….kudos to all for aiding the setup of the first mafia state in the world from whence to better corrupt and control the finances of the rest of europe

  8. get a life robert and tank-up on italy and spain….italy is in the group of the 8 most advanced and industrialised countries in the world and you talk of fruits and vegetables!! please! but where are you from? if you are an american you show the kind of ignorance that is a bit too common amongst your compatriots…otherwise read up anyway….. saluti

  9. I keep wondering when some country will tell Goldsacks of money, to shove it. And, when will someone decide to go after those responsible.”IMF bailouts for Greece and Ireland may work.”

    My biggest question is, where is all the money that heads of these countries borrowed? How much went to the people and projects, now that the people are made to “make sacrifices” for the IMF.

    The IMF is giant shark travelling to troubled countries, and convincing their leaders to assume huge debts building things, provided by Bechtel and Halaburton. And the cycle of entrapping people into debt they have no choice about but must pay; while the Elite’s and Oligarchy put it in their bank accounts.

    Thank you IMF for your help.

  10. As economist, it isvery tough to find the real solution for all European group. We have two good exaples in PIIGS. First is Ireland that disclose their problems and use the competitive wage-deflated policy but what Ireland actually get is higher unemployment, higher bad debt in financial sectors, panic in total economic and financial system and higher government deficits to compensate loss in banking system and higher government debts. I think 85 billion rescue fund is too small compared with more than one trillion of total banking assets in Ireland. Ireland may need upto 300-500 billion to restructure all bad debts in the system. I think Ireland is good for transparency but it is bad for them to disclose their problems and cause noone really want to get involve.

    Another bad example in PIIGS is therest with no disclose on real information on their problems. Greece have hidden their deficitanddebts. Spain and Portugal have hidden their banking problems. For Spain banks, they still use the book value for accounting and nearly 60-70% of toal banking-system lending is the real-estate-related loans. The truth is almost Spain bank is not much different from Ireland but they donot disclose theproblem to anyone.

    The way European try to solve the problem is getting worse because they are telling everbody that no private investors will suffer from these PIIGS, but as economist, I think only one solution is letting the losses to investors asquickly as we can to prevent the unexpected crises.We have to understand that if everyone know that they are goingto lose theinvestment, we willneverface the crises but the crises happen because a lot of people havenot expect the loss on investment and economic decision. In the case of Ireland, I cannot find the real solution without debt restructuring andwe can arrange orderly restructuring or uncontrolled restructuring. EU give Ireland with 85 billion support with the policy to reduce government spending but that is causing the problem worse with higher unemployment, higher bad debt and higher government deficit. Or in the case that EU let Greece or Spain spoil EU members money to increase deficit and hide banking problem make the problem evern worse with total unexpected crises in the future if all information have been disclosed.

    I think Germany leader is right but she is wrong not to act aggressively and fast enough on orderly debt restructuring issues.

    I think we cannot find the solution for EURO without debtrestructuring. Whether PIIGS leave EURO currency, disclose or hide the problems or not, they will have to restructure the debts at the end. Why donot we restructre now to end the problem.IMF should bring all capitalized system to work not bring to collapse like this.

    The next crisis will happen if IMF still help hide the problem and keep problem bigger.

  11. Why not take Germany and the stronger smaller EU countries and create a monetary union with the UK ? The UK may be not in the same position as Getmany but they have a plan and will undoubtedly become strong again . You then have in five years a super string currency held together by the industrial and financial centres of Europe . Just an idea .

    Leave France ,Greece and the rest to the dogs they deserve it .

  12. Indeed.
    Romania refused to accept 25 billion euros, with a lot of strings attached so it would create a new revolution there, and Mr. D Kahn got very upset….
    People and contries understand what’s going on…
    Debt is modern slavery.

  13. Italy didn’t “join the EU”. Italy was one of the six first founding members of the EU. Long before Spain, the Scandinavians, the UK.
    Do you know how old the European Union is?

  14. >>Why not?

    Democracy? Self-determination? Accountability?

    >>German’s enjoy better government?

    Depends how far back in history you look … and maybe how far forward. A larger state offers more scope for corruption. And wasn’t big German Chancellor exposed as having some secret funding arragements a few years ago?

  15. Britain is like Greece or France, but luckly, they have the “printing” machines in their control…and City, is the extension of Wall St …

  16. I think you have left out Scenario no. 5: a crash of the union. Presently, EU politicians are selling scenario 2, while trying to achieve 1. This is almost certainly not going to work (for example, Edward Hugh’s recent post on Greece: Second, the default mechanism may make the EU much more vulnerable, to point of self-destruction (the Paul de Grauwe view: Scenario’s 3 and 4 are not worth discussing, three for obvious reasons, 4 due to the systemic coupling.

  17. The problem is that the financial euro was created to solve a political problem ie the french fear of a reunited dominant germany. Now it looks like they have caused this to happen.

    This reminds me of the concept of policy resistance that was taught as part of the System Dynamics course at MIT. Fascinating.

    On the post, the fourth scenario (the “New Deutsch Mark” departure from the current eurozone of Germany + close satellites) is probably the best outcome for Europe, but the question of France and the hangups about the future of the Franco-German axis will probably hold up discussions in its favour for far too long, giving time for other less ideal outcomes to establish themselves. The next 12 months will not be pretty here in Europe.

  18. #2 is highly unlikely. The eurozone itself was barely approved, actually voted down by popular majorities in several member countries. To integrate further is fanciful.

