Thursday, January 13, 2011

The Fiasco Continues in Europe.

German Politics Torn Asunder

The politicians of the eurozone have no way to solve their sovereign debt crisis -- other than one -- and they loathe the one solution available to them (printing euros). So instead, Europe's pain continues to be dribbled out in small, sharp doses, like a large bandage that is only slowly getting pulled off.
The overall picture is not hard to paint. During the good times, the periphery countries of the eurozone borrowed a lot more than was prudent. They essentially took out someone else's credit card -- one could argue Germany's -- and had a good time.
But now that massive heap of bills is coming due for Ireland, Spain, Portugal, Belgium, Italy and the rest, and no one wants to honestly face what this means. The prospects of bearing up under the debt are just too painful.
Think of a household where the sole breadwinner has a huge burden of non-recourse student loan debt. If the other members of the family see half the monthly paycheck going toward this debt, even as they shiver for lack of heat and eat canned spaghetti for dinner each night, feelings of anger will rise. Especially if the debt is not getting smaller anyway.
The other problem is that many European economies are oriented toward government spending. So when the government cuts back, the economy actually shrinks further. Firemen, policemen and teachers get laid off. Retirees spend less as their pension plans are shrunk, and so on.
This reality can create a sort of "death spiral" catch-22 in which cutting back in the name of paying down debt only makes the debt burden worse. The result of slashing budgets means income falls faster than the total debt.
When a country gets in a vicious spiral like this -- where belt-tightening leads to further economic slowdown, which makes existing debt even harder to bear -- the final result is a severe recession, or possibly even an economic depression.

You don't much hear about this happening, though, because countries typically start printing money before they get to that level of debt-induced pain. The potential social backlash of severe economic downturn is usually too dangerous for the politicians in power to contemplate. So they print money instead, and otherwise find ways to "monetize" their debt obligations.
Printing money is what Argentina did -- a country that has experienced hyperinflation in the past, and one where independent economists put the current inflation rate at 25%. Local Argentines are buying property and vehicles as a "store of value" hedge. The FT reports that Argentine vehicle sales were up more than 40% in 2009.
The eurozone situation is different, though, because Greece, Portugal, Ireland and the others cannot monetize. They can't print away their debts because they do not control their currency. They got into a shared arrangement with another country, Germany, that does not want to see the value of the euro inflated away.
This deep clash explains why the eurozone crisis is so painful, and why it is being so dragged out. On the one hand, the eurozone periphery countries are sputtering and choking under their heavy debts. On the other hand, the fiscally sober Germany, a country that shares the euro, does not want to see the value of its currency trashed.
Germany has moral weight in the eurozone because it was German credit that allowed the whole thing to work, and famed German productivity that helped make the eurozone prosperous. Others like Ireland, the Celtic Tiger, boomed spectacularly for a time, but fatally gorged on leverage and real estate.
Now the German export engine continues to hum, and the mood of the other eurozone members has turned sour. Germany is viewed as the "deep pocket of Europe," as George Soros has put it, and both sides are resentful about this. The periphery countries are resentful that Germany would just let them struggle like worms on a hook. Germany is resentful that ever more generosity -- a generosity with no foreseeable bottom -- is being asked of it.
As of this writing, there is a sort of rotating crisis spotlight on the various periphery countries: First Ireland, then Portugal, then Belgium and so on. Lately it has been Portugal's turn in the hot glare of this spotlight.
Meanwhile the euro has been declining, recently hitting multimonth lows against the USD, as it becomes ever more clear new bailouts will be needed.
At the end of the day, the European Central Bank (ECB) will have to take the old route -- it will have to print euros, or monetize. The way it can do this is by buying up sovereign bonds and purchasing them with euros created from thin air.
Germany will hate this "must print" option, but the alternatives are not really palatable. If one of the eurozone periphery countries decides to go ahead and default -- a major, gut-wrenching decision -- then a domino-chain effect would ripple through all the others. The longer that default is avoided and debt pain is endured, however, the more that economic slowdown will put pressure on periphery political leaders, through angry protests and citizen backlash and riots in the streets.
And so the whole Europe story marches forward toward an impossible-to-avoid conclusion. The reason that Europe's politicians can continue to say impossibly optimistic things, and otherwise act like ostriches with their heads in the sand, is because they have trained themselves not to face reality. They are very good at mentally and emotionally denying where the future inevitably leads.
Within Germany, meanwhile, a sort of "tea party" movement is rising up to protest against the inevitable trashing of the euro. Ordinary Germans are still extremely sensitive to inflation, thanks to their remembrance of the Weimar period, and are also extremely hesitant to pay for the follies of others.
"Surveys show that many Germans are worried about the future of the euro," Der Spiegel reports, "but the country's political parties are not taking their fears seriously. The number of grassroots initiatives against the common currency is increasing, and political observers say a Tea Party-style anti-euro movement could do well."

As Der Spiegel goes on to note,
Unnerved by shaky, debt-ridden countries and bailout packages worth billions, the majority of Germans want the mark back. In a survey conducted in early December by the polling firm Infratest dimap, 57 percent of respondents agreed with the statement that Germany would have been better off keeping the mark than introducing the euro. Germans, it seems, are gripped once again by their historic fear of inflation: According to the Forschungsgruppe Wahlen polling institute, 82 percent of the population is worried about the stability of their currency.
Now, a network of euro critics is capitalizing on this atmosphere... "The return of the mark? I can imagine that we could see the rise of a German Tea Party focusing on precisely this issue," says Thomas Mayer, chief economist at Deutsche Bank, referring to the conservative American political movement.
The mood in Germany will be something to watch, because the disappointment of Germany's citizens is all but inevitable (as far as the euro goes). They will continue to see their adopted currency degraded and inflated, maneuver by maneuver, as the realities of crisis bear down.
The euro, trading around $1.29 as of this writing, may continue to fall in the first half of 2011 -- contributing to a corresponding USD rise that could take many by surprise. Expect German anger to intensify as it does... and if the euro falls a lot, expect that anger to become red-hot. The real wild card, then, would be a political backlash so strong that Germany's current leadership becomes like the walking dead -- able to continue acting and making decisions, but with an utterly destroyed base at home. The chancellor has another very uncomfortable year ahead...

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