Munchau: “we are moving closer towards an involuntary break-up”

September 20, 2011

This post originally appeared on Edward Harrison’s blog Credit Writedowns

I just want to highlight three things here from Wolfgang Munchau on the euro zone because he reaches conclusions I have reached.

In an FT article with the pro-European title of “Eurobonds and fiscal union are the only way out”, Munchau writes about a Greek default:

In Berlin, there is now a consensus among senior policymakers that Greece is very likely to default inside the eurozone, but not right away. By the time it happens, the European financial stability facility will be empowered to protect European banks directly. Those who advocate this approach clearly hope that the improved institutional set-up will be sufficient to deal with contagion.

That’s exactly right. There is no stomach for a full fiscal union. That’s not going to happen. Moreover, Germany is preparing for Greek bankruptcy. The markets see this as a near certainty, so it makes sense to get out in front of the event. What Germany wants is an ‘orderly’ bankruptcy, whatever that means. It’s not clear any default will be orderly, but at a minimum the Germans want to be well-prepared and that means extend and pretend.

Munchau also writes about Italian solvency:

The EFSF and its successor, the European Stability Mechanism, have been set up to handle small countries. They are not big enough to handle large countries. Besides, Italy does not have a short-term funding gap, but a long-term solvency problem. With debt of 120 per cent of gross domestic product, a potential real economic growth rate of around 1 per cent, and a long-term interest rate of 5-6 per cent, Italy’s debt sustainability is in doubt. A monetary union, which solves crises through a combination of default and backstops for the financial sector, would hardly solve Italy’s problem.

Yes, the European Sovereign Debt Crisis is a solvency crisis. My version of what Munchau writes is this:

Is it debatable whether Italy is solvent longer-term? Sure. That’s why Italy is under attack. But the right way to deal with this is to stop the panic and address the issues that could lead to longer-term insolvency. Remember, Italy has a primary surplus. It is high debt and interest costs plus slow growth which are Italy’s problems.

Bottom line: without growth or fiscal surpluses, Italy’s debt to GDP grows. That’s how the numbers work. Miraculous growth is not going to happen for demographic reasons (Italy is old). So you have to see cuts to get the debt levels down.

Finally, there’s the money quote. Munchau writes about the dissolution of the euro zone:

The ruling of the German constitutional court has raised legislative hurdles, while political hostility is rising. We are moving away from what I consider the only effective solution to the crisis. This means, by extension, that we are moving closer towards an involuntary break-up.

My version of why a breakup of the euro zone is likely:

This ruling by the German Constitutional Court does allow the EFSF to operate as planned. Most commentators have focused on this. However, the language of the decision means there can be no eurobonds and no “supra-national” fiscal agent because these are in violation of the German constitution.


In my view, eurobonds and a “supra-national” fiscal agent are almost the only mechanisms which make the euro zone viable. Therefore, with these options now excluded, the euro zone is almost doomed to failure. The euro zone double dip is almost here and I think that spells bailout fatigue, austerity fatigue, default, and political unrest which will break the euro zone apart.

Does anyone have a different view? If so, please post it in the comments.

Feel free to make comments on the original post.


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A breakup may very well happen, because it would be bad for the euro-based countries, and bad things that are essentially a tragedy of the commons are hard to avoid. Actually, it will be bad for a lot of countries:

1. Let’s start with Germany. Germany is able to export a lot of cars and machine equipment because the euro has been depressed. Once they go back to the DM, or whatever currency that is based on the strength of their economy, their exports will drop, as their stuff becomes more expensive. they will regret the end of the euro.

2. The southern countries that are able to attract more trade and tourism because they all use a single currency will lose trade and tourism. they will regret the end of the euro.

3. The dollar, which, given the U.S. deficits, is over-valued, will become even more over-valued. There is no price being paid for our deficit spending, and killing the euro will make it worse. Our exports will also cost more, which will increase our trade deficit even more, and increase our unemployment, which will force us to spend more on safety nets. Further increasing out budget deficits. Not that anybody outside the U.S. is prepared to do anything about it.

4. The pound will also increase in value,as there will be no euros around to exchange for dollars. They’ll be in the same boat as the U.S., except they don’t really make anything they can export now anyway. Their cars are not very good, although Britain is a nice place to visit.

5. Spain, Italy, Greece – who will want to lend them money?

The renminbi will stay the same, because China has their plan and they’re sticking to it.

