Pettis on Eurozone Pathways and Endgames

Michael Pettis, like Simon Johnson a few days ago, has tried mapping out what he thinks future scenarios for the eurozone might be, and what that means in terms of possible winners and losers.

One of Pettis’ strengths is that he takes the time to be explicit about his reasoning, which gives readers the opportunity to see where they might beg to differ. And as much as I like his post, I think he makes one fatal assumption at the top, that the eurozone has more time than it really does. Here’s his frame:

If Europe is going to “resolve” the current crisis in an orderly way, it is going to have to move very quickly – not just for the obvious financial reasons, but for much narrower political reasons. I am pretty sure that the evolution of European politics over the next few years will make an orderly solution progressively more difficult.

For ten years I have used mainly an economic argument to explain why I believed the euro would have great difficulty surviving more than a decade or two. It seemed to me that the lack or fiscal centrality and full labor mobility (and even some frictional limits on capital mobility) would create distortions among countries that could not be resolved except by unacceptably high levels of debt and unemployment or by abandoning the euro. My skepticism was strengthened by the historical argument – no fiscally fragmented currency union had ever survived a real global liquidity contraction….

….in spite of very clear historical precedent, very few analysts, even the greatest euro-skeptics, are wondering about of the changes in electoral politics that are likely to take place in Europe over the next few years as a consequence of the euro adjustment. For example Wolfgang Munchau has an excellent article in the Financial Times in which he concludes, like I did in my post last week, that:

The eurozone is manoeuvring itself into a position where it confronts the choice between two alternatives considered “unimaginable”: fiscal union or break-up.

…. After my piece last week on financial prospects in Europe I received a lot of comments and questions from clients, especially about this part:

Political radicalism in these countries will rise inexorably as a consequence of rising class conflict. As Keynes pointed out as far back as 1922, the process of adjusting the currency and debt will primarily be one of assigning the costs to different economic groups, and this is never an easy or conflict-free exercise. Of course the less stable a government becomes as a consequence of this adjustment, the more likely it is to prefer very short-term solutions.

…..The point I was trying to make in the passage is an obvious historical one – that the resolution of Europe’s crisis will inevitably involve a difficult political debate over apportioning the cost of the resolution.

Obviously I think he is right, but I would add that the window for that choice is a small one. If Europe doesn’t move quickly, within two or three years it will probably be very difficult, if not impossible, to engineer fiscal union. By then domestic politics are likely to be too unstable for the European political elite simply to arrange union over the heads of the citizenry.

I’m curious to get reader input (and do read the entire Pettis piece, it’s wonderfully thoughtful), but I see the conundrum in plain view. The eurozone does not have two to three years to come to resolution. The markets are pounding on weak countries now, and the inter-related credibility of nation-states and their banks are in serious doubt. And he is right, that the difficulty of apportioning costs, particularly among so many players, means that this situation cannot be resolved quickly. Political processes and market responses operate on hopelessly different time scales.

Richard Smith and Swedish Lex were similarly doubtful about Pettis’ conclusion, while still admiring his analysis. Swedish Lex noted:

believe that he underrates the risk of a sudden and chaotic death for the euro, the reason being that absolute crisis management can only be successful in containing disaster for so long. The rottenness of the euro system is now so apparent that markets AND le peuple will see through the propaganda immediately.

Had I been Irish, I would never have accepted this level of servitude.

The real fix – political and fiscal union – would probably cause and political and constitutional crisis in Germany. So the Germans are unlikely to go down that path, should they ever realize that this was the only viable solution, which is far from certain.

I guess this leaves us with Trichet to print money in the short and medium term. Trichet and Bernanke will then have become the money printing duo that occupy the field in the absence on political leadership on both continents. I wish I could draw cartoons.

Note it is not yet clear the Irish will accept this level of servitude. The critical date is December 7, when the Irish Parliament is due to pass the austerity budget. However, there is good reason to think that that might not happen. And if the Irish politicians, as might be expected, refuse to drink from a poisoned chalice, at least as far as their careers are concerned, Lord only knows what happens next.

Print Friendly, PDF & Email


  1. dearieme

    Germany is a federal republic. How many foreign lander could it incorporate? I imagine that the list would stop at Austria, the Netherlands and Flanders. Of these, only Flanders seems likely to need rescue. I can’t imagine the Dutch ever being interested.