    Just one example: treasury union would require a synchronized legal system. Yet Germany would never agree to Greek law, nor vice versa. We are decades away, at minimum, from realistic unification.

    By far the most likely outcome is the most obvious one: eurozone survives, but without its weakest links.

  19. Predictive mental model: Paul left the Beatles first.

    Like Germany, Paul was panned by creative critics, but was a hit factory, a one-man assembly line for exportable product.

    Like Europe, the rest of the Beatles by 1969 were either strung out on smack, living in Indian ashrams, or never that great at the drums in the first place. Did they quit? Of course not. Too much to lose.

    Instead, Paul grew tired of subsidizing miscreants, and bailed out.

    This predictive model, which is the subject of my macroeconomics PhD thesis, says Germany will leave first.

  20. Nothing will stop the contagion because the speculators are making money off driving down the prices on the debt, country by country. It’s that simple. They are just like the naked short sellers destroying companies and I personally find them repulsive.

  21. and, of course, that was the end of paul’s great period if you want to extend the analogy. There is a lot to be said about a custom’s union; must less about a monetary union.

  22. I believe the original planners of this would not be unhappy with decades – a quarter century, say. A generation. The thing has be set in motion.

  23. “End of Paul’s great period?” I might not know diddly squat about economics, the EU and shorting PIIGS, but I do know that Wings was a much better band than the Beatles, and Paul definitely did not stop churning out hits. “Helen Wheels” case in point.

  24. my thoughts exactly. What’s in it for Germany in the long run? Germans will be the first ones out.

  25. I am not an economist, nor do I play one. The question from my non-economist POV is why are all the big player’s, from France, Germany, USA, etc so unwilling to make any of the actual investor’s pay for this?

    Having watched who is actually going to be hurt by all this is not the banker’s or governments (although some politicians will be replaced) but actual people. The US SCOTUS decided that corporations are people, but they won’t be sharing any of the pain that mere mortals will experience.

    Have nations just moved past or willfully ignored that fact or are they saying that the actual bad player’s need to be excused, yet again?

    As a mere mortal, there is no where that I can go, nothing that I can do. I feel more and more like one of the sheep (or cattle) that is being led down the path to the slaughter house. I do wonder if I am alone in this thought process or am I just being old and paranoid?

  26. Unfortunately, you are not alone in your thought process (no offense). The reason the investors are not going to share in the pain (at least not initially) is that to the extent the holders of the debt are the banks, that would wipe out their capital so they would stop lending, and that is bad for the economy. And to the extent that the holders of debt are pension funds, there would be a popular outcry by people who put their money in the safest of assets (government bonds) and are now being screwed.

    Also, SCOTUS didn’t declare that corporations are people. The issue was wheter when people organize into various entities (corporations, unions, etc.), they can donate money to political camplaign through those entities, instead of directly.

  27. afisher,

    I am not the best person to answer your question. I know little about Europe and so I may need someone else to help out some. But I can get things started from a US standpoint on the basics.

    Defaults and incremental loses on loans result in write-downs. These balance sheet adjustments in turn reflect on the earnings of a lending institution and that influences the value of that corporations stock. As stock devalues that results in less wealth and that means less consumption and that can of course mean fewer jobs. As those who lose their jobs then default on other loans the process is amplified and repeated, more write-downs cause more stock loss which causes more job loss and etc. Adverse feedback loop.

    Those who you might see as worthy of punishment in the issuance of these failed loans are typically salaried employees. They may have some personal loss due to some of their compensation coming from bonuses, and they may lose their jobs, but in most cases their failures are offset by other successes and so even if they are required to take a ‘haircut’ it usually is not mostly their hair that falls to the floor. It is everyone’s hair in the grand scheme of things.

    Write-downs are rescinded growth. Banks don’t lend out ‘their’ money, with a fiat currency being lent out through a fractional reserve banking system, this dictates that the money being loaned belongs to everyone, and, it is the very fact that everyone must lose when loans fail that makes this so. And in a global economy with a shortfall in global aggregate demand, everyone does truly mean ‘everyone’.

  28. Seconding theroundearth’s comments. Whether it made sense to be part of the EU or not, they’re already part of it. The question now is: “what are the costs of leaving?”

  29. The current equilibrium is unstable. They either need to move to greater integration, unified fiscal policy, fewer cross-border labor frictions. Or they need to move apart.(Break currency union) In the status quo many of the other vectors for equilibration of monetary disequilibrium are not present.

    I’m thinking that none of the EU members are really ready throw in the towel. They’ll probably commit to bailouts, and if necessary looser monetary policy, is/are as extensive as necessary to prevent default.

    I highly doubt tough talk now will stick.

  30. In the absence of a mechanism to balance current accounts (perhaps raising or lowering VAT rates in proportion to deficits or surpluses?), which Angela Merkel apparently will never allow, rather than merely fiscal policy, the only plausible options are that the peripheral countries leave the euro together (your option 4, which could instead be viewed as Germany leaving the euro) or that they leave the euro separately (the more likely alternative to your option 3, since Spain and Italy, at least, will not sell their children to the Germans). As you say, one interesting question is whether France will stick with Germany or instead become the anchor of the southern euro (the ecu, finally?). I would bet on the latter choice: Mitterrand’s determination to replace the Bundesbank with the ECB was not so much a postwar political calculation (although he was willing to see Germany united in order to get it) as it was a reaction to the failure of his attempt to reflate the French economy in the early 1980s; and anyway he’s dead and today even the Socialists would rather see France as a leader than a lapdog. Another interesting question is how existing euro debts will be allocated between the floating northern euro and southern euro. Creditors might fairly expect this to be in proportion to the respective national exchange rates fixed within the euro – but why wouldn’t the southern euro states just repay their euro debts in southern euros?

