Felix Salmon

The European crisis gets quietly worse

By Felix Salmon
September 28, 2010

Edward Hugh has a must-read overview of the euro crisis as it stands right now: not nearly as panicked as when everybody was concentrated on Greece back in May, yet in many ways worse than that.

Greece still seems certain to default sooner or later, and its bonds are trading at levels very near to those seen in May. Spain has improved a bit — but that tiny improvement seems to have been accompanied by a significant rise in complacency on the part of the government, so it’s unlikely to last long. And both Ireland and Portugal have deteriorated significantly.

Ireland’s debt is trading at worse levels than ever before, its economy is still in recession, and its banking system is a mess; in Portugal, the public deficit is likely to reach 9% of GDP this year, and the country’s debt spreads are also looking distressingly similar to Greece circa April 2010.

Writes Hugh:

Like former US Treasury Secretary Hank Paulson before them, Europe’s leaders, having armed their bazooka may soon need to fire it…

The EuroArea countries could be likened to a group of 16 Alpine climbers scaling the Matterhorn who find themselves tightly roped together in appalling weather conditions. One of the climbers – Greece – has lost his footing and slipped over the edge of a dangerous precipice. As things stand, the other 15 can easily take the strain of holding him dangling there, however uncomfortable it may be for them, but they cannot quite manage to pull their colleague back up again. So, as the day advances, others, wearied by all the effort required, start themselves to slide.

What’s certain is that if you’re going to fire your bazooka anyway, it’s better to fire it earlier rather than later: the cost of a bailout always rises the longer it’s delayed. So why are the ECB’s bond purchases dwindling, and why is the much-vaunted European Financial Stability Facility still surrounded by so many questions? Yves Smith quotes the FT’s Wolfgang Munchau with some worrying math on that front: essentially, the EFSF won’t be able to lend cheap money to struggling countries at all.

In other words, the Eurozone’s bazooka might turn out to be even less effective than Paulson’s was. And if that’s the case, there’s no point in throwing good money after bad at all: it might be easier and cheaper just to slice that Alpine rope at a strategic point and sacrifice a weaker member or two for the sake of keeping everybody else safe.

Of course, slicing the rope would be easier if and when one of the peripheral countries actually wanted to do so — to attempt their own competitive devaluation in the global currency war. The stricter that the Germans are about the conditionality attached to new funds, the likelier that’s going to become.

In any crisis, there comes a point where it’s easier to let things fall apart than it is to keep things together. Given how fractious the European project has always been, and given that the generation of politicians who staked their careers on the European Union has now completely retired from the scene, a breakup would seem to be an inevitability at this point. The only question is when it will happen, and who will go first.

7 comments so far | RSS Comments RSS

The whole world is being crushed by the China wage of $200 per month. Chinese people should be earning much more by now, but for the distortions of their government.

The only solution is widespread austerity. We shouldn’t be so afraid. We won’t die from austerity. We are a million miles from the Great Depression in terms of living standards, in a world of cheap and abundant Chinese goods. Food is proportionally far, far cheaper than it was at that time. Austerity in 2010 is eminently tolerable.

Chinese prices will eventially go higher. They have already attained their workforce peak. Facing austerity in a world with less cheap Chinese goods, a probable outcome, will be much harder.

Comparisons with the Great Depression are insane and proof that those making the comparison have no idea how bad the Depression was.

Any deflationary aspects of austerity can be countered by printed money provided directly to common people.

Posted by DanHess | Report as abusive

Felix, have you seen Anglo-Irish Bank’s interims? They’re a horror story. I don’t think I’ve ever seen a worse bank loan book. It’s problem that’s totally beyond the reach of the Irish government and far too big for the EU to handle. The Irish should immediately call in the IMF.

Posted by Gaw | Report as abusive

Felix wrote “Of course, slicing the rope would be easier if and when one of the peripheral countries actually wanted to do so — to attempt their own competitive devaluation in the global currency war. The stricter that the Germans are about the conditionality attached to new funds, the likelier that’s going to become.”

Nice observation Felix — I think the two obvious candidates are Greece and Italy. Greece because A) they’re the worse off fiscally and B) they’re populace is least likely to support additional austerity. Italy because if Italy ever wants out, I’m sure Germany would rush to help her leave.

Posted by Kosta0101 | Report as abusive

“The only question is when it will happen, and who will go first.” Exactly so, as to the when I’m sure it will be before lunch, what I’m not so sure about is if it will be the eurozone or the EU.

Posted by hansrudolf | Report as abusive

What a load of emotional nonsense. You should also distinguish between default as in never ever pay and default as in roll over Bonds into new issues: part of Greece’s problem is the very short term nature of much of their debt.

Suggesting Europe is about to crumble is a bit like saying that the US will break up because of the economic failure of places such as Cleveland or Detroit. Suggesting the Euro’s unbundling is inevitable is like suggesting the US Dollar is a failing currency because of the amount of US debt held by the Communist Chinese.

I know there are many rumours spread by short sellers from time to time, but I don’t expect to see them so well supported by Felix.

Posted by FifthDecade | Report as abusive

Leading with monetary union always looked a bit like leading with one’s jaw. Introduction of a common currency should have been nearly the _last_ item on the checklist for the European project–something that seemed obvious and long overdue when they got round to it.

The alpine analogy is picture-perfect: the project confronting the Eurozone today is how to get Greece out of it without wrecking the entire European economy. Greek membership is a terrible deal for the rest of the zone, and it is rapidly becoming clear that it is a terrible deal for Greece as well, which simply can not compete as junior partner to the Bundesbank.

The project after that is working out who really belongs in the Eurozone in the first place, whether there ought to be such a thing at all, and if there shouldn’t, whether anything can be done to unwind the whole enterprise.

Posted by ckbryant | Report as abusive

How about the actual public finances of those Eurozone slackers ? Are they better or worse than they were in May ? And how about the interest rates paid by the rich relatives who bankroll those slackers ? Are the markets disciplining them for supporting the slackers ? Sure they are, they ask them to pay even less than they were paying in May !
Now, markets may not wish to acknowledge the improvements, but then they also failed to acknowledge the serial bubbles of dot.com, stockmarkets and housing while they were inflating. So it would be interesting to see some more evidence apart from the spreads.
I have some reservations as to the competence of Mr Salmon on the matter of politics in the PIGS and Ireland. So, the opinion expressed in the article rests on very little concrete evidence.
Just reporting on the course of the spreads should not be disguised as analysis. One has difficulty seeing the value added.

PS Please correct the reference to Munchau. The name is actually Münchausen.

Posted by ggeorgan | Report as abusive

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