Regular readers know that I think the Euro currency system is highly flawed and unlikely to withstand the test of time. And the more I think about the problems in Greece the worse I think the situation really is. I think bailout fever here in the states will have damaging long-term repercussions, but that is nothing in comparison to what the Greek bailout could result in. There’s no denying that the EU rescue package was likely necessary, but does little to resolve the structural problems in Europe. The problem remains – the currency structure is highly flawed in that it unjustly punishes trade deficit nations. A country like Greece has no choice but to turn to Germany every time a fiscal problem unfolds. The fact that the Greek government does not have the internal banking tools to properly serve their own citizens is ludicrous.
Marshall Auerback at New Deal 2.0 recently had some excellent thoughts on why he believes Greece is the equivalent of Bear Stearns (and not Lehman):
“Although we have hitherto characterized Greece as the EMU’s “Lehman” problem, the rescue package announced on Monday makes us that think that the better parallel for Greece might well be Bear Stearns. Bear’s “rescue” in March 2008, initially looked like it enabled the global financial markets to avert a growing crisis in the asset backed securities markets. What it did in reality was kick the can down the road, as the underlying structural problems which created the crisis in the first place remained unresolved. The credit crisis that began in August 2007 involved failure of both the liquidity and the solvency risk systems. The consequent freeze-up arose because the subsequent bankruptcy of Lehman and collapse of AIG destroyed the markets’ expectations (built up by years of bailouts) of their being an ultimate market maker, which would always be able to deal in these securitized instruments.”
Morgan Stanley recently raised the same concerns calling the EU/IMF bailout package a “pyrrhic victory”. As they noted, none of the larger structural issues have been resolved and the likelihood for further bailouts, contagion and inflation is highly likely as several other countries are in precarious debt situations as well:
“The bail-out and the ECB’s softer collateral stance set a bad precedent for other euro area member states and make it more likely that the euro area degenerates into a zone of fiscal profligacy, currency weakness and higher inflationary pressures over time. If so, countries with a high preference for price stability, such as Germany, might conclude that they would be better off with a harder but smaller currency union. And because the Maastricht Treaty does not provide for the possibility of expelling euro area members, the only way how Germany could achieve this would be by leaving the euro to introduce a stronger currency.”
MS says the risk of a break-up is greatly increased and largely being ignored by the markets:
“the risk that it happens is far from negligible and the consequences for financial markets would be very severe. Hence, investors ignore the euro break-up risk at their own peril.”
The latest news is that Germany is not entirely behind the bailout and is greatly concerned about the long-term repercussions. They are right to be concerned. Being a trade surplus nation and the strongest economy in Europe they are now realizing that they gain little from the Euro currency as it is currently structured. MS elaborates:
“countries with a high preference for price stability, such as Germany, might conclude that they would be better off with a harder but smaller currency union. And because the Maastricht Treaty does not provide for the possibility of expelling euro area members, the only way how Germany could achieve this would be by leaving the euro to introduce a stronger currency.”
I think a break-up is not only inevitable, but would actually be a long-term benefit for the entire region. We are seeing exactly why the convertible currency system has failed time and time again throughout history. The inherent restrictions in times of war or financial distress are simply too great. In addition, Europe will never be the United States. There is simply too much history to truly ever unify these nations as the States in America are United.
What would be the catalyst for such a break-up? Most likely a highly traumatic event such as a Lehman Brothers bankruptcy. So now the question remains; who gets to play the role of Lehman Brothers and when will it occur?
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.