The Euro falling into a recession?

http://www.economist.com/node/21540259?fsrc=scn/tw/te/ar/bewareoffallingmasonry

by aespinoza • 15 years ago

56 117 15 years ago

economist.com

davidw• 15 years ago

The phrase that struck me is "The risk that the currency disintegrates within weeks is alarmingly high"

Weeks ?! Wow... that's a very short time frame.

nickpp4• 15 years ago

What exactly does a currency disintegration mean, anyway? Even of the economy goes into recession, the euro would still be on the market, used by all these countries.

mootothemax2• 15 years ago

the euro would still be on the market, used by all these countries.

A country doesn't have to continue using the Euro. It would be... painful were they to switch, but it's by no means impossible.

SkyMarshal• 15 years ago

It means Greece, followed by Portugal, Spain, Italy, possibly Ireland, all leave the Euro and re-issue their own currencies. Suddenly the Euro is not the currency of a 400 million person economy anymore, but something smaller.

vladd3• 15 years ago

Euro disintegration implies an abolishment of its treaty ( http://en.wikipedia.org/wiki/Maastricht_Treaty ) or a ratification which would severely limit its scope (and significantly affect the list of participating countries).

michaelty• 15 years ago

Intrade has it at 8% that a country drops out of the euro by the end of the year.

http://intrade.com/v4/markets/contract/?contractId=713738

seltzered_• 15 years ago

eric janszen at itulip.com has been speculating on a euro fracture, due to the lack of a cohesive

I find it surprising how just 3 years ago the euro was becoming a safe-haven, with Jay-Z flaunting them in his videos.

DanielBMarkham2• 15 years ago

I read a lot of financial commentary. In the last year the discussion about the Euro breakup has gone from "if it breaks up..." to "when it breaks up..."

There is a lesson here about taking systems of people and trying to mash them together without acknowledging the necessary pain. I'm concerned that now we're in the end game, and more and more complex strategies are just going to make things worse. I would never advocate any kind of violence, but there's a good reason why Napoleon was the one person who did the most to modernize Europe.

The general consensus seems to be that a recession is already under way, and the contraction will continue until this all gets straightened out.

VladRussian• 15 years ago

>but there's a good reason why Napoleon was the one person who did the most to modernize Europe.

if you mean centralized government of the Empire - i'd not agree, there were other big Empires in the Europe which preserved, instead of solved/improved, the problems. If you mean Napoleonic wars, when i'd agree and add WWI and WWII.

Tichy6• 15 years ago

The most convincing argument seemed to me that the way the Euro was set up is simply not workable/secure - for example they can not just print more Euros because of lots of rules.

But that kind of thing hardly seems to be the problem of mixing too many people together, it is simply a flaw in the system.

Of course the initial problem might have been that the system could only be some lowest common denominator of all the systems it tries to combine, making it almost impossible to create something good.

I find it interesting that there are therefore two interesting problems: how to set up a stable currency, and more importantly, how to set up a decision process that produces good results and doesn't alienate everybody.

k-mcgrady5• 15 years ago

The problem is that monetary policy is not set on a country by country basis. The economic cycles of countries differ and trying to control monetary policy on a global level leads to policies that do not help any country.

DanielBMarkham2• 15 years ago

Yes, it is a structural problem. Separately, the governments are ruled by politicians that get their mandate from the people. They tried to keep local fiscal policy and yet somehow together have a unified monetary policy. That's the kind of problem that's blatantly obvious from day one. What happened was a series of complexities that were added to these systems of governance that obscured this underlying reality. This trend looks to continue, with more and more schemes using more and more complex policies and products. It doesn't look so good.

Of course, I'm just relating what I've been reading. I can tell you it's been quite alarming and yet strangely placid. Like watching a slow-motion train wreck.

I didn't mean the number of people. I meant the idea of smashing up lots of different systems of government and cultures through byzantine layers of bureaucracy instead of just replacing them with a centralized government (which would have worked very well, probably, but it was politically unfeasible)

k-mcgrady5• 15 years ago

I don't think the Eurozone will not break up. It will most likely lose some members though. These will either be the larger economies like Germany or the smaller ones which should never have been allowed in in the first place.

seanalltogether• 15 years ago

In other words, you can't have a single economy without a single government responsible for enforcing the rules.

brador2• 15 years ago

Can someone explain why the UK is not shown in any of those graphs? I thought it was part of the Euro?

sateesh• 15 years ago

No U.K is not part of the Euro, the currency in U.K is Pounds (GBP)

seanos• 15 years ago

UK = £ Sterling

rmc4• 15 years ago

The UK is part of the EU, but it is not in the Eurozone and does not use Euro currency. Sweden and Denmark are also both in the EU and, along with the UK, did not switch over to the Euro.

brador2• 15 years ago

So will the UK be well protected from this fallout?

