Europe’s crisis has gone nuclear. For readers of this column, the endgame in Europe, which is likely to be a currency break-up, hardly comes as news. But the event itself will be traumatic for all of us. The most likely scenario is some sort of two-tier eurozone, where the euro breaks into a strong and weak euro. And yes, you guessed it: we will be in the weak camp.
The euro simply can’t go on as is. Even fiscal union (which would be a disaster for us, because our corporate tax rate would be the first thing to go) can’t help what is now a currency in its death throes.
The reason the euro is likely to be consigned to history is simple. As argued here for years, the currency is a profoundly destabilising influence because it amplifies credit booms and exacerbates normal recessions.
To examine this dilemma, let’s go back to first principles about how economic systems are supposed to work.
The most basic attribute of an economic system is that, when working properly, it smoothes the business cycle. The business cycle is a normal thing. When things are going well, human nature is such that we think that this will go on forever, so we become recklessly confident.
This causes us to do stupid things, like buying too much property at the top of the cycle and borrowing too much to finance this effervescence. This is a mistake.
In contrast, when things are going badly, human nature becomes too pessimistic and believes that the economy will never recover. We therefore sell too much in the downturn at whatever price we can get and, if we can’t find a buyer, we let prices fall further. We stop spending and save too much because we can’t see an end to the downturn. This, too, is a mistake.
The role of wise economic policy is to control these wild human emotions. When things are getting too hot, economic policy should cool things down and, when things are getting too cold, it should warm things up. Unfortunately, the euro does the opposite.
We all know what happened here in the boom. Too much credit fuelled too much optimism and more than a little bit of added local financial criminality, leading to disaster. But let’s not go over that again; let’s focus on what is happening right now.
In ‘normal’ economics – the economics you would learn in school or university – the rate of interest should fall when a country goes into recession. If a country has its own currency, there is no default risk premium. So lower activity leads to a lower demand for credit and a lower interest rate.
The fall in the rate of interest allows those in debt to pay their debts at a lower rate to reflect the lower income they have suffered as a result of the recession.
Conversely, there are those who didn’t take out debt and see the new economic paradigm as an opportunity. They can therefore borrow at lower interest rates. They take a new risk, borrow money, re-invest it in the economy and the economy begins to recover.
This is how things work in the US and Britain because they have their own currency. American and British long-term interest rates have never been lower because the system works and everyone knows that lower interest rates are necessary when the economies are in such a precarious position.
In contrast, within the euro, this ‘smoothing’ mechanism doesn’t work. This is because the euro is a ‘foreign’ currency for everyone. For Germans, the euro is too Italian, and for Italians the euro is too German.
Therefore, there are perceived risks everywhere. Money leaves Italy in a slum and gets sucked into Germany because the very foreignness of the currency makes investors feel safe only in Germany rather than Italy, which is actually using a foreign currency that it can’t print.
Therefore, ‘normal’ economics breaks down in the euro and is replaced with a perversion of traditional economics. Far from falling in a recession, the rate of interest actually and counter-intuitively rises in a recession, making things worse and eventually threatening a melt-down. Think about what happened here last year. As the economy slowed down, the rate of interest charged on Irish assets increased, rather than decreased. This is ludicrous.
Think of Italy in the past few weeks. As the Italian economy slowed down, the rate of interest at which the Italian government could borrow went up, not down.
This creates an enormous liquidity problem. As the rate of interest on Italian government bonds goes up, the price – and thus the value – of Italian government bonds goes down.
But who holds Italian government bonds? Why, Italian banks do. This means that the value of the Italian banks’ portfolio goes down as the price of the bonds fall.
Does this make them more likely to lend? Of course not, as they are now in a position where their balance sheet is weaker than before. What do banks with weaker balance sheets do? Do they lend? Of course not, they try to get money in rather than give money out. So they stop lending.
What does this do to the economy? If there is less lending, it makes the economy contract even more.
So the rate of interest in the euro – outside Germany – behaves in precisely the wrong way. This economic perversion, is made all the more problematic by the policy reaction of the mainstream EU economists.
