Europe – Till Death Do Us Apart?

Nouriel Roubini has written pretty much what I heard from him last Friday in a FT piece. Naturally, it has attracted a lot of comments, esp. the title. I wonder if Mr. Roubini chose it or the FT editors did. TGS thinks that this possibility can no longer be brushed aside.

One of the first comments comes from one Sony Kapoor who has started a new think-tank called Re-define. Interesting assembly of talent and interesting agenda. That said, his Plan B does not quite cut it, in my view. Not sure if discriminatory treatment of private creditors on the one-hand and Greek banks and the European Central Bank on the other would be feasible. It could be legally challenged. It could set a precedent in the case of Ireland where UK and US banks are also considerably exposed. Even if feasible, it might still be considered a default by credit-rating agencies, triggering a whole set of chain reactions.

On Sunday morning in Singapore, I had a 90-minute conversation with my friend Srinivas Thiruvadanthai, the Director of Research at the Jerome Levy Forecasting Center whose piece on the US fiscal policy appeared here. We ran through a laundry list of options for the Eurozone and all of them looked practically daunting.

The ECB can continue to fund the crisis countries by printing Euro. It would get the ECB in conflict with the (true but unstated) agenda of the Federal Reserve to cheapen the US dollar. Germans might be up in arms. The ECB itself does not seem keen on doing it.

The other option is to go with the hair-cut (assuming a default is legally tolerated) on existing debt, devalue the Euro (feasible?) and announce plans to move to a very tight fiscal union (fiscal policy rights delegated and with automatic fiscal transfers in times of stress) in two to three years. Again, how feasible is it? Will crisis states give up the sovereign right to tax and spend? Will other European States be agreeable to fiscal transfers and even if they are willing, under what conditions would they be willing?

The third option is for Germany to leave the Eurozone. That would immediately devalue the Euro. The crisis countries can then declare default and enter into a restructuring negotation with creditors. Realistic?

Or, we have a core-Eurozone and a peripheral Eurozone. One day, they can merge again? Legal nightmare to bring that about?

Imposing more austerity is not going to restore confidence. [I shall have a separate post on ‘Expansionary austerity’. I was and am a believer of that but circumstances and context matter]. It has not resulted in interest rates falling and credit ratings improving for Greece. It has had the opposite effect. It is not credible because it is not workable. There is no light of ‘self-sustaining growth’ at the end of the austerity tunnel. Much lower costs – it means, much lower wages and standard of living – and a currency devaluation are needed to bring investors back. Is Greece ready? Are other crisis- affected nations ready?

Yes, the debtor nations can do asset sales. But, would it suffice? Will not the buyers know that the sellers are desperate and hence bargain to pay well below fair value for the assets? Will the public accept that?

The Eurozone debt situation is one of the many issues for which I do not have a feasible answer. If I may be permitted to guess, the eventual answer will be a restructuring of debt (technical default), tighter fiscal union and a weaker Euro, if Europeans  want to preserve the Euro. I wonder whether the Americans and the Chinese are keen on the Euro surviving.

(Postscript: The Roubini article appeared in the new ‘A-list’ that FT has launched. The full ‘A list’ of authors is here. The A-list series began with Larry Summers’ contribution and it has Glenn Hubbard of Columbia University and Jim O’ Neill of Goldman Sachs. Evidently, FT editors have not seen ‘Inside Job’ yet)

3 Responses to "Europe – Till Death Do Us Apart?"

  1. Blankfiend   June 14, 2011 at 11:05 pm

    I agree with your two options:
    1. ECB charter changes to make it more like the FED, able to finance national deficits.
    2. EFSF or ESM buys stressed debt and re-issues it as essentially a Eurozone bond.

    Option 1 would require Treaty changes, and ECB loss funding would come mostly from Germany. If another large player, like Spain, or Italy, was taken out of the contributor column, Germany would be in a tight spot.
    Option 2 leaves Germany in the same position, and may be challenged in Constitutional Court.
    Either of these options, if conducted without public support, are exactly the type of things that can radicalize populations if losses are actually realized. Think Boston Tea Party, or Hitler, for that matter.
    FT had an interesting piece today about how intertwined the banking systems of Bulgaria and Romania are to Greece. It will be interesting to see what happens in emerging Europe when Greece defaults.