    On another view, look at this list: Republic of Ireland, Portugal, Spain, Italy, Belgium, plus Greece. It’s as if the old Catholic world is being restored, as it was before the Papist schismatics tore it apart in the Middle Ages. Whether any reformed countries will join them, time alone will tell.

  2. dearieme

    And another thing – though the Pettis piece is certainly good stuff, it has an odd weakness: he seems to suppose that income taxes on business somehow are different from income taxes on people. They are, but only in the sense that they obscure who carries the burden – is it the owners (e.g. shareholders), the employees or the customers? It isn’t the businesses themselves – they are only a legal fiction; they are not consumers.

  3. Mark

    Fiscal union would have to be forced upon the Germans,Dutch,Finland.
    Democracy in these countries would have to be abolished.

  4. attempter

    Political processes and market responses operate on hopelessly different time scales.

    If you mean the electoral schedules of neoliberal sham pseudo-democracy (as opposed to true democracy which always has instant recall), then yes. That’s part of the intentional scam of representational “democracy”. The elites want to give themselves long breathing spells to commit their crimes more or less unaccountably.

    However, I’d like to point out that it’s part of the Big Lie that there’s anything natural, rational, or inevitable about the existence of these “markets” or the way they function.

    “Markets” as we know them are a purely artificial political creation, and that they’re able to act the way they do is a political prerogative this kind of system artificially bestows upon them to the detriment of the people. (And of other competing rackets. For example, why is destabilizing the currency via counterfeiting a crime, while doing so via the carry trade is not? Clearly an arbitrary ideolgical choice was made which empowers one set of gangs over another. That’s all it is. But the currency is assaulted either way, and the system clearly has chosen against actually preventing assaults on the currency.)

    So everything these criminals do is a political act, politically enabled by the system, as well as passively enabled by the people’s political choice to allow it to continue to their own continuing injury.

  5. disgruntled

    Another thing. If the “bailout” “deal” isn’t put to a vote in our parliament there will be a constitutional challenge. The Germans aren’t the only one with a Karlsruhe.

    It’s seriously hard to express the level of anger here. At the moment it’s submerged between both shock and basic grit. We like to just get on with things here and not make a fuss. Also, most people are relatively internationalist and are actually quite fearful of the politics of this. This is an unknown. But it’s driven by disgust. The main ruling party, Fianna Fail (soldiers of destiny – the name should give you a hint of their origins) is the most successful political party in Europe. It’s been in government for almost the entire history of the state. It’s about to be decimated in an upcoming election. The change in our politics is seismic. What happens with the opposition parties is also an unknown, but I could hazzard some guesses. The two main parties are Labour and Fine Gael (Tribe of the Gael), the former centre-left, the latter centre-right. Labour has gone from having support of about 10% to 25-30% and is vying for largest party status. But we also have a host of smaller parties, groupings and independents in our parliament. The most significant of the rest is Sinn Fein (us ourselves – or formerly the political wing of the Provisional IRA). They are genuinely leftwing and nationalist. Watch their support explode. We also have essentially the formation of a new party made up of lots of individual hard left groups, called the united left alliance. Per your post on the loss of the radical left in the US, these groups are going to pull Labour leftward. In competing for the middle ground “responsible” vote they are being outflanked. The politics here is getting very very interesting!

    But we’re also intensely aware of our own narrative. We know our history. We’re sick of emigration. We’re sick of legalised and institutionalised corruption. We’re sick of capitalism that when the chips are down is just theft. There have been no criminal prosecutions. Most of the idiots are still in their incredibly well paid positions. The “there is no alternative” mantra has been shoved down our throats for three years. And then we learn that on top of our own inept, greedy, corrupt politicians and elites, the EU is going to shaft us aswell.

    Well, I think you get the picture.

    By the way, you’ve probably heard it a million times, but great blog.