In the face of the downturn where people are saving and not spending, and the rate of interest is rising not falling, the fools at the EU say that the answer is that the government should raise taxes and cut expenditure. But this means that the economy will contract more.
What do you think happens when the government reacts to a slowing economy by raising taxes? Obviously, the economy slows more. In Italy, to take the most current example, this increases the risk on Italian assets – and Italian interest rates rise more. How dumb is that?
Thus, unlike the US or Britain (or Japan in its 1990s crisis) interest rates in the peripheral countries of the eurozone rise in a recession.
This obviously means that the euro is a perversion when it comes to the ‘normal’ functioning of economic policy. Its inconsistencies make the problem worse. All this makes the break-up of the euro probable, because it is a destabilising influence.
In good times, the euro ensues that too much money flows into growing countries, pushing good, sustainable growth into dangerous boom territory. In contrast, in a recession, too much money leaves countries because investors believe that the country won’t be able to pay its debts. This makes a bad situation worse and drives recession to depression.
So what happens next? A two-speed euro is the most probable outcome now, where we and the rest of the periphery join a weaker, ‘soft’ euro currency, while the core remains in the ‘hard’ euro.
For the likes of the French, they had better drive this forward quickly because, the longer they wait, the more likely it is that France will join us in the ‘soft’ euro and that would be a political disaster for the euro federalist fetishists in Paris.
In reality, the political irony is that a two-speed Europe will not be instituted to save Italy, Greece, Ireland or Spain, but to save France. Plus ça change, plus c’est la meme chose.
Will the two-speed Euro happen if Germany is not as strong as perceived? Deutsche and Commerzbank shares have fallen. A toxic bank may be required for Commerzbank loans, Deutsche is selling assets to gain capiyal [recognise a pattern here?] Apologists for the poor performance of Deu bond sales maintain that tis is because of the low rate of interest. Markets are rapping Merkel, Schaeuble and Roessler on the knuckles over stability bonds and issuing conflicting statements through the media. I am not sure what’s on the playlist for this week’s round between Bank and Politic in the EU but I’d… Read more »
WHAT CAUSED THE FAMINE?
CROPS WERE EXPORTED. FETCH HIGHER PRICES ABROAD.
COLONIZED = NO TARIFFS AND CONTROL -> FREE MARKET
TODAYs DEBT = OLD PEONAGE -> NO WAY TO ESCAPE.
NO NATION CONTROL OVER CURRENCY -> MUST GO INTO DEBT TO BANKS TO GET MONEY.
CENTRAL BANKS-> BANK OF INTERNATIONAL SETTLEMENTS.
MARKET CONTROLLED CURRENCY. MARKET = LENDER -> SETS RATES TO BORROW AT.
GLOBAL SUPER RICH LEND TO & PROFIT FROM MORE DEBT.
SPOT THE DIFFERENCE.
What bothers me most is that no matter how rational you are in your estimate of what’ll happen next, precisely the opposite happens – and if you decide to take a more histrionic stance, guess what?, reality rewards you by proving you to be correct. We are looking at systems way outside their steady state conditions, yet the people who are trying to control it are still using the same steady state rules for corrective feedback. This is basic control theory in action. A time comes when you must re-assess the system to see what the new rules are. The… Read more »
Excellent synopsis of the performance of the ECB and how the ECB and the EU have got it so badly wrong. It also correctly points out that the demands to France are what will determine the timing of what will occur. Sarkozy’s current poll ratings in France are at Brian Cowen levels of satisfaction. The British media are providing us with details of the case that exists, to prove that DSK was set up in the chambermaid episode. If I were Francois Hollande (the presumed Socialist Party French Presidential candidate) then I would be extremely careful. Because he is already… Read more »
1. CALL FOR THE IMMEDIATE RESIGNATION OF PAUL APPLEBY! 2. ENORMOUS SOCIAL INJUSTICE 22 months ago, in January 2009 the Office of the Director of Corporate Enforcement (ODCE) Paul Appleby started investigations into Anglo Irish Bank matters. Incredible events took place since this started, highlights such as top ranking Bank officials refusing to hand over passwords, or Anglo bosses claiming privilege over certain documents, might still be remembered in the public sphere. What might have slipped the public is Mr Appleby’s remarkable statement from 29th May 2010: Appleby said there was now a “note of realism” about how long it… Read more »
In his series, concerning Financial history, the Scottish historian Niall Ferguson, stated that at the end of everything, it all depends on the bond market.
