EURO EXPERIMENT: German Steel or Schmucks?

Currencies / Euro-Zone
May 21, 2010 - 11:56 AM

By: Gordon_T_Long

The European Crisis is proving to be more of an unraveling than a contagion.

I have long written that the European Monetary Union (EMU) constitution and Euro currency should be viewed in the context of a risky bet versus a sound regional monetary strategy. The odds of the EMU’s survival are presently reflected in a plunging Euro, despite a historic and unprecedented intervention. This indicates that the EMU’s existence in its current form is now a bad bet.

The good news is that this is becoming obvious and it suggests that the serious governance flaws of the 17 year Euro Experiment may finally be addressed. It took a crisis to see its first test, which has been the generally accepted view of when the euro experiment would prove its viability. The established momentum of the EU since its inception and its broad acceptance prove that its survival is presently a matter of European preference with most Eurozone members feeling it an absolute necessity. We’d therefore expect to see the EU constitution reformed. What should concern investors the most however is how the mechanics of what will be a ‘forced reform’ will unfold. The highly visible process will have profound implications to the stability of global financial markets and to a very tenuous global economic recovery.

I see the long standing philosophical difference between Germany and France to be at the core of this potentially very public resolution. During the recent behind closed door emergency bailout negotiations, these differences are reported to have come to the fore. Additionally, Frau Merkel and Monsieur Sarkozy are very different personalities. Will Frau Merkel show German Steel or as the German tabloid Bild proclaimed on news of the Euro bailout, become ‘schmucks’? Will Sarkozy the ever populist media hound prove to be a true diplomat or display what Germans perceive as insulting French arrogance? Unfortunately, the world must wait and watch while financial markets will no doubt fluctuate wildly on the uncertainty of the outcome.

What financial markets are oblivious to is just how crafty these two politicians are. There is more going on regarding a European strategy than the media once again fails to recognize.

For the accompanying slide presentation see: Tipping Points - Commentary http://lcmgroupe.home.comcast.net/~lcmg ... entary.htm

WHY THE EURO EXPERIMENT IS FLAWED

The core issues with the Euro Experiment which need to be resolved are about a workable governance structure. They can be summarized as follows:

There is no effective policing of sovereign fiscal authority.

There are no sovereign penalties for failing to adhere to the “Eurozone Stability and Growth Pact“

A single currency does not allow a standard depreciating currency option with which to resolve a sovereign growth or productivity failure without forcing a devastating sovereign economic austerity shock.

There is no ability to effectively coordinate Monetary and Fiscal Policy initiatives during a financial crisis.

The ECB is not empowered to monetize national sovereign debt. It is specifically constitutionally banned from doing so.

The International Herald Tribune outlines the issue as follows: http://www.nytimes.com/2010/05/08/world ... urope.html

Europe’s consistent inability to move quickly enough to get ahead of the financial markets during the Greece crisis is shaking the euro and the foundations of the European Union itself, as critics of the euro have long predicted would happen. The question being raised with increasing urgency is whether the European Union can fashion a mechanism to speed decision-making before irreversible damage is done and the euro itself slips into history.

The delays are inevitable, most experts say, stemming from the nature of the European Union and its own institutional voids:

1 - No single government,

2 - No single treasury

3 - No effective fiscal coordination

4 - No mechanism for crisis management

Every major decision on the euro must be negotiated among member states and European institutions, a torturous process that also plays up political fissures both within and among member countries. That breeds uncertainty and even panic among investors, who already doubt that the Greek deal that the European leaders finally sealed on Friday night will forestall an eventual restructuring of Athens’ crippling debt.

“The European Union is running behind events,â€