A day of reckoning for the EU

We fret and worry about a two-speed economy in this country, and the government has even slammed a tax brake (the opposite of a tax break) on the faster of the industries – mining – to slow it down, but Australia’s problem is a quiet Sunday drive compared to what’s going to happen in Europe.

Greece is required to suffer a 4 per cent annual contraction in its economy as part of the bailout agreement that will keep it out of bankruptcy, and it’s not alone in misery.

The other over-indebted peripheral Eurozone countries – the rest of the PIIGs, Spain, Portugal, Ireland and Italy as well as politically unstable UK – are also facing chronic deflation and recession as the bond markets and banks abandon them.

But in the core of Europe the strong are getting stronger – especially Germany.

That’s because the wallowing PIIGS are pulling Eurozone interest rates and the common currency down: rates are low and will have to stay there and the euro is in the midst of a major devaluation.

It’s what might be called the Irony of Maastricht, the Dutch town in which Monetary Union was signed 18 years ago: the weak are getting weaker because they can’t devalue their currencies relative to the strong; but the strong are getting stronger because their currency is devaluing against the rest of the world.

Money is flooding into German bonds as a safe haven from the PIIGS, driving long term government interest rates lower. The key European Central Bank short-term interest rate is 1 per cent and going nowhere: imagine the riots in Greece if official Euro interest rates went up as well as everything else.

The euro has devalued 16 per cent since December and plunged 5 per cent in five days at the start of this month as concerns mounted about contagion spreading from Greece to the other peripheral countries, causing potentially massive losses among the banks

And there’s the small matter of whether the Greeks will accept years of declining standard of living and high unemployment. They won’t so most observers believe a debt reconstruction (default) will be needed sooner rather than later.

The loose ECB monetary policy and the devaluation of the euro apply equally to all European countries. Germany benefits powerfully, along with The Netherlands, Belgium, Austria and to some extent France, although it’s somewhere in the middle – neither strong nor weak.

The one blot on this two-speed outlook is the banks: the German and French have been happily lending to Greece, Italy and Spain ever since Monetary Union protected them from currency realignment and gave them what they thought was a “Brussels Put” – a bit like the so-called “Greenspan Put” that led to the credit and property bubble in the United States before the crash took it away.

France’s and Germany’s leaders at the time, Mitterand and Kohl, forced Monetary Union on a deeply reluctant European Union.

Now those two countries don’t know whether to laugh or cry: 18 months after the collapse of Lehman nearly sent them to the wall, their banks are not strong enough to withstand another event like that.

They are into the peripheral Eurozone countries for as much as 2.3 trillion euros and it is not hard to come up with losses of a billion euros if one or more these countries is forced to “restructure” its debts (that is, not pay it back).

On the other hand their economies, along with Austria, Belgium and the Netherlands will be helped by low interest rates and a big and continuing fall of their currency.

Yes, they’re up for big dollops of bailout money in the years ahead, either for their banks or PIIGS or both. But they will likely have plenty of money to give.

Read the full article with links, HERE
Alan Kohler, BusinessSpectator
Alan Kohler