_delirium2• 15 years ago

Denmark, Latvia, and Lithuania are sort of partway in the Euro: they joined ERM II, which guarantees a fixed exchange rate to the Euro. So while they retain separate currencies, those currencies are just alternate units for the Euro, at a fixed conversion, unless they break the peg, and how they rise/fall against other currencies like the dollar or yen is 100% determined by how the Euro moves. Though admittedly it'd be easier to break the peg than to unwind full Euro membership, so the exit strategy is clearer.

I believe Sweden and the UK are the only two non-recent EU members with fully independent, floating currencies.

rmc4• 15 years ago

I forgot about all the new eastern and central European member states that are in EU but not eurozone, eg Poland, Romania, etc. Most of those joined the EU after the euro started, and so couldn't join eurozone, though many are starting the process.

danmaz744• 15 years ago

There is so much shortsightedness in this whole crisis. What had to be done was clear from the start:

* recognize the dangers of this crisis and act boldly

* have much stricter controls on Eurozone countries, and have mechanisms to automatically cut expenses/raise taxes when some don't respect the rules (as Greece so blatantly did)

* compensate that making the ECB the lender of last resort of the Eurozone Countries

It's getting late, but there is still time to do this. But our leaders need to stop being timid and worrying so much about their reelection.

rmc4• 15 years ago

have much stricter controls on Eurozone countries

That would require some new treaties, and in some countries, require a referendum, i.e. a popular vote. If there's a big financial problem, you don't want that to hang on the popular vote or some small member states.

have mechanisms to automatically cut expenses/raise taxes

EU doesn't have the ability to levy taxes, only member states.

The cynic in me says that with the ECB bailing out & funding several states, that the ECB already has the power to dictate taxation matters to some of those states already. Let's see if that saves the euro.

danmaz744• 15 years ago

Yes, changing the treaties now would really be a big problem; but it looks like they're thinking about bilateral agreements to start with. That would be a much faster approach.

As for taxes to levy, I didn't mean that they would be levied by the EU, but that the member state would have to do that automatically to keep the imbalance in check. Not easy to enforce, but I'm pretty sure a way can be found if there is the political will.

barrkel6• 15 years ago

That wouldn't have fixed the problem. Did you know Germany broke Maastricht spending limits well before most other countries did? That Ireland had a debt to GDP ratio of ~30% before the crisis - and it never burned any failed bank bondholders because of pressure from the US Fed's Tim Geithner, as well as the ECB? In Ireland's case, the US and the ECB coerced it into forcing its citizens to take on private debt owed to foreign bondholders.

And Germany would still not acquiesce to letting ECB become a lender of last resort. FWIW, Germany didn't want Italy joining the Euro, much less Greece.

danmaz744• 15 years ago

With the ECB acting as the lender of last resort, there wouldn't be a sovereign debt crisis at all in the Eurozone: Interest rates just couldn't have risen so high. I'm pretty sure that would have fixed the problem - not Greece's crazy expenditures, but the spreading of a lack of confidence in other Eurozone states debts.

To get there, (mostly) the German and European leadership would have needed/need to reassure (mostly) the German public with different rules that would make a new Greek case impossible, and to make it understand that the more timid you are, the more you're going to pay for the crisis, Germany included.

dman• 15 years ago

I have always been interested in how the Euro does in the long run given that it is not directly backed by taxation and given that the central body does not appear to have the broad mandate to enforce a fiscal policy for the entire Eurozone. The next year should be really educational in this regard.

tlammens• 15 years ago

Sometimes I think headlines like this are the cause of a recession rather than the facts behind it. Economy is more about psychology than it is about numbers.

(Of course there were governments and financial institutes which have behaved badly in the past, no denying there.)

veyron7• 15 years ago

The very same agencies that are generating the headlines are leaking the headlines to hedge funds hours before. There is a current SEC probe of S&P over concerns that employees disclosed info about the downgrade to hedge funds hours before the announcement.

wildjim• 15 years ago

I have regularly wondered how all these Hedge Funds (let alone the Banks) are doing so well without some kind-of inside information and/or some means to "generate interest or concerns" in the direction they would find the most beneficial.

dreamdu5t• 15 years ago

The Euro is a tragedy of the commons. Each individual country can benefit from using the central bank but all share the costs.