In fact everything depends on the bond market.
There is a theory that the bond market will snap, and the price of precious metals, and oil will rocket.
I think the term “endgame” is interesting – because that is what matters.
And therefore we need to plan accordingly.
Deco, you are on the right track, as even the countries that can print their own currency are facing renewed recession and higher than normal inflation. Think stagflation, think 1974 – 1984, regardless of the inept Euro policy response. What broke stagflation then was a forced backlash against vested interest unions, who were rightly trying to protect their members’ interests but couldn’t see that the harder they fought the more they reduced the size of the available ‘cake’. This time, it’s not the unions but the financial industry. QE was a massive bailout and little of it came out the… Read more »
The article is very clear on what is happening but not the why. How can Europe succeed with commom fisacl and monetary policies for counries with such a diverse range of economic issues. Ireland over borrowed, making private debt public and just plain bad at government leading to budget deficits. Greece with over half the world’s shipping but no proper tax system and lousy at government. Germany highly efficient now, big surpluses but but given a lot of help in the past in rebuilding its economy and infrastructure etc etc. It is so easy for the self serving markets to… Read more »
Charlemagne Empire Encore
( France & Germany )
Yes ,these twins are inseperable and so are Sarkozy and Merkel .They have chemistry on and off the stage .They hold and sweat and they laugh .Their X-Factor has no comparison.
Maybe the dynasties of the Hapsburg and Bourbon should find solace together with Austria thrown in for spice.
I have some savings in a Euro account with a Bank in the Isle of Man. What will happen to these in the event of a two tier Euro? Which tier will these savings go in to?
OT Deco I think you mentioned recently that some have expressed doubts about David Kelly’s suicide – was it murder etc? This site (Richard Webster: Sceptical Essays), which I stumbled across while looking for something else, has a lot of sense: http://www.richardwebster.net/riseofaconspiracytheory.html He’s very good on modern witch hunts in general, with a shocking story about the Casa Pia case in Portugal. http://www.richardwebster.net/casa-pia-carlos-cruz-reporterX.html He made mention of our own Irish versions in recent years (I say ‘made’ not ‘makes’ as he died recently) although there is of course a bit more context to al these cases than simply the mass… Read more »
I really wish Comical Ali had Oli Rein’s job. Atleast if he walked out and had to say stupid things like “I can’t see the euro failing” he would do so and be funny.
God I miss that guy.
Here is a link to his quotes:
http://www.welovetheiraqiinformationminister.com/#quotes
The Euro was essentially conceived as a tool of European integration. What we are going through now is a necessary part of the convergence that a real and worthwhile federal states of Europe requires. The different states of the US manage with the one currency. There is no reason why we should not either. We started European integration, we should finish it. It is worth doing. Either the countries of the EU live up to the combined character of the Euro, or not. For our own country’s part, we would have NO problem living up to the strength of the… Read more »
subscribe.
The first thing I notice about the article is every second paragraph interchanges “economy” and “currency” as if they were the same. This is standard economics 101 and the reason for the mess. This is monetarism run wild, and why even well meaning politicians simply fall over their own shadow, their arguments trailing off with truthiness as they begin to see the hopeless vacuum of economics as preached by London School of Economics, Keynes, Friedman, Mises, Hayek or almost any other “guru”. If the article was rewritten with a clear intention to split economy from money, it would be very… Read more »
First of all interest rates are going down as the core are heading for recession. Ireland is insignificant and we only think about ourselves , there may well be a new PIIGS currency sometime in the future but I doubt it ….it will be back to the punt for us because what have we got in common with Italy, Spain, Portugal or Greece . I think David has got this one wrong , it will be a punt pegged to the Euro. This would not be the end of the world domestically as we would still be faced with the… Read more »
Suspicious that our futures are not already plotted. This “state of the nation” on Friday is highly suspect. Is he is going to tell us we are in the German union and Angela will be doing our budgets for the forseeable future. Lets face it its all about Germany not taking a hit, end of. Youve got one pissed off Kraut in this woman and I dont blame her frankley but WTF does that have to do with me? I am extremely wary of Friday nite as I have the feeling it is being shoved down our throats like it… Read more »
Near 0% interest in the UK and America is for the banksters benefit. Free money for them to speculate, and create endless trouble for ordinary people
If 1 euro currency wasn’t bad enough, now you tell us there will be 2.