  31. There is the European Union (EU), which is basically a free trade zone, and a very good Idea. And there is the European Monetary Union (EMU) which is the part of the EU where the Euro is used as common currency and which is monetary madness.

    One simply cannot have the same monetary policy and a common currency in countries which have so different labor ethics like in Europe and where the productivities are diverging so fast. The hard working and saving nations of the EU countries can indeed support a strong currency, but the others need a weak one. Milton Friedman warned for that already 10 years ago.

    I think the EMU has already self-destructed. Mr. De Grauwe is very right in saying excessive private debt caused the Euro-crisis. Only he omits to say it was the monetary madness of the Common currency that caused this excessive private debt: inflationary low interest rates all over Europe caused the general credit euphoria. This common monetary policy was totally contra-indicated for fast growing countries like Ireland where it lead to a housing bubble just as in the US.

    A permanent bailout program by the taxpayer as De Grauwe suggests is the worst of solutions imaginable. Mr. De Grauwe should know from the history of his own country (Belgium) that a in nation where the one part of country eternally pays for transfers to the other, the contributors ultimately end up by revolting, and that such transfers ultimately end up by ripping the country apart. In case of the free trade zone of the EU, that would be a most regrettable consequence.

  32. Well, even if it was necessary to bail out the banks (in the sense that the adverse spiral of write-downs and bankruptcies that would have otherwise happend would have been even worse than what we experienced), it doesn’t follow that we needed to bail out the bankers.

    We could have nationalized the banks, then resold their valuable assets to new owners and managers, meanwhile forcing the old ones out and making their creditors take haircuts (or maybe scalpings or even decapitations) and forced them to restructure. Think GM, on a bigger scale. We would have eaten the losses on their bad assetss–but I don’t see how that would have been worse than what we have now, where all of their losses in perpetuity are either explicitly or implicitly picked up by the taxpayers and their political power has grown even more.

    We also could have seized the opportunity to impose some regulations on the finance industry to reduce their propensity to gamble recklessly with everyone’s money.

    We also could have had some serious investigations into whether any bank executives could be held criminally responsible, and, if so, prosecuted them.

    But we did none of those things. We just asked how high when they commanded us to jump. And now the looting of the wealth of nations by financiers has gone global.

    afisher, you are neither alone nor paranoid. I would describe you as awakened.

  33. The German voter sounds like a teabagger. How did they “help” Ireland by getting the Irish to assume liability for the extremely risky and foolish loans German banks made to private Irish banks? This is all about extend and pretend so the German banks don’t have to go to there German depositors and investors and explain how they lost all their money.

  34. @Roberto, Sorry for putting Italy and Spain in the same basket. But if Italy can compete with the German’s industrial might before, I think there was no need for the country as a whole (I think northern Italy is pretty competitive) to repeatedly devalue its currency just to stay competitive. Again, I know this is a simplistic argument but my point is many of the weaker EU members joined the club because they hoped to be able to tap German’s funding cost eventually once they join EUR aside from other benefits. If one attaches high importance to macro stability which is reflected by low interest rate as the importance backdrop for growth, then the benefit of lost cost of funding will be a very important motivation for joining the EUR.
    Speaking about the fact that Spain and Italy are already in the Club. Hm, I thought the public can always opt out of any club that they joined of course with some consequences. ;-). The last time i checked, both Spain and Italy are still democratic countries.
    FYI, I am an Indonesian.

  35. @paul: Free trade zone is a great idea if you have fully free flow of labour as well. I guess it is pretty easy for highly skilled engineers to move from Fiat to VW or traders to move from UniCredit to DB but i am not so sure that this is true for many many type of jobs. Language barrier comes to my mind as one of many barriers.
    So, I still think the benefit of being able to tap into german government’s low funding cost is the main “benefit” for many other EU members to join the EU in the first place. I guess this is why Swedish decided to opt out because they didn’t see this as huge benefit for them.

  36. Evidence abonds that Portugal, Italy, Ireland Greece and Spain no longer have sovereign debt seigniorage, and are not viably obtaining and will not be viably obtaining revenue from sovereign debt sales; any upcoming bond sales are being done by banks which submit debt or have submitted debt to the ECB for funding of new debt issues. Such means of obtaining money is simply a ponzi financing, it is monetization of debt, and cannot be sustained much longer. The yenguy believes the sovereign crisis will intensify, and that out of Götterdämmerung, an investment flameout, that according to Bible Propehcy, a Sovereign, Revelation 13:5-10, and a Seignior Revelation 13:11-18, an Old English term for top dog banker who takes a cut, will emerge to establish fiscal sovereignty and credit seigniorage for both Europe’s financial institutions and residents.

  37. “helping all these other countries”? Are you really that ignorant? How is it help to give me a massive loan so that I can pay back your banks who made reckless investments pumping up a property bubble that’s saddled a whole generagtion in Ireland to decades of debt aided and abetted by the ECB? Meanwhile Germany free-loads on everyone else’s consumption, exporting un-employment to the rest of the eurozone. Germany should leave and take its vassal states with it. See how your exports do valued ina currency who’s exchange rate is determined by your own consumption.