Why are there still people trying to convince us that the mere existence of more lenders is a solution to debt?

nhaehnle3• 15 years ago

You've got it the wrong way around. At least according to the official rules, none of the member countries can benefit from the ECB system.

The ECB has broken that rule because they realized that if they stick too tightly to it, they risk a breakup of the Eurozone, and that would eliminate their power base. By giving the least possible amount of support to troubled countries, they hope to stay in power - at the cost of the real living standards of the peoples of those countries, of course, as you can see with a quick look at the double-digit unemployment rates there.

The Euro could become a tragedy of the commons, but it isn't one at this point in time. It is more an example of Wile E. Coyote running into the air since 2000 until, around 2008-2009, he realized that there is no longer any ground beneath his feet. Since then, he's falling.

antr3• 15 years ago

Currently, the disintegration of the Euro is highly unlikely:

- If each country leaves the Euro, debt (including that with the U.S.) will remain as it is (no change in face value),

- If each country has its own currency, the inevitable devaluation will increase the value of the debt, and cost of interest (on local currency terms), making it impossible for many countries to repay that debt (including that with the U.S., which is well over $350bn)

- This will result in the immediate default for a long list of countries.

Food for thought

yxhuvud5• 15 years ago

Sovereigns do not play by the same rules as the rest of us. They can unilaterally declare their debt to be in their new currencies, if they separate.

If each country leaves the Euro, then this will definitely happen. If only some does, then it will be up to the courts to decide what the treaties says.

Tichy6• 15 years ago

Of course they could, but there might be consequences. For example nobody might be willing to lend them money again in the future. Or there might be wars ("if you don't want to pay me what you owe me, I am going to take it by force").

Overall, who is going to guarantee a contract between states (like money lending)? There is no superpower that watches over them and punishes them if they do wrong, they have to fight it out among themselves somehow.

antr3• 15 years ago

You are misreading the comment while making untrue economic and policy comments.

"They can unilaterally declare their debt to be in their new currencies, if they separate." is juts a wrong statement. How is sovereign debt different from corporate debt? Do you have an example?

Example: If Italy goes back to the Lira, the face value of Italian debt that the U.S. Government holds, in dollar terms, will not change, even if that debt is changed to Lira, IT IS NOT re-valued to a price the Italian Govt. sees fit. Should a devaluation of the debt occur, the U.S. would have to write-off billions from its balance sheet (assuming a devaluation of the Lira occurs, which is most certain).

If each country does this, billions will have to be written off, there isn't such thing as "Sovereigns do not play by the same rules as the rest of us.". I suggest you read any debt offering memorandum from any European Government or even the U.S. Government, all terms, clauses, reps/warranties are clearly explained and detailed.

barrkel6• 15 years ago

This is true, but it is not sovereigns that determine whether they are in default or not; "credit events" are determined by third parties. When they're triggered, CDSes and other forms of insurance may become payable.

This is also why splitting up isn't necessarily going to fix much. Lots of banks are only solvent so long as they can hold many of these bonds on par on their books. Start having credit events, and crystallizing losses, and you get one bank after another falling over.

It's the fear of bank failure dominoes that is keeping credit out of the market; ironically, this fear of insolvency is destroying liquidity, which in turn is increasing insolvency risks - as long as banks are liquid, they can live indefinitely on the money they skim off the rate difference between their assets and liabilities. The ECB is in fact surreptitiously keeping the system afloat by purchasing bonds, but not liking it at all.

There's no simple solution to the whole mess; no matter what happens, I think it's going to be painful.

Freestyler_3• 15 years ago

It's already a recension, the Institute of International Finance (IIF) had said that last week. The last months the situation in Europe has gotten drastically worse. The expected growth of the economy in 2012 is -1%.

MaysonL• 15 years ago

Headline wrong, twice:

1) Question mark. Recession already starting.

2) Not falling, pushed.

adabsurdo• 15 years ago

depression would be more accurate.

the problem, i think, is that there is a core contradiction at the heart of the euro system:

1) you can't have a currency union, without a fiscal union;

2) you can't have a fiscal union, without a true political union;

3) the euro area is a currency union with neither a fiscal or a political union.

in other words, for a currency union to work well, you need to shuffle money around. but you can't do that without political legitimacy, or if people feel like the money is going to "them", as opposed to "us".