An eternity in hell awaits those who support the policies of the new world order. Federalist Totalitarian government and stealing money and liberty from people.
Euro currency was the currency that was touted by the political class in Ireland and elsewhere as the answer to boom and bust cycles and was presented in such a way to the gullible public at large.During the last recession in the 1980’s Ireland’s interest rate was in reality at Minus 1% between 1998 until we joined the Euro currency like its earlier version the ERM proving to be useless.Ireland again has a generation of deflation,mass emigration to look forward to. Franco German control over all our affairs is scary now with more intrusive external control not only in Ireland… Read more »
The Euro is indeed a perversion, to quote the article : “Therefore, ‘normal’ economics breaks down in the euro and is replaced with a perversion of traditional economics”. and… “This economic perversion, is made all the more problematic by the policy reaction of the mainstream EU economists”. and… “This obviously means that the euro is a perversion when it comes to the ‘normal’ functioning of economic policy”. But notice how the implied, and stated perversion is economic. This is very unsatisfactory and must be remedied. It cannot simply be swept under the carpet. The Euro is a perversion because its… Read more »
WARNING MOON WOBBLE
Commencement begins on Wednesday and to PEAK on 12th December.
There’ll be no 2 speed europe or anything like it. The political leadership is not even there to make that happen. This will turn into a massive splash and it wont be 3.8bn for an adjustment…it’ll be 17bn in 2012.
The entire system is smashed. SKF group in Sweden are noticing a major falloff in ball bearing demand and these guys supply the bulk of them.
Going by Die Welt and Le Monde today, Merkel and Sarkozy have no chance of another or different union. The poison of the Euro is deadly, and even these 2 economic partners, the real motor of Europe, are in a pre-industrial tantrum.
The euro is indeed damaging the physical economy, and for sure some have noticed, and have clear heads on what this means.
Obutail We need to understand what is the meaning of this important word especially when we mark the first anniversary of the event today. The tail is the end of a living organism and furthest from the head as was the case in Ireland.The length of the tail signifies the distance from the head . Obu stem has its meaning to signify a musical instrument .In this case it is a wind instrument and the tail moves when it is played . The significance of the head moving to the melody of the ‘wind instrument’ indicates that a conspiracy was… Read more »
My greatest fear in the immediate aftermath of fragmentation of the Eurozone is that Border zones in Ireland, Belgium, Austria, Germany, France and Spain will be ungovernable, becoming a “Wild West” of drug smugglers, gun-runners, currency speculators and profiteers. When a few incidents escalate we could be back in a ’30-year war’ scenario.
Looking on the ‘bright’ side, unemployment will be greatly reduced as there will be widespread demand for mercenaries, gardae, security guards, close protection enforcers, customs officers, coast guards, debt collectors, stool pigeons etc., –all paid cash in hand.
Public servants and immigrants take note.
So what happens with an introduction of a softer euro ? Does this mean the Irish have to concede to a devaluation of their currency (approx 30%)???
If this happens how does it logistically /physically take place ???
What does it mean on a day to day basis for everyone ??? What things change … please elaborate …. without hysteria attached LOL Tx
The EU FRONTEX force has already a Limes (Roman boundary), in good old Roman style, with “camps” for refugees.
Ireland which never had the Roman empire, has difficulty appreciating the admiration for that pest in EU and British circles. The effort and cost gone into rebuilding the old ruins is stunning. I expect they will offer the infamous Mithra alters for public use, again.