  38. So after Ireland ‘sacrifces’ itself for the good of the Euro Zone by taking on their bankers debts, it could be tossed to the wind. Interesting.

  39. The German voter may not want to bail out his own banks no more than the Irish voter. I Think the issue here is the power of the rich over the poor, the investor/banker over the public servant/young person. The people of Europe need to unite and demand an apology from the ECB and the bankers for the way they have behaved. Then they can bring in legislation to make the banks more responsible in the future. The ECB can just print loads of Euros to pay back depositors where old banks fail. The Fed does this in the States 200 Banks have failed in the last couple of years.

  40. Considering that I was not forgiven a 21 cent short error for COBRA payment, and the Bible was used as ammunition to prove I was trying to cheat UHC (now we all know that was a schtick the industry used against millions)

    So here we go, dueling quotes:

    “Simon Peter was the apostle in charge of the workers at Hippos, and when he heard Jesus thus speak, he asked: “Lord, how often shall my brother sin against me, and I forgive him? Until seven times?” And Jesus answered Peter: “Not only seven times but even to seventy times and seven. Therefore may the kingdom of heaven be likened to a certain king who ordered a financial reckoning with his stewards. And when they had begun to conduct this examination of accounts, one of his chief retainers was brought before him confessing that he owed his king ten thousand talents. Now this officer of the king’s court pleaded that hard times had come upon him, and that he did not have wherewith to pay this obligation. And so the king commanded that his property be confiscated, and that his children be sold to pay his debt. When this chief steward heard this stern decree, he fell down on his face before the king and implored him to have mercy and grant him more time, saying, ‘Lord, have a little more patience with me, and I will pay you all.’ And when the king looked upon this negligent servant and his family, he was moved with compassion. He ordered that he should be released, and that the loan should be wholly forgiven.

    (1763.2) 159:1.5 “And this chief steward, having thus received mercy and forgiveness at the hands of the king, went about his business, and finding one of his subordinate stewards who owed him a mere hundred denarii, he laid hold upon him and, taking him by the throat, said, ‘Pay me all you owe.’ And then did this fellow steward fall down before the chief steward and, beseeching him, said: ‘Only have patience with me, and I will presently be able to pay you.’ But the chief steward would not show mercy to his fellow steward but rather had him cast in prison until he should pay his debt. When his fellow servants saw what had happened, they were so distressed that they went and told their lord and master, the king. When the king heard of the doings of his chief steward, he called this ungrateful and unforgiving man before him and said: ‘You are a wicked and unworthy steward. When you sought for compassion, I freely forgave you your entire debt. Why did you not also show mercy to your fellow steward, even as I showed mercy to you?’ And the king was so very angry that he delivered his ungrateful chief steward to the jailers that they might hold him until he had paid all that was due. And even so shall my heavenly Father show the more abundant mercy to those who freely show mercy to their fellows. How can you come to God asking consideration for your shortcomings when you are wont to chastise your brethren for being guilty of these same human frailties? I say to all of you: Freely you have received the good things of the kingdom; therefore freely give to your fellows on earth.”

    (1764.1) 159:1.6 Thus did Jesus teach the dangers and illustrate the unfairness of sitting in personal judgment upon one’s fellows. Discipline must be maintained, justice must be administered, but in all these matters the wisdom of the brotherhood should prevail. Jesus invested legislative and judicial authority in the group, not in the individual. Even this investment of authority in the group must not be exercised as personal authority. There is always danger that the verdict of an individual may be warped by prejudice or distorted by passion. Group judgment is more likely to remove the dangers and eliminate the unfairness of personal bias. Jesus sought always to minimize the elements of unfairness, retaliation, and vengeance.”

    Cheap is the twin sister of Greed. Judge the “king”…

  41. I started to follow this blog for insights on the US economy, and instead I get this sort of dreaming about the EUR’s future. The EUR was indeed one of the things that made German reunification palatable to the French. It also was one of the things that would assist the “single market” for financial services and boy, did it do that..Finally, the EU project is of course, destined to end in some form of redivision of the European map, either by forming a sort of US os E, or a subset of what that could have been.

    There are many reasons why widespread antipathy vs the EU exists in Britain (and even more so in the US but for good reasons) . Some of that may date from the time Britons were facing war with Germany, some from the postwar years when their imperial existence was destroyed. In general, the UK public is extremely ignorant about the potential benefits (and disbenefits) of being a member of the EU/EUR. One wonders, why the rest of Europe puts up with them. Britain appears to attach no value to membership, but also, the other members (except the ones who seek opportunistic alliances) derive very few benefits from UK participation.

  42. There is a simple answer to your question (or suggestion): the locals would insist on being paid in Euros, and they are the people that count locally. Anyone thinking otherwise lives on Fantasy Island (or, the UK).

  43. @Robert

    I fully agree that the lack of labor mobility (du to the language barrier but due also to Europe’s generous unemployment schemes) does indeed slow down the optimal allocation of resources. Still the added value of free trade remains huge thanks to the comparative advantages, even with reduced labor mobility.

    I also fully agree the Swedish were very right to opt out of the EMU. It allowed them to adopt an independent monetary policy suitable for their economy.

    However I think “the benefits (for countries like Greece or Portugal) of being able to tap into German government’s low funding cost” is a myth invented by the bankers.

