Tuesday, November 29, 2011

Breakup of the Eurozone

by Richard Crews
Twelve years ago 17 countries on the European continent embarked on a bold experiment. They agreed that, despite having different languages and cultures, despite having a history of centuries of wars among themselves, despite having emerged only a half-century earlier from World War II--the most devastating conflagration the world had ever known--despite all these things, they would abandon their separate rights to establish individual monetary systems and join together in a single currency, the Euro. The developing global marketplace seemed so vast and powerful that they thought it could heal their cultural rifts forever.

Since then they have discovered that their styles of governance and fiscal management differ significantly. Some (like Germany) have grown strong industrial and marketing economies and well adapted taxation and other government fiscal policies. On the other hand, some (like Greece, Ireland, Italy, Portugal, and Spain) have continued to provide government services (from salaries and pensions to education, health, and safety measures) that they could not afford--they have maintained archaic and inadequate tax structures; and they have borrowed on international bond markets to make up the differences.

Over the past few years it has become clear that these disparities cannot persist--that the economically weaker countries can undermine the Eurozone enterprise as a whole. Specifically, if any of the weaker countries cannot pay back the money they have borrowed, the countries and the European banks that have lent them this money will be in trouble--they, in turn, may not be able to pay their obligations to their creditors, depositors, and other investors.

The first threatened default--Ireland--was handled successfully. The other Eurozone countries guaranteed the debt and Ireland tightened it fiscal belt.

But the next--Greece--was bigger and more complicated. A series of measures seem to be too little and too late.

Now Spain and Portugal seem in jeopardy. Even the huge economy of Italy--definitely too big to fail--seems threatened.

The entire Eurozone financial structure now seems on the brink of cascading into collapse.

What does this mean in terms of the European and world economies? Suppose the Euro is no longer issued or guaranteed by a consortium of countries? In that case each country on the European continent would revert to issuing its own currency--the Dutch guilder, the French franc, the German mark etc. And these currencies would, once again, trade against one another--the stronger ones would be preferred in contracts, business transactions, banking, etc. The weaker would sink in value--they would buy less in the market place. Both of these factors--both the fluctuations and the relative strengths (or weaknesses)--would be problems.

Suppose, for comparison, the U.S. government ceased to issue and guarantee dollars. Suppose your salary or pension began to be paid--if it was still paid at all--in California or New York "dollars" which fluctuated in value on a weekly or even daily basis--one day a head of lettuce cost a dollar and a week later it cost fifty cents or two dollars. Contracts (to roof your house or to buy a car) had to be carefully written to protect both parties--so carefully that they became impractical--in fact, impossible.

Even though this worst-case scenario is very unlikely, businesses, banks, and governments around the world have already begun to hedge against losses that would be incurred in any fiscally volatile times. They have begun to hold larger cash reserves (in stronger currencies such as U.S. bonds and precious metals), to lend more cautiously, and to favor short-term over long-term commitments.

The contraction of business and other fiscal activity around the world has already begun. We stand, with the Eurozone's economic fragility, on the brink of a severe worldwide depression.