Add to FRONTEX, now, compliant officers in Athens, a NATO officer Italian Defense Minister and it looks like they are preparing for nasty, ehem, regrettable action, what?
Yesterday , a senior Polish Minister pleaded with Merkel and the Deutsch Volke for the Germans ‘to act’. He said he did not fear ‘their activity’ but did fear’ their inactivity’. These words are revealing a powerful message that have not been quantified and analysed properly. I do not believe that an active German policy is less feared than an inactive one. I believe this Polish minister was attempting to sway the Germans to relieve the ongoing Damage in Europe in general because the existing complete economic mechanism favoured them. Lets think about it .If the existing inactive mechanism is… Read more »
Global Glass-Steagall, Now! This from FOIA, Bloomberg : Bloomberg yesterday revealed some of their findings from 29,000 pages of documents, covering 21,000 transactions, revealed by the FED under FOIA, blocked for two years. Concurrent with the $700 billion Troubled Asset Relief Program (TARP) program, approved by Congress in September 2008, and run by the U.S. Treasury Department, the FED ran a separate, {secret}, program which ran up to TEN TIMES that amount, eventually totalling over $7.77 TRILLIONS, by March 2009. On the single, “neediest” day, December 5, 2008, bank borrowing from the FED topped $1.2 TRILLION in a 24-hour period.… Read more »
A host of hysterical end-of-the-world cries for hyperinflation all over press, only a paragraph here : ‘Humanitarian Corridors’ for Brits Should Eurozone Collapse? Stoking fears that a Eurozone collapse could lead to Armageddon, the British Foreign Office is drafting contingency plans to aid British nationals trapped in the collapsing edifice of the Eurozone. The DT, citing unnamed Foreign Office sources, says the contingency plans would have to deal with British travelers’ inability to access cash, and also the dangers of “riots and social unrest.” DT’s AEP quotes Myron Scholes suggesting the FED will buy up Euro debt, which ECB cannot… Read more »
Greek Statistical Agency Head Accused of Treason The head of the Greek Statistical Agency (Elstat), appointed by European Commission and IMF, has been accused of treason and is currently under investigation by a Greek prosecutor. Elstat head Andreas Georgiou, a former IMF official, stands accused of falsifying the Greek deficit upwards for 2009 from the official 13.4% to 15.8%. The new figure in effect forced Greece into the bailout. If convicted, he could face a life sentence for treason for “betraying the country’s interest.” The decision to investigate follows a complaint by a former Elstat member, who was dismissed by… Read more »
This blog is turning into a site for conspiracy theorists, nutjobs and extremists. Might be time for me to check out.
Adam Btrne: I totally agree that many of the comments here are over the top. The reality is that people are afraid. They have every reason to be afraid as we have recent experience of an ethnic social breakdown on this island. I too have considered withdrawal from the DMcW scene but have decided to stick with it for the time being, as it seems better to have crackpots out in the open, where their opinions can be tolerated, refuted or ridiculed, than lurking in the shadows where they might infiltrate a political party as fifth columnists and become a… Read more »
Afternoon,
I would hate to lose some of our most informed contributors, so lets not fall out. I agree that people are scared and angry and that is why all sorts of ideas take hold.
Best,
David
DMcW,
Thank you for the calm words.
No need for anyone to leave this lively blog, even when sparks fly.
Keep up the good work.
Bonbon.
When Normal Economics Break Down
Least we forget the above is the caption of this article so that is the subject to write about here .All Political Leaders are repeating in past few days the endgame and all are frightened .So must we.
->PEOPLE
IF SOME OFFEND YOUR CULTURAL IDENTITY & POLITICAL BELIEFS
WHY NOT USE FACTS OR LOGIC TO REFUTE? WE ARE NOT BABIES.
AND WE CAN ALL USE A SEARCH ENGINE…
NOBODY CAN SAY THEY KNOW EVERYTHING.
