Tuesday, November 16, 2010

The Euro Mess (continued)

“How a Financial collapse Starts” writes Tyler Cowen in his November 15 post in Marginal Revolution.


“The EU is pressuring Ireland to accept a bailout and Ireland does not (yet) want it; this should give pause to those who think that "no bailout" policies are time consistent. More generally, the simplest model is that the EU could take care of Ireland and Greece fairly easily, but the spectre of Spanish default lurks in the background. Spain is a much larger economy and the Germans cannot simply pay up to save it. All pronouncements and policies about Ireland (or for that matter Portugal) should be viewed in light of this larger "game." If Spain were fixed essentially the trouble could be paid off to go away, for now at least. But Spain is not fixed.”

As Irwin Stelzer notes in the Wall Street Journal:

“The shrinking of Greece's economy makes it likely that the inspectors now in Athens will report this week that Greece did not generate sufficient tax revenues to meet its deficit reduction targets. That will be grist for the mill of critics who are saying that the austerity program imposed on Greece by the IMF and the European Central Bank is the road to ruin, rather than to recovery.”

In the end:

“Greece will fail to meet its deficit-reduction targets, and lay plans for a default that will include some grief for the private investors that had a moment of relief when Ms. Merkel's eased her demands for a haircut. Portugal, still unwilling to adopt a strict austerity program, will follow suit, as will Ireland and, eventually, perhaps but not certainly Spain, which is less indebted than Greece. (…)

With a GDP approximately twice as large as the combined total of Greece, Portugal and Ireland, Spain matters. And the outlook is not good. The Spanish economy grew not at all in the third quarter. It's unemployment rate is now 20% and headed higher. Its banks have yet to recognize the losses incurred from property loans that have gone sour, or completed consolidation. Higher taxes and spending cuts will slow things even more next year.

The Royal Bank of Scotland estimates that banks outside the troubled countries hold over €2 trillion of those countries' debt, so their balance sheets will shrink, and with it their ability to lend in their home countries. Not a pleasant prospect in the run-up to Christmas.”

My comment: Remember the alleged virtue of the euro to shield member countries from the financial shocks that would ruin other non member ones? Remember a thing called "the stability pact" that Mr. Prodi famously but belatedly discovered to be a "stupidity"?And remember the so-called "no bailout condition" in the ECB charter? The conclusion: can you trust a monetary system that so consistently produced results completely contrary to its promises? Apparently the markets have some doubts.

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