    Not one single study can prove long term benefits for growth. At best inflationary low interest rates can boost the economy for a very short while. In the long run inflationary low interest rates only have disadvantages. Manipulation of interest rates far below the natural equilibrium level only leads to excessive debt accumulation and bubbles.

    Interest rates are indeed the starting point of all economic calculations. The interest level is not only conclusive in the choice between saving and consumption, but also in the choice between labor-intensive and capital intensive investments. Forging this basic measure only leads to all kinds of wealth destructing distortions. Too low interest rates lead to savings deficits, excessive debt accumulation, inflation, excessive expulsion of labor from manufacturing processes, and to inequitable and counterproductive redistribution from savers to big spenders. The eternal dream of (nearly) free money is an illusion. The interest rate level is sustainable only if it leads to the equilibrium between saving and consumption at which every generation pays for its own consumption without coercing their heirs or other nations to pay for the piper.

  44. The main benefit for populations of joining the Euro was that it would protect them against fiscally irresponsible government. However, the rules were flawed so we will have to start again. Maybe, suspending your country’s sovereignty may be required.

  45. You must be from Belgium. What do you want, be a citizen of a big EU or be a Belgian? As far as I can see, no one has benefited from the EU/EUR as much as the good people of Brussel

  46. As you know, the Germans tried to be friendly to the Britons (who were ruled by Germans for a while, even Q Victoria’s German was better than her English and she spoke German to her husband) often, but the Brits never wanted to play. Now Britain is bankrupt, Germans are happy not to have to take care of them as well. Do you think Germany needs more than Scandinavia, the Benelux and Austria/Slovakia, with maybe a promise to the Poles, Czechs and Hungarians to be accepted upon a thorough apprenticeship?

  47. @robert…if you don’t get things straight it is useless to have any discourse….one more time: italy is in the g8 (i trust(?) you know what it is, btw, now it has enlarged to the g20) since its start …italy was also one of the founding fathers of the eu, which means, so that maybe you can understand it, they are one of the original members of the club….don’t bother to respond, i have wasted enough time already

  48. @paul: I am not even sure that interest rate policy is relevant for the long term growth. But obtaining a low immediate funding rate will always be attractive for many many misguided politicians or policy makers. So, since I assume that Politicians to be more rational than wise, I guess they were more attracted to the quick gain from the low funding cost to fund their fiscal debts. The debt/gdp ratios of these EUR periphery nations were pretty high before joining the union.

  49. @Rien

    It is my personal conviction that only “TAX COMPETITION” can effectively protect us all against fiscally irresponsible governments.

    For that purpose we need (small) independent nations with full fiscal autonomy. The biggest advantage of (small) autonomous states is that that businesses and citizens can move rather easily when a neighboring state provides better public services at better tax conditions. Such an ultimate democratic control by the community keeps the growth of the state apparatus within reasonable limits and ultimately results in good governance.

    A political European Union would go in the opposite direction. It would centralize fiscal policy into a tax cartel similar to OPEC from where there is no escape.


    Or read:

  50. CBS,

    I don’t exactly disagree, but I think the socializing of losses, or the TBTF considerations, need to be seen in a broader context. Right now, what is slowly becoming apparent, is that service-based economies are too dependent on their FIRE sectors.

    The emerging nations having been given the right to impose capital controls by ZIRP/QE policies etc., has cast further doubt on whether the demand for foreign capital is capable of sustaining ‘investor nations’.

    Fiat currencies and fractional reserve banking have made the value of exogenous capital dubious. The ‘actual’ value of capital in a fiat system rests in the viability of profit because that is the only constraint on the creation of capital. Capital is simply created ex nihilo when that creation itself can be justified by risk factors, in other words. So… why would any nation need foreign investment?

    Naturally though, refusing foreign investment tends to set warships to sail so resistance through capital controls and other means are only possible in certain historic conditions, but, that is where we are to a nascent degree.

    Consequently, as demand for foreign capital continues to wane, and as the resulting excesses of liquidity continue to show a propensity to cause bubbles where these excesses are not recognized as such, as in the recent crisis, the socializing of banking losses will almost certainly continue to exacerbate cyclically. It will probably follow then that banks will fully come under the auspices of their respective states, where they should have been since the inception of fiat money.

  51. Re: @ guest___”foolish loans German banks made to private Irish banks?” This graph was posted by a comment on this board some time back “Ireland Bailout / Big Picture”…Ref:

    “German banks don’t have to go to German depositors and investors and explain how they lost all their money”…Ref: “Insolvent European versus American States” please note that the peripheries in EuroLand all have a distinctive function (eg. Greece/ Tourism; Ireland/ Highly Skilled Workforce; Italy/ Tourism & Culinary; Portugal/ Tourism/Aquadic Foods?; Spain/ Tourism & Foodstuff)…but bounded by geography which is not necessarily a goog or bad thing? Bottomline consumer orientated markets internalized?
    Please note the, “Debt Weight Graph (enlarged WSJ”
    My opinion of Europe is one of a contraian view. That is EuroLand should welcome all countries large and small and work with each in realistic financial terms of equitable achievement in proportion to the whole and align fiscal parameters to facillitate the benefits and drawbacks of joining. Why should the EuroLand not be a United Europe with the where with all to compete with China and India in the latter part of the 21st Century? If not now when…when too late is a nonsequitur.
    Please don’t ever allow a “Federal Central Banking System” as used in America to literally destroy your “EuroLand”. Banking helps countries prosper if under wise (a rarity today?) leadership. Greece created their own problems with ridiculus, rabid fraud, and malfeasance accepted by all! However, Ireland was destroyed within by their onw “Banking System” which parallels the United States to a “T” !

