May 17, 2012
What we are seeing now is the breakdown of conventional wisdom in Europe. With respect to the Euro, conventional wisdom is a strange and stubborn commodity. Normally it is technocrats who are at the vanguard of conventional wisdom. Theses technocrats don’t have to work in the public service. They can hide in dynamic companies for a while. But what bonds them together is a technocratic fear of change.
Fear of change is the handmaiden of fear of failure. Many so-called “serious” people believed the conventional wisdom that the Euro could not break up and they don’t want to look very silly when it does. They are driven by this fear of failure. If something, which they have staked so much of their reputation on, changes or succumbs to the redoubtable gravity of economic logic, they will fail. The worst thing that can happen to people who take themselves very seriously is being wrong.
Most of us get things wrong a lot of the time; we make mistakes and hopefully learn from these mistakes, but “serious people” – the purveyors of conventional wisdom -can’t bring themselves to admit this. Over the next few months we will see the kitchen sink thrown at people who have concluded that on the balance of evidence the Euro will break up.
In Ireland, to suggest that something which serious people have staked their reputation on is actually false will lead you on a journey of three phases. This journey was experienced by those who were skeptical about the housing market and the soft-landing. The same process is repeating itself with the breakup of the euro.
The first phase, when you query conventional wisdom is ridicule. The second phase, when your ideas are gaining traction, is the violent opposition phase. This can take many forms. Then the third phase, when the march of events overwhelms the conventional wisdom, is the “everyone- pretends-they-were-on-your-side-all-the-time” phase. I suspect that we will get to that third phase on the euro quicker than anyone expects right now.
The problem for the Euro is that it probably should never have happened. It can’t survive unless Germany is prepared to infuse money to the periphery for the foreseeable future, as it was prepared to do in East Germany or as the north of Italy is prepared to do with the south of Italy.
Germany will think long and hard about its next moves because it likes the Euro to an extent. The Euro gives it exchange rate stability in its biggest trading market, the Eurozone. And because it is much weaker than new Deutsche Mark would be, it gives Germany a huge exporting subsidy vis-a- vis America and China. Further, because terrified capital is flooding out of the periphery to Germany, the German economy gets investment funds much cheaper than it has done for years.
However, in order to keep industrial Germany happy, the punters need to continue bailing out the likes of Greece, Spain, Ireland and Portugal. And, if Italy goes, they will have to dig deep.
The average German doesn’t want this. In fact, Angela Merkel got the lowest vote ever for the CDU in Rhineland Pflatz last weekend: evidence, if needed, that Gunter isn’t happy – despite the lowest level of unemployment in a generation.
Equally, the average German realizes that to keep the Euro together, he will have to tolerate higher inflation in Germany. Only through the re-flation of the (already booming) German economy can there be any hope of solving massive current account imbalances — which more than anything is responsible for the Eurozone’s plight. These are big jumps for the German establishment and the German people.
While they contemplate the future at leisure, the rest of the Eurozone is panicking. There are 25 million people on the dole in Europe, 18 million of these in the Eurozone. Unemployment is rocketing in the periphery and youth unemployment is about 30% in Ireland, Spain, Greece, Portugal and Italy. This can’t go on. Every indicator of activity in Italy and Spain is now plummeting – from new car sales to retail spending.
Outside Germany, Europe is suffering from a “liquidity trap”, whereby the people have so much debt they don’t want to borrow and the banks are so fragile they don’t want to lend. This means that the deleveraging we are experiencing is driving prices downward and this is making people believe that the bargain is not today but will come tomorrow. So they don’t spend even when prices are falling.
The policy response to this has been fiscal contraction at a time of a liquidity trap. Hoping this will work and turn the economies to growth is like putting an anorexic on a diet and expecting her to put on weight.
The economies of the periphery will get weaker and weaker and Germany will get stronger and stronger. At a certain stage, the Germans and other northerners will get sick of bailouts at the same time as the southerners and ourselves get sick of austerity.
We are already seeing that process play out in Greece. But Greece is only the forerunner of what will happen in Spain and by extension Italy too.
This will force the Germans back to the poker table as they try to minimize the cost to them of carrying the periphery and the periphery will try to maximize the subsidy they get from the Germans. Who blinks first?
All the while, the logic of the monetary union, which was to create the same interest rates and financial conditions all across the union, where an Irish bond was valued the same risk as a German bond, goes up the swanny.
The Germans in the weekend election have said they are not happy, the Greeks likewise. The Spanish banks are bust and the French have just kicked out the architect of the present diet for anorexics policy, Sarkozy.
With such uncertainty and the likelihood of more bailouts and negotiations ahead, would it be that smart to show our hand right now, particularly as conventional wisdom is about to shift?