THE BLOG IMPROVES WITH TRUTH -> NOT HURT EGOS
AD HOMINEM IS A FRAUD
http://plover.net/~bonds/adhominem.html
I agree with John some very credible people who don’t seem to be extremists or nutjobs are definitely very worried. Everyone seems to be looking to someone else to sort it out. What we do know for sure is that there is too much of an imbalance in the wealth distribution in the world. We know countries and citizens willingly over borrowed. We know banks willingly over lent. We know the system has tried to fix this by protecting the lenders first and foremost and in doing so furthered the imbalance of wealth distribution. We know the markets which were… Read more »
The extremists are those who put $80 billion and rising on the working people’s backs. Who want to print trillion of worthless paper, now, to save their fellow extremists. If one says they should go to jail for treason, who is the extremist then? Glass-Steagall is a clear-headed rational and effective response to a massive murderous injustice perpetrated by calm well dressed extremists like Monti, Papademos, Cowan, Lenihan. This is not a rage response, that is why it will work. It is also not some magic bullet pulled out of a hat at some circus. It has a proven record,… Read more »
State of The Nation Address We are led to believe that our national leader is commencing delivering the above on Friday night .We expect his words to be heart warming and convincing and that as a leader he is doing all in his capacity ‘to fix’ what the previous government ‘damaged’. This propaganda exercise puppeteered in front of a national audience has the blessing of Merkel & Sarkozy .Mr Kenny is a debased politician now just like the currency our Central Bank issued and as such his words are without clothing to show. His choice of timing to make this… Read more »
I wonder will he propose the referendum that he threatened Merkozy with, when they demand Treaty changes?
Would I be correct in estimating FG/Labour’s chances in any referendum or election as being dismal?
Fear was used to push through the Lisbon II the second time. More fear can be applied to squeeze even more out of people. “Financial Armageddon” if we do not print?
It is clear who wins in all this – Sinn Fein, not afraid.
The most likely effect of strengthening political union in the eurozone would be to give Germany the power to control the other members’ budgets and prescribe changes in their taxes and spending. This formal transfer of sovereignty would only increase the tensions and conflicts that already exist between Germany and other EU countries. – Martin Feldstein –
http://www.project-syndicate.org/commentary/feldstein42/English
Afternoon,
I have been watching what is playing out and talking to alot of people I trust and I can sincerely say that we are watching the debt house of cards crumbling, not just in Europe but all over the world.
Watch for Japan next (debt ratio of 200%) and then the big one USA which will need to refinance 40% of its totaly debt in the next 18months.
Best,
David
A must see : the cartoon on this now, The miraculous multiplication of money, just as Geithner, Barosso et all. demand.
http://www.handelsblatt.com/
Imagine Geithner’s face when some Obama aide pushes this note to his desk.
Just in case they pull it from the web, its a donkey, well, producing golden coins.
Wonderful insult!
So that house of cards crumbles even after the massive secret bailout that Bloomberg reported (posted above). The bailouts did not and could not save the system, so the entire unmerciful punishment on ordinary people is to no avail. When this intensifies, and it will, as DMcW rightly just pointed out, the entire reality will change – what people thought they could never do, suddenly becomes possible. Of course the other side, those most threatened by this will drop all limits on any action they will unleash. So it is extremely dangerous, and at the same time a huge opportunity… Read more »
What will happen to foreign currency accounts held with Irish banks if the Euro breaks up? We do a lot of business with the US and hold in Dollar account with BOI.
Next suggestion to come to your screens….
ECB to lend to IMF, this is the ultimate nightmare scenario!
Just in case… I know I posted it two times already since I am here, but there might be still some people around who did not see this and who still are puzzled as to how we came here, everyone can understand this, no financial latin or habilitation in economics required.
http://crisisofcredit.com/
“In reality, the political irony is that a two-speed Europe will not be instituted to save Italy, Greece, Ireland or Spain, but to save France. Plus ça change, plus c’est la meme chose.”
Looks like the Brits were right to be suspicious of the French over the last few centuries.
I say we (All except France & Germany) should divorce ourselves from “MERKOZY” and wipe the “SARKY SMERKAL” of their faces. “The waters might be MERKY and full of ShARKS but no-ones sitting COZY”
Just transfered all my pocket money from Permo to Barclays , Sterling idea???? hope so