The leaders who created the euro were trying to go about it the other way around: currency union would lead to fiscal union, which would lead to political union. but now, in a recession, with things going bad, they are finding that, in fact, they would need all three for any part to work correctly.

why are the Germans refusing to let the ECB be the lender of last resort? the core reason is that they see, correctly, that this would put them on the hook for the past and likely future mismanagement of the Greeks and Italians. of course, they can't say this publicly, so instead you hear all sorts of nonsense, hyperinflation this and weimar that.

or, to put it another way, would the Germans let this kind of thing happen to other Germans? I don't think so! Greeks and Italians are "them", and in bad times people feel less generous and fall back to the "us".

but at the same time, of course, their refusing to let the ECB, as it were, bail out the Greeks and Italians will inevitably lead to their default, exit from the Euro, and who knows what after that. at the very least, expect nationalist parties everywhere to rise in the polls.

let's just hope that we're not rebooting to the early 20th century.

umarmung2• 15 years ago

Excellent post.

1) you can't have a currency union, without a fiscal union; - correct.

2) you can't have a fiscal union, without a true political union; - unknown, but history is on your side.

3) the euro area is a currency union with neither a fiscal or a political union. - correct.

There may be a way to incentivise independent states to act in their collective interest and thus create a fiscal union without a true political union. However, if there is such a way, it has certainly never been applied to date for the Eurozone. This is the grand experiment ongoing in the EMU.

In a sense, the experiment not only already failed, but failed from the outset due to states choosing to ignore leverage rules in the 1997 Stability and Growth Pact, including even Germany.

The probability of this ending well, or without Germans paying in some shape or form and potentially severely against their long-term interests, is low.

If Germany had any sense, they will be making preparations to leave at any time, possibly taking the few remaining Germanic (+Switzerland) and Scandinavian creditor nations with them too.

danmaz744• 15 years ago

The point is that Germany IS going to pay for the crisis anyway, because if Greece, Spain and Italy defaulted, the German banks would lose hundreds of billions of euros of German money. The European economy would enter a crisis that would last years (decades?), and most of German exports are to other European countries - thinking that they could have a great economy amid a European depression is just stupid. And I'm not even thinking about the possibility of wars should become "everyone for himself" in Europe again.

So, it isn't a matter of self interest vs. generosity: it is a matter of understanding that it would be MUCH less costly to make the ECB lender of last resort now than to wait and just hope that things will fix themselves. Moreover, in Italy the only real risk is that of interest rates on its massive debt going too high: Italy already has a primary budget surplus, with "normal" rates the debt would already be shrinking.

lutorm• 15 years ago

When Sweden voted whether to join the Euro zone back in 2003, one of the arguments against was this exact scenario. They said something like "there has never been a successful case of a permanent currency union without a fiscal union in history. Even if remaining outside of the Euro will have a small negative effect on the Swedish economy, it's akin to paying insurance against the (in their opinion at the time) substantial risk of a Euro collapse."

zerostar07• 15 years ago

So if there are sufficient amendments to the EU treaties, Sweden is bound to join?

nickik• 15 years ago

> you can't have a currency union, without a fiscal union

This is just not true. Didn't we have Gold and Silver for a common currency for a very very long time? Didn't countries just default back then?

The problem is not the currency the problem is implicit (now explicit) agreemand that countries cant default in the eurozone. Greek could of have defaulted just as Island did. The only loosers would have been the people holding the debt. There would no Euro-Crisis just a crisis of the countries that do really have a fical crisis.

umarmung2• 15 years ago

1. A peg is not a common currency/currency union. Critically, you readily come on and off a peg.

2. Various types of gold standards have failed many times in history, including pegs to gold. The reason is almost always the same: countries will overspend no matter what currency they use - wars/militarism are often the excuse. Notable failures include:

- helping worsen, if not cause, the US Great Depression (US Fed decided to defend the peg to gold);

- helping cause the Weimar German hyperinflation (due to the victors taking almost all the German gold reserves for WWI reparations).

3. Free floating, market-traded fiat currencies solved the core problem of a physical fixed currency like gold. But like gold, they do not, nor can they, prevent governments continuing to overspend. However, they do allow a mechanism to punish them for doing so, i.e. the capital markets!

Unfortunately, the capital markets are unable to enforce their own brand of spanking and consolation in this case because there are no individual currencies per government in the Eurozone. So, it has to whip them using the main stick it has left which are the separate sovereign debts, but cannot console them with lower currencies.