  6. Hubert

    Read the whole Pettis-post. Well structured, yes, but I could not find anything surprising or new in there.
    The Eurozone will just go on doing what it is doing now: Constructing and increasing Bailout Funds and bringing the ECB up to speed. Here in Germany the Landesbanken “sold” their Toxic POS into some off-balance-sheet Government vehicle and it is not discussed here, not even in Blogs.
    So I have to disagree with Swedish Lex: The “peuple” will not see through the propaganda – they know that something is fishy here but they do not understand what and there is no political avenue for that.
    Heck, even professional analysts get swamped by aggregated numbers about Bank exposure. Real net exposure to Ireland is not to be found outside the higher banking circles.
    So the ECB will backstop banks and and buy bonds, the markets will go up again. The Germans will protest, the ECB will stop for a while. Then markets will panic and the ECB will go again.
    Also the Irish: They always can drop out at a moments notice and probably should. What can/will Europe do – send in an army?
    If they do not get fresh money, they will. They will renogiate interest rates down and maybe do some concession on their corporate tax front. Or they will drop out categorically. The losses will accrue to THE FUNDS, no longer the ECB – that was the sense of that whole maneuver the last weeks.
    The Greeks also – if they really have to repay, they will drop the Euro and say FY. Again – what will the Eurozone do then exactly?
    Also, I have now read around 50 times in the FT that Angela M. will derail the whole thing. PLEASE. She will not. She is only fighting for political survival next year when her party will lose important state elections. Sure she is not happy with Germanys savings being watered down by streams of new ECB money – but what can she do? Dropping out of the Euro (besides being a dangerous idea) is a No-no in german politics and the next Government, Red-Dark Red-Green will not either. So Merkel is full in and will stay in. Paris and Brussels know that very well.

    Also there are constructive avenues for Eurozone: Outlaw CDS all over Europe. REALLY outlaw them. This could bring a lot of time. Hellasious at suddendebt.blogspot has some constructive proposals in this direction.
    Sure, the whole EURO thing will not end well but it will take longer than most think. And what will end well in finance terms ? The US? Great Britain?

  7. Bas

    An expanded permanent EFSF will create a European bond market – and an embryonic fiscal union – by default.

    Despite all the efforts in the anglosphere to force a separation of the currency union, it will most likely survive intact. Maybe the anglosaxon merchants of fear and discord will coax the Irish into some fatal breakaway, but that’ll be all.

    Autistic Britain and ignorant America continue to underestimate the political resolve behind the EMU. Now they are speculating on social unrest and political radicalization, mainly based on faint memories of the misunderstood European history lessons their broken educational systems afforded them.

    If financial conditions are, on aggregate, more sustainable in the eurozone, in terms of social conditions the US and UK are a lot worse off, with the continuing Verelendung of their debt-laden lower social strata.

    Some perverse form of projection seems to be going on here..

  8. Hubert

    Also, Pettis proclaimes to write a “political” post – and then not going into “politics”.
    He omits that the core is all-in on the Euro project. Yes the whole thing is horribly flawed and will not work long term. But TPTB will defend it at all costs. They will spread Euros like the US spreads Dollars. Axel Weber might vote “Nay” in vain protest as a simple ECB-board member or “Yay” as its President – in any case there WILL be a majority. Axel Weber is not there to defend German savers. That would be a misunderstanding. He is there for the German political class. He is a typical political a..h… and will always act as such.
    Then Pettis claims “Political radicalisation” will not allow a fiscal union.
    1) I do not want to pay for the banks mess with my Euro savings. I will have to anyway, but I do not want to – and would vote against it if I had a chance, which a will not have until 2017 on the Gemran political calender; and then it will be too late anyway. Does that make me a political radical ?
    2) There is no such thing as a binary Union vs Non-Union. The Treaties signed said “no fiscal Union above the Brussels Budget. There was a “non Bail-out” clause in Amsterdam/Masstricht – this clause was worth Zero in May 2010. Treaties and laws are there for us normal people. Politicians do whatever they agree to do. Now we are in “Off-Balance-Sheet-Union-Mode”. As a “On-Balance-Sheet-Union” is a loser at national elections for Germany and I suppose some other countries, too. So it will stay off-balance-sheet. The “peuple” have no chance to say “NO”. There is not Party for ANTI-BRUSSEL in Germany yet. Fiscal Union will not be declared. It will be implemented by Bail-out Funds and losses to ECB owners.
    3) Fringe Countries will drop out of the Euro. So what? The bank loans to these countries are worth 20 – 70 cents anyway on the Euro here and now. Only the bookkeeping might have to change. Bookkeepers will take care of that.
    4) Spain and Italy are TBTF in Euroland. They will be supported by all means. (forbid CDS, capital controls, no short selling of debt, ECB market making to name a few). There are intelligent ways to do this and eventually, even our stupid politicians will find out about some of them and hurt the CDS-clearing-banks a little bit (THEY will tell THEM in advance and there will be another rally ….)
    5) “Capital flight countries” like Greece and Ireland will default/drop out whenever they want. They should do it once Capital Flight gets bigger than New Money coming in. Capital flight unfortunately is a child´s game in a common currency.

