Before European readers get upset about the discussion of continued concerns about the eurozone, some of its eager defenders appear to subscribe to an extreme form of indeterminacy.
If you recall the famed Schrodinger’s cat, the indeterminacy of the position of an electron is made (somewhat) more comprehensible by a thought experiment in which a cat is in a box with a vial of poison gas which will be released when radioactive decay reaches a certain point. Is the cat alive or dead? Perversely, the cat is neither until he is observed; he is in an indeterminate state. But once the lid is opened, he is either dead or not dead, the indeterminacy resolves into one quantum state or the other.
Now of course, we don’t know if the eurozone will survive this test. Even though member nations are in theory committed to its success, it requires the surrender of a considerable amount of national sovereignity to create enough of a eurozone fiscal architecture to make it viable in the long term. Completion of these arrangements is one obstacle to success; a additional self-imposed hurdle is the severity of the austerity programs required of member nations (and the refusal to employ internal rebalancing, aka, promoting more consumption in Germany, to aid in the increase in savings in periphery countries). But point that out, and some readers here react as if you are telling them the cat might be dead, when they deem that to be an unacceptable line of thinking. They would rather live with the indeterminacy of hope than consider that the eurozone will either prevail or be restructured in a serious way, and they seem unwilling to look at the conditions and odds associated with each end state.
While concern about Greece persists, Spain is now looking far more wobbly. It now has virtually no access to international capital markets, and its banks’ borrowings from the ECB increased 26.5% since May. Bond prices fell sharply as government officials ‘fessed up to the difficulties domestic firms were having in raising funds.
This development is also stark confirmation of what this blog (most notably, Rob Parenteau and Marshall Auerback) have warned: that fiscal austerity at the same time when the private sector is deleveraging is a one-way path to economic contraction and deflation, unless you can severely depreciate your currency so that rising exports provide some ballast. As the Financial Times noted:
However, a government austerity drive, which economists say will delay economic recovery, continues to undermine confidence in the country’s ability to refinance maturing bonds.
This has pushed up the costs of sovereign and private sector debt issuance and deprived weaker banks and companies of short and medium-term liquidity and financing.
Yves here. Note that this shows, vividly, that the policy that the ECB has insisted, vehemently, at the G20 meeting would work, that implementing austerity programs would increase confidence and support growth, is being repudiated by the markets. Worse, a UPI story by Martin Walker (hat tip Marshall Auerback) demonstrates not only how firm Trichet’s commitment to this misguided program is, but also how it is creating a rift with the US:
Well-placed European sources say last weekend’s meeting of Group of 20 finance ministers saw a strident row between U.S. Treasury Secretary Timothy Geithner and Jean-Claude Trichet, head of the European Central Bank.
It began when Geithner made his appeal for the Europeans to go easy on their austerity program….emergent economies were doing well and the United States was recovering; but both could be derailed if the Europeans slammed on the collective brakes. (One source says that Geithner went on to say that massive European spending cuts would be like adding the deflationary crash of 1931 to the stock market collapse of 1929.)
Trichet, his face red and his voice raised in anger, turned on Geithner. How dare the Americans speak this way, when the whole crisis was the fault of the Americans? It was the U.S. sub-prime mortgage crisis and the bonus-crazed culture of Wall Street that had got the world into this mess. But the Americans were taking no responsibility and very little of the burden….
Trichet made a point of stressing that European spending cuts would actually help the global economy by restoring market confidence, shaken by Greece’s sovereign debt problem and concerns about other members of the euro currency…
Perhaps Geithner was too polite to turn the tables on Trichet and point out that it was the eurozone and its policies that had let Greece drift steadily into such trouble…had also allowed France and Germany to flout the core rule that budget deficits shouldn’t go to more than 3 percent of gross domestic product. The eurozone, by trying to marry a single currency with more than a dozen separate national economic policies, had brought this problem upon itself. Many eminent economists, including the 1989 report for EU Commission President Jacques Delors, had warned specifically that this would be a critical problem.
Yves here. While the blame game makes for good theater, the central point is crucial: the eurozone is adopting disastrous policies to restore market confidence, and appears determined to adhere to them in the face of outright rejection.
As Ambrose Evans-Pritchard reports in the Telegraph (hat tip reader Swedish Lex), the French financial group AXA believes the €750 billion rescue package is a mere band-aid:
Ms Zemek [head of global fixed income at AXA] said the rescue had bought a “maximum” of 18 months respite before deeper structural damage hits home, with a “probable” default by Greece setting off a chain reaction across Southern Europe. “It would be the end of the euro as we know it. The long-term implications are at best a split in the eurozone, at worst the destruction of the euro. It is not going to end happily however you slice it,” she said…
Axa said there was “no chance” that the EU’s €750bn “shock and awe” shield will succeed since it treats Club Med’s debt trap as a short-term liquidity crisis…
A number of ex-IMF officials have said the policy is doomed to failure since there is no devaluation or debt relief to offset the ferocious fiscal squeeze, and may endanger the credibility of the Fund itself. The IMF had floated the idea of a debt restructuring but this was blocked by the Brussels.
The strategy assumes that voters in Greece and other Club Med democracies will endure years of pain for the sake of foreign creditors. “It’s a pipedream,” said Ms Zemek…
Contagion from a Greek default would be harder to control than fallout from the Lehman collapse. “This has huge implications for banks. These bonds didn’t just disappear; they went somewhere, allegedly into French money markets and insurance companies, or on to French balance sheets,” she said….
Axa said the America’s currency union is successful because Washington has over-riding legal powers over the 50 states. “It is a precondition for the system to work but it doesn’t exist in Europe and the bond markets are starting to figure this out. We are looking at a noble experiment on the brink of failure,” said Ms Zemek.
Yves here. The problem now is the sovereign debt sits at banks that in many cases have positive net worth thanks only to charitable accounting. The eurozone members cannot credibly backstop the debt. Writedowns and losses are inevitable. It would be better to do it in an orderly fashion, via restructuring, but indeterminacy, aka extend and pretend, is the order of the day.