Southern Europe Debt Crisis, Economies Teetering on Brink

Southern Europe Debt Crisis, Economies Teetering in the Brink of New Recession

Economics / Global Debt Crisis Feb 10, 2010 - 09:32 AM
By: Gary_North

The euro is the focus of attention these days. This is because of a fiscal crisis in Greece, and looming crises in Portugal and Spain. Italy could follow.

What is the problem? Greece is running a huge deficit in the range of 12.7% of its Gross Domestic Product. The investment world regards a deficit of this magnitude as unsustainable. There are rumors of default.

Spain is running a deficit of 11.4% of its GDP. This is considered a threat to the nation's financial structure. There are rumors of default. http://www.cnbc.com/id/35143132

The United States government is expected to run a deficit of $1.6 trillion in an economy with about $14 trillion GDP. This means the deficit will be about 11.4% of GDP. Of course, this is seen by American economists as all right. After all, the United States is not Spain. Treasury Secretary Geithner assured the viewers on ABC News http://blogs.abcnews.com/politicalpunch ... ating.html on Sunday, February 8, that there is no possibility that the rating on U.S. Treasury debt will ever fall below AAA. "That will never happen in this country." Unfortunately, he neglected to say whether it could happen in other countries, whose credit-rating agencies are not regulated by the United States government.

The euro is officially issued by the European Central Bank. This central bank acts on behalf of all 16 European nations that are part of the European Monetary Union. Non-members are Great Britain and Switzerland.

This system is now an aspect of the European Union, which has been in existence since December 1, 2009, when the Lisbon Treaty went into effect. Yet the legislatures of each of the member states of the EMU have independent fiscal policies. They do not control monetary policy, but they control taxes and spending.

Always before, monetary affairs have been conducted by central banks that represent central governments. The euro is an experiment in a central bank that officially operates on behalf of 16 nations.

FRIEDMAN ON THE EURO

In 2005, Milton Friedman commented on the problem facing the euro and Western Europe. http://macroblog.typepad.com/macroblog/ ... 0Aman.html

The euro is going to be a big source of problems, not a source of help. The euro has no precedent. To the best of my knowledge, there has never been a monetary union, putting out a fiat currency, composed of independent states.

There have been unions based on gold or silver, but not on fiat money – money tempted to inflate – put out by politically independent entities. (New Perspectives, Spring 2005).

His admission that there have been unions based on gold was significant. He did not pursue this, because he rejected the gold standard. He made his reputation as a monetary theorist for his opposition to a gold standard. He was a faithful disciple of the American theorist who was most adamantly opposed to the gold standard, Irving Fisher. Friedman's monetary theories were an extension of Fisher's.

Fisher believed in fiat money unconnected to gold. So did Friedman. Fisher saw a stable price level as the primary monetary goal. So did Friedman. Fisher was willing to accept central banking in principle, because he believed that central banks are more reliable than legislatures. So did Friedman. Fisher never came up with a theory of civil government or economics that showed how central banks could be trusted with control over fiat money. Neither did Friedman.

Friedman believed in the free market, but not a free market in money. He did not believe in a full gold coin standard that is enforced only by the law of contracts. On this point, neither do defenders of a traditional, government-run, government-guaranteed gold standard. The question always arises: How can citizens prevent the government from cheating? What protects them from a government's decision to allow commercial banks and central banks from confiscating the depositors gold? So far, there has been no answer, other than the usual one: defeat at the next election. But, because the confiscations happen during emergencies – major wars, economic breakdowns – the public meekly consents. Always. Friedman offered this criticism of the present arrangement in Europe. In an interview during the boom phase of the economy in 2003, he said this. http://www.rightwingnews.com/interviews/friedman.php

What's going to make the difference is the productivity of the different countries. But personally, as I say, I believe the Euroland is going to run into big difficulties. That's because the different countries have different languages, limited mobility among them, and they're affected differently by external events.

Right now for example, Ireland and Spain are doing very well, but on the other hand Germany and France are doing very poorly. The question is; "Is the same monetary policy appropriate for all of them?" Germany and France on one hand and Ireland and Spain on the other: it's very dubious that it is. That's why you're having increasing difficulties within the Euroland group. As you probably know Sweden, which had not joined the European Monetary Union, voted down doing so and will keep its own currency.

