Euro crisis: The Hollow Euro

Twice in the past century Germans have learnt, the hard way, the value of sound money. Between 1921 and 1923 the Weimar Republic, under the strain of massive WW1 reparations, fell into a hyper-inflationary death spiral. The Mark plunged in value, measured against Gold Standard Marks it fell from a ratio of 1:1 to 1:1 trillion in 2 years. After the German defeat in WW2, their economy was in tatters and the Reichsmark once again worthless. In 1948 Ludwig Erhard, influenced by Austrian School economics, instituted the new Deutsche Mark determined that it should be a sound store of value. During the early post-war period, until the establishment of the D-Mark as a successful currency, German citizens appreciated the value of attaining a hard currency such as Dollars or Sterling. They were the only currencies that could be used to purchase valuable imports. The only way to get hard foreign currencies? Hard work creating products and services for export!

The Germans built their Social Market Economy on solid foundations. The hard-as-nails Bundesbank safeguarded the value of German’s savings while their political class took whatever tough decisions needed to be taken to protect long term German living standards and public services. The Latin countries, on the other hand, often allowed their competitive position to deteriorate. For example Portuguese unit labour costs increased 20% vis-a-vis Germany over the last decade, and Greek unit labour costs increased a whopping 11.2% in Q4 2009 compared with a 0.5% drop in Germany.

This crisis pits the interests of the debt laden PIGS against those of the prudent Germans. Last weekend the Irish press howled with pain over percieved losses in economic sovereignty after the introduction of the new Eurozone bailout package and proposed oversight measures. Meanwhile, the German press worries that the ECB will be pressured into printing money unleashing inflation and lumbering them with a dreaded and feared weak currency. Writing in the Telegraph Ambrose Evans-Pritchard sums up the best options for the PIGS

There is a way out of this crisis, but it is not the policy of wage deflation imposed on Ireland, Greece, Portugal, and Spain, with Italy now also mulling an austerity package. This can only lead to a debt-deflation spiral. The IMF admits that Greeces public debt will rise to 150pc of GDP even after its squeeze, and that Spains budget deficit will still be 7.7pc of GDP in 2015.

The only viable policies short of breaking up EMU or imposing capital controls is to offset fiscal cuts with monetary stimulus for as long it takes. Will it happen, given the conflicting ideologies of Germany and Club Med? Probably not. The ECB denies that it is engaged in Fed-style quantitative easing, vowing to sterilise its bond purchases euro for euro. If they mean it, they must doom southern Europe to depression. No democracy will immolate itself on the altar of monetary union for long.

Similarly see David McWilliams’ urging the ECB to print money, and Constantin Gurdgiev here.

While German newspaper Der Spiegel bemoans the creation of debt transfer union and is very cognisent of pressure mounting on the ECB, in particular from the French, for measures that may generate high inflation, suggesting that Money Printing solution will not play well in Germany.

Still, the price for this bailout is high — possibly too high. The events on that dramatic weekend in Brussels marked the birth of a gigantic European transfer union, where previously unthinkable sums of money are made available to rescue southern euro-zone members. But over and above that, a number of determined politicians under the leadership of French President Nicolas Sarkozy have managed to undermine the independence of the European Central Bank (ECB).

Ever since the launch of the euro over 11 years ago, the French have been annoyed that the common currency generally adheres to German principles. While the French central bank is traditionally viewed as an executive organ of government growth and employment policies, the European Central Bank is politically independent and exclusively committed to the goal of achieving price stability, just like the Bundesbank in postwar West Germany.

Over the past few years, Paris has repeatedly tried to bring the European monetary authority to heel. French government representatives complained at times about interest rates that they felt were too high. At other times, they called for a devaluation of the euro to boost their own exports. Their requests were never granted. Until recently, the ECB enjoyed a reputation for combating inflation even more resolutely than the legendary guardians of the German mark.

All of that has changed since last week. Under the mounting pressure of waves of speculation against the euro, German Chancellor Angela Merkel has allowed herself to be talked into a bailout package that is nothing less than a general overhaul of the monetary union according to the agenda set by the French. In addition to letting the European Commission use the central bank to achieve its own aims, the Germans have accepted the fact that several monetary policy principles are being cast by the wayside. The central bankers are making their printing presses available to finance government loans. They have accepted that European countries are liable for the debts of individual states. They are putting more money in circulation, even though there is already so much liquidity on the markets that a number of experts anticipate that this will soon trigger a rise in inflation.

Now the guardians of the euro are purchasing government bonds from troubled countries like Greece, Spain and Ireland — thereby breaking a taboo that the ECB has always tried to respect. The central bank, which has always prided itself on its independence, has capitulated to the wishes of the politicians.

They note that Merkel is determined to get her man into the top spot at the ECB, but question whether or not the Euro can be saved.

If the German government has its way, Bundesbank President Axel Weber will be tasked with preventing the worse, as the successor to the current ECB president, Jean-Claude Trichet, who is due to retire next year. For the past few months, Merkel has been lobbying heads of state and government in Europe to pave the way for the German’s career jump. A week ago Sunday, Weber sided with the ECB’s chief economist, Jürgen Stark, and the president of the Dutch Central Bank, Nout Wellink, by voting against the purchase of government bonds from heavily indebted euro countries — but then had to defer to the majority.

Merkel appears confident that her plans will go through. After all, she has already arranged for Stark to become Weber’s successor as the new president of the Bundesbank. She recently asked Stark about the position and he agreed.

Should Merkel actually manage to push through her candidates next year, the ECB and the largest and most important of its member banks will be led by two staunch monetary hawks who see it as their primary goal to rein in inflation.

But can this actually succeed? And is it even possible to save the euro?

Update: – Another Der Spiegel article well worth reading The Dangers of the Euro Bailout

But the politicians didn’t do any of that. That’s why they — and not the financial markets — are responsible for the decline of the euro. They will also be responsible if the rescue package doesn’t hold and the euro breaks apart.

But the politicians have succeeded in achieving one goal: There won’t be any state bankruptcies in the euro zone in the future. How could there be? When in doubt, the ECB will just purchase government bonds. The money can’t run out, either — after all, the ECB prints it itself. The American and British central banks are already doing just that today.
But that doesn’t make the situation any better — it only makes it worse. A flood of money like that can’t continue without any consequences. The currency’s stability will be undermined and, sooner or later, inflation will ensue.