After leaving these individual sovereign debt markets in droves and therefore causing government borrowing costs for EZ countries to soar to unsustainable levels, everyone in the markets is finally starting to realise there is no upside in being involved in a common currency which is killing its members.

Locked in a sub-optimal currency area, unable to raise affordable funds, unable to devalue currency, forced to reduce debt levels by austerity, no ability to import inflation (which would reduce real level of debts) because the world economy is entering a downturn, no fiscal union therefore no fiscal transfers, uncompetitive industries and low productivity due to decades of binge spending, therefore low or negative growth outlook...

This is a painful way for any sovereign to live and at some point something has to give!

antirez2• 15 years ago

I think that many people like me, that don't even know economy 101, are now wondering: what happens if euro disintegrates, practically speaking?

80hours2• 15 years ago

Nothing special. Euro would be exchanged with national currencies. No money will be lost or anything. Just a giant currency conversion, but with some turbulence around it.

Having said that, the Euro is a great project. It will trigger a common European economic policy and that will push Europe to the next level.

elemeno• 15 years ago

It's nowhere near as simple as that.

What national currencies will Euros be exchanged for? What rates will they be exchanged at? Will other markets recognise those new currencies (and they will be =new= currencies, since all the Eurozone currencies ceased to exist when they changed to the Euro), and what rates will they be traded at on the markets as opposed to the fixed exchange rate they'll swapped for Euros at.

It took 10 years to get from the establishment of the Euro (then ECU) as a currency to the point where all the Eurozone nations switched to it as the only official currency - there will not be 10 years to switch the other way, and it's going to be very very messy.

The Euro is the 2nd most traded currency after the US dollar, is the 2nd largest reserve currency after the dollar, it's used as part of currency baskets for setting FX rates of numerous other currencies. Were the Euro to dissolve, the second order effects in markets around the world would be extremely turbulent, and likely highly damaging to the world economy.

Claiming that it would be 'Nothing special' is naivety at it's most dangerous.

InclinedPlane2• 15 years ago

Your statement is false on its face. The Euro has not triggered a common European economic policy but instead has made the impact of dissimilar economic policies worse.

What is the route from point A to point B here? An economic crisis that forces tighter Eurozone policies? Military enforcement of economic policies?

yxhuvud5• 15 years ago

Depends a whole lot of how it disintegrates. Every country for itself, or a divide into southern and northern fractions with radically different policies?

Anyhow, short term, there will be a lot of fallout where exchange rates for contracts and loans stop being predictable leading to a drop of trade, and quite possible a lot of failed banks and other big institutions (probably saved by their respective governments, but it will still be a shaky time).

Long term (assuming the sovereign debt is made into national currency and not kept in Euro[]), the increased flexibility will make the economic status of the different Euro members a lot sounder. There will be consequences of less trade though, since it is not free for the companies to protect themselves against currency effects.

[] If they keep the debt in Euros while not being on the Euro themselves, then I expect hyperinflation. Thankfully for them (but not necessarily for the creditors) they will be able to do such a transition by a stroke of a pen. Sovereigns play by their own rules after all.

80hours2• 15 years ago

> the increased flexibility will make the economic status of the different Euro members a lot sounder.

Why should it? The troubles we see now are NOT caused by the Euro but by overspending. Or are you saying the US economic problems are caused by the US dollar?

forgottenpaswrd• 15 years ago

For europeans, a lot of bad things, the most important:

1)Forced conversions of savings from euros to pesetas, liras, francs, and in the process devaluating their purchasing power 50% or more(somebody have to pay for the excesses in financing industry and history says it is always the people as the people that have money will fly or ask expert advice to not being touched)..

2) Increment cost in commerce between Europeans as you will have to convert pesetas, escudos or liras to francs witch takes a hight commission and bureaucracy(time and money) cost.

3) If you go to other European country you will need to change money(and pay) and if you don't use it all you need to convert it again.

4) Debt is denominated in euros, so when countries start printing money for paying their obligations (pensions, functionaries) debt will be more impossible to pay than already is.

twp• 15 years ago

It's worse.

If the Euro breaks up it will break up into two. The currency of the top half will skyrocket and those countries will quickly become uncompetitive and so their economies will crash. The bottom half will find that they earn is some useless currency but that their debts are denominated in Euros. They will find themselves crushed under an impossible debt burden. Think negative equity on a national scale which last decades.

I know which half I would rather be in, but it's gonna be horrible for everyone.

The Euro falling into a recession?

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