He asked what he imagined was a rhetorical question: "Is the same monetary policy appropriate for all of them?" He answered no. That was because he was a fiat money economist.

The free market-based answer would be this: "There should be no monetary policy. There should be only the enforcement of contracts."

Friedman assumed that there must be economic policy. This begged the question: "Set by whom?" The various parliaments? The various central banks? A combination? He opposed a single central bank. He also opposed gold. He opposed a single European parliament. That put him in a dilemma. There is only one answer remaining: competing parliaments. This is what we have now. This system is not working.

In 1999, he wrote a letter to an economist. The economist used it and other sources to write a paper on Friedman's view of the euro. On March 9, 1999, he wrote: http://www.cato.org/pubs/journal/cj28n2/cj28n2-10.pdf

As you know, I am very negative about the euro and I am very doubtful about how it will work out. However, I am less pessimistic about it now than I was earlier simply because I never expected that the various countries would display the kind of discipline that was required in order to qualify for the euro. The convergence in inflation rates, interest rates, and so on was greater and more rapid than I would have expected.

Still, he hoped the deal would not go through. He wrote on April 17, 1999,

What most troubles me as it does you is that members of the euro have thrown away the key. Once the euro physically replaces the separate currencies, how in the world do you get out? It's a major crisis. As a result, I would strongly agree with your view that the euro should be abandoned before January 1, 2002.

At the same time, the odds are very great that it will not be abandoned. The defects of the euro will take some time to show up; nothing happens very rapidly in this area. There are fewer than three years to go. Even if difficulties deriving from the euro occur in those three years, the political system is unlikely to react quickly enough to end the euro. As a result, I think it would be very desirable for some systematic thought to be given to devising some way to get out of the straitjacket of the euro after 2002. The least Italy should do is to keep intact the plates which are used to produce lira.

No nation got out. They all surrendered monetary sovereignty to the European Monetary Union and the European Central Bank.

THE DAY OF RECKONING IS HERE

The crisis over Portugal, Italy, Greece, and Spain – PIGS – continues to escalate. Because they have surrendered their monetary policy to the ECB, these nations are unable to inflate their way out of the fiscal crisis. This leaves the following options.

1. Default on some or all of their debts
2. Pay higher interest rates
3. Cut spending
4. Raise taxes
5. Withdraw from the EMU
6. Withdraw from the EU
7. Wait for a bailout by the ECB.
8. Choices 2-7

There is a legal question regarding withdrawal. These nations have surrendered their national sovereignty to the New Europe. How can they regain it? At what price?

If they leave, the EU will have to impose sanctions. Military invasion is out of the question. Want to fight Spain across the Pyrenees? How about fighting Greece in the hills? So, the sanctions would be economic. A major one would be to impose high tariffs on these nations. The borders would be closed.

These four nations are ruled by politicians who cooperatively sold their nations' sovereignties for a mess of pottage: access to northern Europe's capital and markets. They are highly unlikely to secede.

Then what? The EU has restrictions on the fiscal deficits: 3% of GDP. Total debt cannot go above 60% of GDP. This goes back to 1993: the Stability and Growth Pact. In 2005, the rule was adjusted at the request of Germany and France. No European Union nation has honored these restrictions. In a report, "Public Finances in EMU, 2009," the authors described the effects of the big bank bailouts. http://ec.europa.eu/economy_finance/pub ... 390_en.pdf

Member States have supported their banking sectors with measures amounting to about 13% of GDP and have approved funds worth another 31% of GDP. The largest share (7.8% of GDP in terms of measures taken; 24.7% of GDP in terms of measures approved) are guarantees on bank liabilities, which do not affect public debt and deficits unless they are called upon. The rest pertains to relief of impaired assets, liquidity support and capital injections (p. 2).

So, there are no cross-border sanctions. The rules are being violated.

This raises a problem: the threat of a national debt default by one of the PIGS. Greece insists that it will do no such thing. But the rates on insurance against Greece's national default have been rising.

The Greek government is trapped. It cannot secede. It cannot inflate. So, it has to decide: default, higher interest rates, or run a budget surplus. The latter is out of the question in any European nation. So, it is down to default or raise interest rates. I think the latter is most likely.

Or it can wait and see if the ECB comes through with a bailout. If the ECB does bail out Greece, this will send a clear signal: the end of any need for fiscal responsibility by the PIGS. It will also end any legitimate hope that the euro will become a stable, reliable fiat currency.

