The euro breakup thrill ride begins

November 9, 2011
talking for months about creating a "core" euro zone with real fiscal union, markets sure as hell didn't go up.  

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It’s important not to read too much into today’s mid-afternoon stock-market wobble. But in the wake of the news that Germany and France have been talking for months about creating a “core” euro zone with real fiscal union, markets sure as hell didn’t go up. And one anonymous diplomat gave a succinct explanation of why:

This will unravel everything our forebears have painstakingly built up and repudiate all that they stood for in the past sixty years,” one EU diplomat told Reuters. “This is not about a two-speed Europe, we already have that. This will redraw the map geopolitically and give rise to new tensions. It could truly be the end of Europe as we know it.”

I’ll go out on a limb here and guess that the diplomat in question isn’t German. But whoever it is, they have a point. There is no way that the European periphery will go quietly, resigned to their second-tier fate and their third-tier currencies. And without their consent, this idea is going to get very messy, very quickly. Even if it never happens, simply debating it could suffice to cause enough intra-European mistrust and vitriol that the markets simply cease lending to all but the very safest borrowers. And the ECB can’t lend to everybody.

Meanwhile, Silvio Berlusconi has turned himself into a lame duck, and is being as obstructionist as possible with respect to allowing his successor to do his job. In fact, it seems at the moment as though new elections won’t take place before February — which is far too long as far as impatient markets are concerned.

If you haven’t read it yet, you should really check out Mark Carney’s speech from last night in London, on the subject of global liquidity — something he describes as “the Keyser Söze of international finance”.

If you die, the proximate cause of death is always the fact that blood has stopped flowing to the brain. Similarly, if you’re in a crisis, the proximate cause of the crisis is liquidity, or rather the lack of it. You can be insolvent for as long as you like, so long as the money keeps flowing; it’s only when the money stops that things come to a head.

And we’ve reached the point, in Europe, at which the money has stopped flowing. Barclays has already declared that Italy is “beyond the point of no return”, and Greece hasn’t been able to fund its deficits either domestically or in the international markets for ages now. This is what happens in crises: the money stops, and then governments and central banks are faced with a choice. Do they step in, lending freely where private actors fear to tread? That’s the right thing to do if what you’re facing is merely a liquidity problem. But if it’s fundamentally a solvency problem, then layering on extra debt just makes matters worse.

And in Europe, of course, the governments are as likely to be part of the problem as they are to be part of the solution — if there is a solution, which is looking increasingly improbable.

All of which is to say that there are going to be many more days like this. Europe is becoming increasingly unpredictable: the crisis has claimed the scalps of two prime ministers in the past week, and they surely won’t be the last.

Martin Wolf says that the eurozone is unlikely to survive. Paul Krugman is saying the same thing. I’ve been saying it too. But one thing’s for sure: a euro breakup is emphatically not priced in to markets. So fasten your seatbelts: it could come sooner than you think.


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