The root cause of the western world’s debt problem is that the distribution of wealth and income in the last few decades has been so narrowly concentrated in a small segment of society, that states and consumers have had to borrow to keep the peace. The debt should be restructured, but the only way that can happen is if those who have been in narrow segment of the society that has accumulated the biggest share of the wealth allow it to be devalued. But I doubt that will happen voluntarily, because dammit, those people earned it!. And so while they won’t write down any of the debt to avoid state bankruptcies, they will have their wealth written down when the value of the economy crashes.

Posted by KenG_CA | Report as abusive

“The southern countries that are able to attract more trade and tourism because they all use a single currency will lose trade and tourism. they will regret the end of the euro.”

A tourist of importer/exporter would have to buy pesetas, drachmas or lire assuming the southern countries would go back to using their own currencies. But the currencies would be “cheap” to the Euro and dollar, thus attracting more tourists and making their goods cheaper in world markets. If anything, their trade and tourism would likely expand.

Posted by Bernanke | Report as abusive

As George Schultz once said, “If something can’t go on forever, it won’t.” But that doesn’t mean it can’t go on for a very long time. For example, it has been recognized for at least 30 years that the Social Security system in the U.S. is on an unsustainable path. The scale of the imbalances in the Euro financial system are no greater than those in the U.S. fiscal regime and the opportunities to stretch out the “end-game” seem just as great. There is a constant drumbeat of hype about why the ECB is not the solution. The ECB is “reluctant” to buy sovereigns, unsterilized QE is “anathema” to the ECB, etc. True, printing money can’t be a long-term solution. But it sure could buy a decade or two. The Euro Zone is bigger than the U.S. If the ECB just prints about what the FED has printed in the past three years alone, it can buy up most of the threatened sovereigns (of course, the resulting moral hazard would create that much more bad sovereigns over time, but the resulting “confidence” would easily allow the worldwide banking system to absorb trillions of new Club Med paper over the next decade or two. To me, this is the Occam’s Razor “solution” to the debt crisis. Yes, as in the U.S., it would mean a continued transfer of wealth from producers and savers to banks and government employees. But despite the Tea Party, leftist agitation with Obabma, etc., this political battle really hasn’t been all that close in practice.

Posted by JeffBlake | Report as abusive

@Bemanke, I think all countries benefited from a single currency, and if that goes away, they will lose business. Having one currency as you travel through Europe is a big selling point. Importing from Europe is easier when it is all priced in Euros. Think of traveling through the US with 50 different versions of the dollar.

Posted by KenG_CA | Report as abusive

The problem with the Euro is that it distorts the reality that people all over the globe would rather buy the fruits of smarter harder working German labor than less well educated, less hard working Greeks, Italians, or Portaguese labor. The Germans must read Tom Friedman… you know… they actually prioritize all that science technology engineering and math stuff.

I agree with KenG_CA that the EURO has helped all of Europe… but it has helped the Germans a little and the PIGS A LOT. Without France and Germany there is just no way the Greeks and Italians could have floated all that debt at such low rates in the first place. The U.S. is on essentially the same path Europe is… our demographics are a little better, our work ethic is a bit stronger (because our social safetynet is not QUITE as comfortable as theirs.) Yet in the end we are just totally abusing our status as the worlds reserve currency.

In my mind the free money QE1/2/soon-to-be-3 Fed is totally and exclusively responsible for the meoritic rise in gold. We have very publicly told the world that we don’t want the responsibiliy. The problem is with a much cheaper dollar will come much more expensive energy.

Posted by y2kurtus | Report as abusive

Why can’t Greece default without a breakup of the Euro zone? Indeed, what is the benefit to Greece of leaving? They should just unilaterally restructure their debt and be done with it. The Euro doesn’t demand a fiscal union any more than California issuing debt demands that it be in a fiscal union with the rest of the states.

Posted by DaDaDan | Report as abusive

The only benefit to Greece of leaving the Euro would be it could devalue its then currency. However, the costs would be enormous, and legally it could only leave the Euro by leaving the EU. On leaving, all the various positions of Greek debt in Euros would come under considerable pressure, particularly the French banks, but also all the banks in all the EU area as there would be some domino stacking effects eg British and German banks with holdings in French banks would lose as well as the French banks; this would knock on around the world with another – and much bigger – bank crisis.

Why would Greek default be a bad thing? If it is replaced with longer term debt underwritten by stronger partners and the liquidity issue has already been addressed, what can be bad about a Greek default?

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