  52. I am indeed still Belgian but I’d rather be a citizen of a small independent Belgian Province with the size of some ± 1 million inhabitants.) – see my answer above.

    It is said indeed that Belgium benefits from the presence of the EU administration. As a middle-class citizen living near Brussels, I must tell You that I didn’t notice anything of the kind. All I see is that houses prices around Brussels tripled since the last invasion of new bureaucrats. I paid the final mortgage payment for my house 15 years after it was built. Now my children need to engage in a 40 years debt slavery if they want to buy a house that is even smaller than mine.

  53. Rien,

    The following confuses me a bit:

    “I started to follow this blog for insights on the US economy, and instead I get this sort of dreaming about the EUR’s future.”

    So… if I understand you correctly, on a thread about about Europe’s future (‘Endgame’), you are disappointed that “insights on the the US economy” are lacking, on a posting that you chose knowing the US economy was not likely to be discussed.

    Then, when you “get this sort of dreaming about the EUR’s future,” which is coming from every last participant here, (an aspersion made clear by your generalized implication), and that unmitigated ignorance made you feel obligated to set us ‘all’ straight.

    Gee whiz, Rien, thanks, I suppose that means then that this last comment of yours tells all. Which implies then that the benefits of stability from a large currency stock, and fewer trade restrictions; and the negotiating advantages of a large trading bloc, are not of any importance.

    Or, upon reading your comment more closely, it could be that you have a penchant for insults without much, or any, support.

  54. Why The Euro Zone Can’t Break Apart

    Tuesday, Nov. 30, 2010 11:42AM EST – excerpts

    “Unlike true love, the euro really is forever.

    That may seem a reckless notion to advance just as Ireland becomes the second highly indebted member of the 16-nation single currency area to require a bailout, following Greece, and as bond markets close in on Portugal and Spain.

    But the cost to any country of leaving the euro zone would be so high, and the damage that an exit would inflict on the currency and the remaining members so great, that no government would rationally choose to secede, or to push another out.”

    Argentina’s 2001-2002 economic crisis and $100-billion (U.S.) bond default, which reduced millions of people to poverty, would pale in comparison with the likely chain reaction across Europe.

    “There would be chain bankruptcies. A run on the banks would be certain. It would be far worse than Argentina,” said Jean Pisani-Ferry, director of the Brussels economic think-tank Bruegel.”

  55. Austria? You’re kidding? With their banking systems exposure to Eastern European paragons of fiscal virtue like Hungary I doubt very much if you could really rank them in the first tier. Come to think of it, when you look at the extent of the exposure of German banks, Northern Italian banks and Benelux banks to the imploding east I think your whole argument that this is a manageable situation falls apart… a bit like the European project.
    Scenario 5.
    We are seeing the beginning of a great political and economic collapse in Europe.

  56. Pat,

    You have usurped the number ‘five’ and the premise too:

    “I think you have left out Scenario no. 5: a crash of the union.”

    That was: Rik @
    November 29, 2010 at 11:57 am

    This thread could have benefited from a number dispenser like those at the DMV.

  57. AfterQuotes relates Francois Mitterrand said: “Since each nation is undergoing a crisis, they all tend toward egotism. Each country first wants to rescue itself, whereas they will only be rescued together.”

    Marketwatch reports Michael Hewson, an analyst at CMC Markets. “It is now becoming increasingly clear that the only options open for a final solution are to either adopt closer fiscal policies across all European countries, and with austerity fatigue already creeping in across European populations that looks unlikely, or for the single currency to somehow restructure itself in a manner that represents the differences between the respective stronger and weaker economies.”

    I’m 60, living, in the Pacific Northwest, it’s only been recently that I’ve been interested in economics and investments, and have read some on Austrian Economics, and have benefited from insight into some of its principles such as debt deflation; but I’m not a libertarian, I am a Reformed Christian and bond-servant of Jesus Christ.

    Years ago, I stumbled across the book En Route To Global Occupation by Gary H. Kah, Huntington House Publishers, Lafayette, Louisiana, 1992. And now its chapters come back to memory to fit in with the Bible’s prophetic Book of Revelation Chapter 13, to help me understand that out globalization, waves of carry trade investing, quantitative easing, and a currency union in sovereign crisis, ten regions of global governance are forming.

    Bible prophecy portends that those living in the Eurozone, as well as all the world, will see a loss of national sovereignty, and live in debt servitude to the beast system of global corporatism, ruling through mankind’s seven institutions and in ten regions of global governance, as held forth in Revelation 13:1-4 where a beast, having seven heads and ten horns rises from the sea.

    We are witnessing the rise of global corporatism, that is state corporate rule in the Eurozone as David Cameron, Dominique Strauss Kahn and Olli Rehn wrapped up a seigniorage aid bailout plan for Ireland, surrounding what the International Monetary Fund chief described as sovereign crisis, as Philip Aldrick, Economics Editor of The Telegraph wrote in November 19, 2010 article, IMF Chief Dominique Strauss-Kahn Urges Leaders To Cede More Sovereignty To EU.

