18 November 2011

A Shot Gun Wedding

The Euro-zone is a tragedy. There is no automatic mechanism for adjusting the relative competitiveness of its members and no mechanism to compensate for this gap by recycling surpluses from one part of the Euro-zone to another.

And so the sovereign debt crisis refuses to go away. There is no more road to kick the can down. The Euro-zone will either quickly move to a political fiscal union backed by Eurobonds or disintegrate. Euro Leaders are loading their shot-guns.

There is no exchange rate to restore competitiveness and the absence of any sense of 'community' is resulting in the removal of democracy and the brutal repression of wages of citizens unfortunate enough to be living in the Euro-zone's periphery.  Uneven competitiveness produced trading account surpluses in the core economies and were matched by trading deficits in the periphery. It is this internal trading imbalance, or fault-line, that splits the Euro-zone and continues to shake its financial institutions to the ground. After a wasting two years in taxpayer financed 'theological' debate on sinning, the crisis will be resolved in a short period of time by separation or by the complete removal of sovereignty.

A Failed Romance.

This failure is a story of unresolved differences in the relative competitiveness of Euro-zone members, and one re-told by Breaking Up? A Route Out of The Eurozone Crisis (C. Lapavitsas et.al. RMF Occasional report 3 Nov 211). The three graphs below, taken from this report, capture the story.

Germany's competitive advantage in the Euro-zone did not result from gains in productivity but rather from applying severe wage restraint on German workers.

Wage restraint on German Workers gave Germany a competitive advantage over its Euro partners 

This graphs indicates a weakness in German productivity. Even Ireland and Greece performed better. 

German competitive advantage in the Euro-zone produced trading surpluses from across the Eurozone. Competitive disadvantage, particularly for Greece, appears in the periphery's trading deficits. Austerity has closed the gap in competitiveness by harshly reducing in wages in the periphery.
Trading account imbalance between members: how was this financed? 

The sovereign debt crisis emerges from how these trading imbalances were financed. While ECB kept interest rates low, Euro core banks, particularly French and German banks, maintained the financing. Lending jumped again after the 2008 Lehman collapse. The assumption that sovereigns would not be allowed to default (moral hazard) increased the over-exposure of these banks. 

Banks in the periphery also had access to cheap funds to expand their assets. Cheap credit fueled an illusion of high GDP growth rates in trading deficit countries (particularly Greece). The crisis of 2007 exposed the illusion, laying bare the divergence in competitiveness. Periphery countries found themselves heavily in debt and in Greece a large amount of this public debt was now owned by foreign lenders

The 2008 Lehman collapse was a shock to all parts of the Eurozone as exports and investment fell. The recession induced both automatic increases in government expenditure (e.g unemployment benefits) and falling tax revenues, which in turn increased Government deficits. Rescuing private sector banks from the impact of the Lehman's collapse, increased the deficit further. 

The financing of increasing budget deficits increased the growth sovereign debts in the periphery. When it became clear that the core economies, mainly Germany, would not take any responsible for theses debts, the sovereign debt crisis switched from a liquidity to a solvency crisis. Individual debtor economies no longer had the ability or growth to support such large debts.  Austerity measures reduced the ability to pay back debts even further.  The core economies instead focused on only the effects a default on an economy's sovereign debts would have on their own banks - the very banks that had become over exposed by taking advantage of the common currency. The welfare of the periphery economies was secondary to the goal of protecting the Euro and the banking system that sat on it. 

The euro project had failed to achieve any real convergence between its economies. But like a scandal, It is the cover-up that does a great deal of of the damage. Differences in the euro-zone economies, in terms of human, capital and physical resources, were left exposed without an counteracting mechanism to replace exchanges rates. Instead, the Euro-zone economies diverged whilst cheap credit and the Euro banking system financed the illusion.  In the case of an inefficient small economy like Greece, the lack of internal competition (localized monopolistic and cartels) translated into a higher rate of inflation than the core Euro-zone economies. The inflation rate hides another further distortion - relative price changes.  Since the introduction of the Euro, the costs of basics (food, fuel, rents, mortgage payments, etc) increased sharply while many "luxury" items (TVs, cars, electronics,etc) fell . There is no mechanism to fix this. It also means that the poverty wage line has increased. 

FISTal consolidation:  the beating of an economy into shape.  Any shape will do, but it must submit

Due to the changers in relative prices in basics to luxuries, forcing Greece go back to 2001 wage levels will create third world poverty conditions and political instability. By blaming sovereign debt on sovereign states, treating the symptom and ignoring the cause of the crisis, Euro leaders are playing a dangerous blame game encouraging nationalism and racism whilst exploiting the fear of financial instability to place the Euro-zone under an un-elected centralized authority. The secret hope is that European voters will welcome this as an alternative to austerity. National government will applied the stick and the fiscal authority may promise some goodies.

In the meantime, Euro Leaders are loading their shot-guns to forced member states to appear at a new 'Lisbon' marriage ceremony. Divorce is not in the statue book.


The Golden Wig Award

The Golden Wig award this year goes to Herman Van Rompey for his uncanny Woody Woodpecker impersonation in..

But who cuts the hair of the Barber of Seville?

And finally ...  how does one measure success?  

According to the new Technocrat Italian PM Monti  "What we're witnessing today is GREAT SUCCESS of Euro and the most concrete demonstration of that SUCCESS is Greece"

"I'm hungry" - The real face of Greece's bailout deal

Less hope for less success.

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