CONCLUSION

The PIGS have no ability politically to cut the costs of national government. The welfare state mentality is universal. Politicians refuse to slow the rate of spending. Raising taxes will tank their economies. Politicians may try it, but there will be painful economic repercussions.

Rising interest rates will tank their economies.

This leaves only one possible solution: kick the can. Promise stability and growth. Promise that they will get their financial houses in order.

The welfare state is based on promises. All over the world, it is facing bankruptcy. But the voters believe in the promises, and politicians dare not tell the truth.

The PIGS are getting no help from the European Central Bank. The capital markets are raising interest rates. Their economies are still declining.

There is an answer: open default by the welfare state. I mean across-the-board default, all over the world. "We are sorry to inform you that, contrary to our expectations and yours, Social Security and Medicare are no longer solvent. The IOUs in the trust funds can no longer be met. They have been shut down." This would be coupled with the refusal of central banks to buy further debt, anywhere, for any reason.

This will not happen.

Rising rates and recession in southern Europe look likely. That recession will spread across the borders.

http://www.marketoracle.co.uk/Article17147.html

German Bailout of Greece, PIIGS Would Herald Shift of E.U. Power To Germany

Politics / Euro-Zone Feb 09, 2010 - 05:22 AM
By: STRATFOR

The situation in Europe is dire.

After years of profligate spending, Greece is becoming overwhelmed. Barring some sort of large-scale bailout program, a Greek debt default at this point is highly likely. At this moment, European Central Bank liquidity efforts are probably the only thing holding back such a default. But these are a stopgap measure that can hold only until more important economies manage to find their feet. And Europe’s problems extend beyond Greece. Fundamentals are so poor across the board that any number of eurozone states quickly could follow Greece down.

And so the rest of the eurozone is watching and waiting nervously while casting occasional glances in the direction of Berlin in hopes the eurozone’s leader and economy-in-chief will do something to make it all go away. To truly understand the depth of the crisis the Europeans face, one must first understand Germany, the only country that can solve it.
Germany’s Trap

The heart of Germany’s problem is that it is insecure and indefensible given its location in the middle of the North European Plain. No natural barriers separate Germany from the neighbors to its east and west, no mountains, deserts, oceans. Germany thus lacks strategic depth. The North European Plain is the Continent’s highway for commerce and conquest. Germany’s position in the center of the plain gives it plenty of commercial opportunities but also forces it to participate vigorously in conflict as both an instigator and victim.

Germany’s exposure and vulnerability thus make it an extremely active power. It is always under the gun, and so its policies reflect a certain desperate hyperactivity. In times of peace, Germany is competing with everyone economically, while in times of war it is fighting everyone. Its only hope for survival lies in brutal efficiencies, which it achieves in industry and warfare.

Pre-1945, Germany’s national goals were simple: Use diplomacy and economic heft to prevent multifront wars, and when those wars seem unavoidable, initiate them at a time and place of Berlin’s choosing.

“Successâ€

Euro-Zone Debt Default Risk Crisis, "UR ALL PIGS FROM HELL!â€

From The Times
February 11, 2010

A continent looks on nervously as Greek union flexes muscles

http://www.timesonline.co.uk/multime...ns_682951a.jpg

Public sector workers in Greece have launched a nationwide strike in protest at government measures to tackle the country's huge budget deficit

Roger Boyes in Athens
30 Comments
Recommend 10

The historical hub of civilised Europe found itself cut off from the rest of the Continent yesterday as workers in Greece grounded flights, paralysed ports and blocked border crossings.

Outside parliament in Athens, thousands of public sector workers shouted “traitor, traitor!â€

Germany backs Greek bail-out as EU creates 'economic government'

Germany is preparing to drop its vehement opposition to a rescue package for Greece, fearing that a rapid escalation of the debt crisis in Southern Europe could endanger German banks and damage the euro.

By Ambrose Evans-Pritchard, International Business Editor
Published: 8:36PM GMT 09 Feb 2010
Comments 108

http://i.telegraph.co.uk/telegraph/m...e_1575241c.jpg

Protesting farmers shout slogans while marching in central Athens Photo: AFP/Getty Images

Wolfgang Schäuble, Germany's finance minister, has asked officials to prepare a plan in time for a summit of EU leaders on Thursday, according to reports in the German media. The options include either a loan from EU states or some sort of institutional EU response.