    Sovereign crisis arose November 5, 2010 as bond vigilantes sustained the interest rate on the US 30 Year Government Bond, $TYX, above 4%, as the US Federal Reserve’s Quantative Easing 2, constitutes monetization of debt; and as Econogirl related on November 10, 2010, that the German government has stepped up its insistence that bond holders must take on some of the costs for any new bailout of sovereign debt; and with Germany’s Merkel call for a sovereign default mechanism at the meeting of the European Task Force On Economic Governance on October 28, and October 29, 2010.

    As a result the currency traders sold the world’s major currencies, DBV, and emerging currencies, CEW, causing the US Dollar, $USD, to rise. This caused World Government Bonds, BWX, and International Corporate Bonds, PICB, to sell off. And commenced an Elliott Wave 3 Down to start in the Euro, FXE, world stocks, ACWI, as well as in the S&P, SPY.

    Now, a Core of Europe is emerging in the midst of a sovereign crisis. Rompuy, Merkel and Sarkozy on November 28, 2010, negotiated and announced, a Leaders’ Framework Agreement to establish a permanent crisis mechanism, that will replace that European Financial Stability Fund, EFSF, that expires in mid-2013. This sovereign debt default mechanism is called the European Stability Mechanism, ESM.

    We see that today, Germany is one of the power forces, in attempting to find a way out of Europe’s sovereign crisis. Ambrose Evans Pritchard commented, on May 2, 2010, in the, in words reminiscent of Margaret Thatcher: “If the aim of Helmut Kohl and Francois Mitterrand at Maastricht was to tie down a ‘European Germany’ with the silken chords of emu, they failed. Monetary union has delivered a ‘German Europe’ after all. And he continues, We now know the answer to Henry Kissinger’s question: “Who do I call if I want to call Europe?” Only one person matters. The Chancellor of Germany.

    Evidence abounds that Portugal, Italy, Ireland, Greece and Spain no longer have sovereign debt seigniorage, and are not viably obtaining and will not be viably obtaining revenue from sovereign debt sales; any upcoming bond sales are being done by banks, which submit debt or have submitted debt to the ECB for funding of new debt issues. Such means of obtaining money is simply a Ponzi financing, it is monetization of debt, and cannot be sustained much longer.

    Theyenguy believes the sovereign crisis will intensify, and that out of Götterdämmerung, that is an investment flameout, according to Bible Prophecy, a Sovereign, Revelation 13:5-10, and a Seignior Revelation 13:11-18, an Old English term for top dog banker who takes a cut, will emerge to establish fiscal sovereignty and credit seigniorage for both Europe’s financial institutions and residents as well all the world.

    Jean-Claude Trichet in address Global Governance Today, made before the Council on Foreign Relations, CFR, on April 26, 2010, called for this new financial state-of-being where he said: “For the good and appropriate functioning of global finance it is extremely important that we, in this new ownership of global governance, have — particularly on both sides of the Atlantic — the implementation of the same rules in the same fashion.”

    Soon there will come unified regulation of banking globally, as referred to in the James Politi and Gillian Tett Financial Times article NY Fed Chief In Push For Global Bank Framework, where The Seignior will oversee all matters of debt and credit, most likely through the Bank for International Settlements, and will eventually implement a global currency system. Carroll Quigley, in his book Tragedy and Hope, relates that the BIS will “create a world system of financial control in private hands able to dominate the political system of each country and the economy of the world as a whole.”

    Francois Mitterrand, was a great prophet in saying “they will only be rescued together” — their deliverance if it be called that, will be the rule of fiscal sovereignty and monetary seigniorage coming from Europe’s Core, that is Brussels, Frankfurt and Basel. Won’t that be a shocker to all anarcho capitalists! Such was God’s Plan from Eternity Past.

  58. #3 is the most likely, but in that case many/all Eurozone members might decide to default at once, on say 50% their debt.

    The problem with the #4 NDM scenario is that Germany would simply be too strong within that grouping, as Krugman argues on his blog. It would be a form of dollarization and that’s very unpopular in advanced countries.

    Maybe the problem will disappear once/if the Euro reaches parity with the USD.

  59. We dont know everything. Actually what we dont know far exceeds what we do know.

    They say the next big thing is here- the revolution is near- but it is just a bit of history repeatin

    Look back at 2008. Many a pundit a’la Mr. Johnson were screaming for full bank nationalization in the US as the only “hope”, “way”, “reprieve” blah blah.

    I vote for- the euro zone will go on with its current roster of nationalities, the bad guys will run down their big deficits over time, the good guys will foot the bill, the bond market schizos will in time start scrambling to buy the same assets they conspired to destroy with vigor, …and the blogger savants will move on the “ONLY TWO POSSIBLE OUTCOMES FOR HUMANITY”

  60. Well, let me put it this way, better outcomes. Their socioeconomic indicators (taking into account also that they integrated the former DDR, an enormous drag on their economy and especially productivity and social security) are exemplary. Politically, it is also one of the better functioning democracies, with high voter participation and regular rotation. Germany is also a country where ther is not a frozen duopoly like in the US or UK but opportunity for new parties (not necessarily nice ones, but that is freedom)

  61. You must be Belgian too! But that thing still exists, born out of secession from The Netherlands, which in turn was created by the Post-Napoleontic Congress of Vienna that basically conserved a fragmented and slightly rearranged (and firmly non-republican) Europe (after Napoleon failed to maintain the “unity” he had achieved briefly). As history is an imperfect but not to be ignored, teacher, maybe the Europe that emerged in the post-Hitler equivalent of the Congress, is now undergoing some fatigue stress and pressure for rationalization and consolidation.

