Friday, December 3, 2010

The Eurozone Crisis: Deja Vu

Randal Forsyth sees similarities between the current unfolding of the Eurozone crisis and that of the U.S. financial crisis a few years back:
Just as the problem on this side of the Atlantic supposedly was just subprime mortgages, a tiny sliver of the credit market where their obvious but unique abuses, the problem in Europe was supposed to be just Greece, which accounts for a few percent of the eurozone's output.

Then the Federal Reserve-engineered takeover of Bear Stearns by JP Morgan Chase (JPM) in March 2008 was thought to be a one-off affair, just as the bailout of Greece last spring was supposed to be. And for a few months, a tenuous stability returned.

In the summer of 2008, the bailout of mortgage giants Fannie Mae and Freddie Mac staved off a full-fledged crisis but failed to inspire confidence. Now, the bailout of Ireland has been ineffective in staving off contagion to even beyond the other PIIGS -- Portugal, Italy and Spain -- closer to the core. Add debt-laden Belgium to this troubled group as the cost of insuring its debt jumped Tuesday to levels paid by Italy earlier in November, 185 basis points ($185,000 annually to insure $10 million of debt for five years.) 
The only thing missing in these parallel developments is the equivalent of the Lehman Brothers collapse for the Eurozone.  Should such a  cataclysmic event occur in the Eurozone it would probably break up the currency union.  So what could this event be?  Here is what Desmond Lachman has to say:
The more likely trigger for the euro’s eventual unraveling will be in the periphery itself. Already, the Greek, Irish, Portuguese, and Spanish governments have tenuous holds on political power. A deepening in their economic and financial crises could very well result in the ascendancy of more populist governments, which might be less willing to hew to the hair-shirt austerity programs dictated by the IMF or to remain within the euro straitjacket. This is essentially what precipitated the demise of Argentina’s Convertibility Plan in 2001.

Another plausible trigger for the euro’s eventual unraveling could be a heightening of the capital flight already underway in Greece and Ireland. Ample experience in earlier fixed-exchange-rate regimes suggests that capital flight can reach such proportions that countries are left with little alternative but to restructure their debt and exit their fixed-exchange-rate arrangements.
How do you see this ending?

6 comments:

  1. Are you serious in even asking that last question?

    It ends when the people of a nation, to me most likely the Irish, take the OBVIOUS path to recovery of simply refusing to repay their debt to foreign creditors.

    http://krugman.blogs.nytimes.com/2010/11/24/lands-of-ice-and-ire/

    Come on, come on, come on. The Euro was not a good idea to begin with. It has not become a good idea just because the groupthink gets entrenched and each smart individual within the borg forgets how vociferously he or she argued against the Euro before the Euro was birthed.

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  2. Anoymous,

    Yes, I am serious on the last question. I would like to hear yours and others opinions on this issue.

    I have noted many times on this blog that Eurozone fails to meet the OCA criteria. So no, I am not advocating saving it at any cost.

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  3. I think it will end when some nations quit the Euro, and pay all or some of their debts in their own new currencies.

    Which may or may not be a bit different from what Anonymous is saying.

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  4. DB: I think you are missing the obvious similarity between the US and Europe which is the extraordinary failure of the financial regulatory authorities to recognize what was going on under their noses; or worse, if they did understand, to do absolutely nothing about it. What a tragedy that this financial crisis and the enormous human suffering that has ensued was eminently avoidable.

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  5. EU bonds is a solution to the debt crisis that I had been advocating since March 2009 on http://mgiannini.blogspot.com/2009/03/my-name-is-bond-european-union-bond.html.
    Never say never again...
    I had been writing about again recently on http://mgiannini.blogspot.com/2010/12/european-debt-crisis-part-ii.html
    When EU foreign currencies were attacked by speculation we got the Euro to replace them. If now we get sovereign bonds to be attacked we need the EU bond to replace them...
    It's true that simple things are never done or understood immediately....

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  6. @ecb

    Even worse than that - the crisis was avoidable and authorities KNEW more than 10 years beforehand it will happen, if they don't change their ways.

    Which of course they didn't, because hey, it doesn't even concern us, we have our money elswhere, nice doing business with you, EU.

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