The news pushed the euro to $1.38 against the dollar, the strongest one-day rally since the single currency began its nose-dive late last year. Yields on Greek 10-year bonds plummeted 36 basis points to 6.39pc in a matter of hours as speculators scrambled to exit overstretched positions, with synchronised moves for Portuguese, Spanish, and Italian bonds.

Michael Meister, parliamentary chief for Germany's Christian Democrats, said the crisis could not be allowed to drag on. "Our top priority is the stability of the euro," he told FT Deutschland. "Should Greece receive help, it will only be under tough conditions and if the Greek government undertakes root-and-branch reforms."

Germany's apparent backing for a bail-out comes despite worries that it will lead to the breakdown of fiscal discipline across the Club Med region. It also raises troubling questions of fairness. Ireland has tackled its own crisis by slashing wages and going far beyond any measure so far offered by Greece, yet Dublin has not received help.

Germany's dramatic shift in policy changes the character of the euro project. It follows weeks of soul-searching in Berlin, and after increasingly loud pleas from Brussels, Paris and southern capitals. The deciding factor was concern that letting Greece fail risked a "Lehman-style" run on Club Med debt, with systemic spill-over across Europe.

German exposure to the region amounts to €43bn in Greece, €47bn in Portugal, €193bn in Ireland, and €240bn in Spain, according to the Bank for International Settlements. German lenders are already vulnerable, with the world's lowest risk-adjusted capital ratios bar Japan.

The breakthrough comes as this week's summit of EU leaders in Brussels rapidly evolves from a policy workshop into an historic gathering that may catapult the EU across the Rubicon towards fiscal federalism and a de facto debt union. The EU's top brass are seizing on the crisis to push for a radical extension of EU powers, saying Greece has exposed the deep flaws in the structure of monetary union.

Herman Van Rompuy, the EU's new president, has submitted a text calling for the creation of an "economic government" that shifts responsibility for economic planning from national authorities to the "EU level".

In a parallel move, Commission chief Jose Barroso said Brussels has treaty powers allowing it to take the reins of economic management. "

This is a time for boldness. I believe that our economic and social situation demands a radical shift from the status quo. And the new Lisbon Treaty allows this," he said.

"Economic policy isn't a national, but a European matter. No modern economy is an island. When a member state doesn't make reforms, others suffer because of that."

Rumours swept the markets all day on news that Jean-Claude Trichet, the head of the European Central Bank, had cut short a trip to Australia to attend the summit.

It is unclear how long Tuesday's reprieve will last, or whether any bail-out involving loans – as opposed to subsidy – can solve the deeper crisis of Club Med competitiveness. Wealthy Greek citizens have shifted €7bn from banks in Greece to foreign accounts, fearing that capital controls in Athens. The withdrawals have echoes of the Mexico's Tequila Crisis in 1994 when Mexicans set off a spiral by shifting funds to the US.

The risk is that capital flight will erode the deposit base of Greek banks, forcing them to shrink loan books. Greek banks do not rely on the fickle funding of wholesale markets – the undoing of Northern Rock – but this does not shield them from a deposit run.

Goldman Sachs has downgraded the National Bank of Greece and GPSB. "Greece faces both a liquidity and, potentially, a solvency problem. While we believe that, individually, Greek banks tend to be well-run, the problems they face are outside their operational control," it said.

hhttp://tinyurl.com/yesr25c

Quote:

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Germany is preparing to drop its vehement opposition to a rescue package for Greece, fearing that a rapid escalation of the debt crisis in Southern Europe could endanger German banks and damage the euro

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The Euro is already damaged. And whether Greece is bailed out or not is probably irrelevant. As we have seen in the US , bailouts do not work. They at best only delay the consequences of failed fiscal policy. If Greece is bailed out, what will the EU and Eurozone do about Portugal, Italy and Spain? And do not forget, Great Britain has already been told by the IMF to can its socialized medicine program (or cut way back) because the GB debt is too high. Since the only backing of the Euro comes from the member nations, and half of them are failing, I would not invest in Europe or the Euro right now. How can they recover if they refuse to address the actual cause of their distress, and that cause has been total embracement of Socialism. They can not cut back because the unions and socialist population will not allow it. I guess we could say the same thing about ourselves. Think about it.