    Maybe we need a BIsmarck? Bismarck refused to merge Prussia (plus satellites) and Austria-Hungary, because the diversity of Austria would be impossible to manage, once the Congress system had become obsolete and he had the opportunity to consolidate the German speaking entities within one state. Had he been able to spit the Dual Monarchy, WW I would probably not have happened, etc, etc Long live Belgium, Vlaanderen de Leeuw

  62. Well, I am not so sure I understand your reaction. I am firmly in favor of a large currency block (provided it is well governed, as the EUR has not been lately) consisting of countries that have the political capacity to handle and manage if necessary the economic transformations that may occur. In Ireland etc that management was lacking and maybe the international banking regime (Basle II) played a role too. And, indeed, I read this blog for US issues, because I think the authors and most of the commenters have their main expertise there.

    But I think that the blizzard of really unrealistic (show me the process that would apply to an exit or break up; there is nothing in the treaty) comments belongs in the category “dreaming” (or nightmaring for some).

    There are a few things that may happen: (1) no further enlargement of the EU or EUR, which would be good but disappoint some countries, like Turkey. (2) There will be increased impetus on the part of the “continentals” to push through a set of finance reforms that are very unpopular in London: the “market” everyone refers to is very opaque and cries out for regulation. In the US that would be difficult given the power of interest groups but in Europe only the UK gvt is under the influence of those. Just take a look at the relevant EU websites for the issues on the agenda.
    (3) the ECB will change its mandate slightly (as Mr Trichet has been hinting today), which will quickly reduce the space for speculators/investors. That may be regrettable from an efficiency point of view, but this situation is far from ideal too.
    (4) that will also mean that the focus will return to the USD and US policy, and the failed G20…

  63. Roubini Sees European Financial Contagion Spreading Into Portugal, Spain

    Dec 1, 2010 4:38 AM ET – Portugal, Spain – Bloomberg

    “Europe’s debt woes are at risk of spreading to Portugal and Spain, and rising budget deficits in the euro area are a concern, saidNouriel Roubini, the New York University professor who predicted the global financial crisis.

    “There’s now financial contagion in Portugal, Spain and to a smaller degree even in countries like Italy, Belgium and others in the euro zone,” Roubini said in a speech to a conference in Taipei today.”

    “There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don’t know. But there are also unknown unknowns. There are things we don’t know we don’t know. ”

    Donald Rumsfeld

  64. Thank you, anonymous. I agree with Roubini’s assessment. It is ridiculous to think that investors are somehow underestimating the resolve of European ‘leaders’ to support the Euro. That’s just nonsense and spin on the part of information ministries. All the hot air in Brussels will not keep the Euro propped up. Eventually there will be a massive exodus and collapse.

  65. I’m inclined to agree with Eichengreen. I think the key is in SJ’s very last line…

    “The rump eurozone will flounder but the positive effects of exchange rate depreciation will be rediscovered, at least for those without too much debt.”

    The critical question is the denomination of debt. If the debt is denominated in local currency, Ireland can unilaterally restructure. Somehow, that’s not happening. If they assume debt in Euros, they can’t unilaterally restructure.

    I think the entire world is perhaps overestimating the cost to ireland of just going it alone, defaulting, re-issueing it’s own new currency, and immediately balancing its budget – and really, the balance is less about fiscal budget than trade gap.

    The cost to the EU would be far higher than to Ireland, which is why (I think) the markets were shocked to learn that Ireland had negotiated such an unfavorable package for itself – particularly after willingly suffering through massive austerity programs at the directive of the jackbooted thugs in Bonn.

  66. Ref: “World Bank / BIS Quarterly external debt”
    Ref: “The World Bank Group” – Table C1/Gross External Debt Position
    Ref: Table C2 – Gross External Debt Position by Sector (US Millions)
    Ref: Table *C3! – Gross External Debt Position by Original Maturity
    Ref: Table / C5/ C6/ C7/ & C8
    Table: C4 – Gross External Debt Position by Instrument
    &SDDS/QEDS Cross-Country Tables 2010 – World Bank Group
    Please Note: The IMF is owned by the United States with a whopping 17% contribution with Japan coming in at a distant 2nd! Currently the IMF portion of the EURO Bailout is $317bn, with the U.S. on the hook for $53.9bn (Greece only***doesn’t include Ireland). PS. Obviously the only reason the IMF is involved…other than the very real fact…our banks (U.S.A. & Japan) are on the hook for ~ 71.3 Euro/~ $96bn U.S. and Japan at 14.3bn Euro/ ~$18.5bn.U.S….Nice! Oh, just some late news today about the IMF buying up Ireland’s Utilities? Amazing!

  67. So a likely scenario is the break-up of the Euro…

    Version 1: weak countries leave: the mere rumour of this would cause bank runs, making their problems far, far worse. These bank runs anticipate the devaluation that is both likely and necessary for these countries.

    Version 2: strong countries leave: the mere rumour of this would cause massive capital flight from any country not part of the departing group, desperate to seek the expected, and necessary, appreciation.

    Basically, any way you cut it, money flees Ireland (and others) for Germany (and others). The advantage of version 2 is that the weak countries don’t face the debt-in-external-currency problem. To be honest, this is the scenario that gives bondholders what they deserve (a loss on a risky asset that went bad).

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