  9. Thomas Barton,JD

    I believe that we will see a December to Remember Default Troika of Ireland, Portugal and Spain. Willem Buiter in several different publications has been cited as saying he sees three defaults in the next 3 to 5 years. He works now for Citigroup and he is being politic in the extreme. All 3 of these nations are now beyond rescue. The ostensible trigger will be Ireland going ballistic on December 7 in rejecting the Hammer of the EU Superstate based in Brussels. With Ireland in open revolt then the bonds of Portugal and Spain will skyrocket. In order to protect Italy the strongest actual economy in the present contagion ward then the other three must be severed posthaste. Pass the ether and get motivated with the bone saw.

  10. Adam

    The euro is over! Political/fiscal union is off the table because the north assumes it means they have to pay for the so called sins of the south and the south assumes it means serfdom to the north. The only question that remains is how long can the elite keep the wheels on the bus; is it 2 months (Yves) or 2 years (Pettis)?

  11. Ronnie

    I think both these articles miss one important point. Most of the PIIGS debt is covered by CDSs several times over. So, a default would necessarily involve an AIG style bailout of institutions that have written these swaps.

    Or they would need to collapse.

    The key to Euro’s survival is to know which intitutions have written these CDSs, and where their collapse affects powerful interests and groups.

    The Euro is very useful because it is one of the few currencies that can print as much money as they need to. Though the Germans won’t like this, this is the the only palatable solution left. A US style QE in Europe. Else the Euro is history that our kids would read about.

    so, the options are -1) A much devalued Euro 2) A full Euro break up with a lot of debt forgiveness for PIIGS and France (because of the very large Italian debt it holds) 3) A partial break up- A much devalued Euro minus Germany and France. Germany and France can bail their respective intitutions in their own currencies. The costs are there, but at least their economies are competitive enough to revive in years.

  12. Martin

    Would “Political Union” mean, that the biggest power would be in an institution, that has a “one person one vote” democratic appointment structure?
    Then probably all the small countries would be against it.

    Overall the Brussels institutions of the EU are currently probably the most undemocratic institutions with similar kind of power, that exist in any so called democracy. In the national political debate Brussels is necessarily a side show, because the important figures in Brussels usually speak just two or three languages, but not the more than 20 that would be necessary to be able to be involved in national debates – and that is despite the currently already quite significant power Brussels hold.

  13. mannfm11

    Yves, I wrote a short response myself. Michael noted your post at the bottom of his, which is what brought me here. I think Michael attempts to put this in perspective of debt problems of the past. The difference this time is the major countries and banks around the world have their own debt problems. The world can’t arrange itself around the payment of debt that cannot be paid and at the same time have any semblance of real economy. The system has financed the customers and employers of the system to the point that the debt outweighs the capacity to act as customer and thus employer. We have moved to false financing by government itself, not only in the US and Europe, but in China and Japan as well. To think these countries are going to bail out the bankrupts when in fact they are the very people and institutions that hold the debt in the first place is absurd. Their economies and the debt cannot both function.

    Pettis does have the right idea, in that the effort is to paper over and not solve the problem. First of all, I think solving the problem means turning the financial economy upside down and likely uncovering fraud that the powerful cannot afford to bare. Instead pretend and extend is the name of the game. I think the very survival of the republic is at stake and yet we watch the ones in power fiddle as Rome burns. Bernanke might have had the right idea 18 months ago, but today he is merely putting more liquidity in the banking system to facilitate the looting that is taking place, giving felons bad checks that will clear the bank. I think the next crisis is right around the corner and because the environment is polluted with fraud, there is very little in place to trust.

Comments are closed.