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The Euro will survive In fine !

We do not believe or at least most of the implosion scenarios of the euro zone regardless of the terms. -Not because we would be trying to find one or several sustainable solutions to the crisis of sovereign debt, but because such a process would cost too much to everybody for different reasons

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Now those who bet on the end of the euro (and there are more and more, for my part, I considered it in many papers several months ago but did not consider it anymore) draw a parallel with the situation of explosion of the EMS in 1992-1993. It is true that the comparison is intellectually tempting

- 20 years ago, it had become unbearable to gather in the same monetary system, the fight against German inflation born of German reunification in 1990 (requiring higher interest rates) and the fight against unemployment from France and countries of southern Europe (with the rising of interest rates by central banks in these countries to prevent their national currencies from dropping vis-à-vis the mark)

- Today it seems impossible to coexist in the same currency union the model of industrial economic specialization of countries in northern Europe and the one of Southern Europe (including France) based on the often non-tradable services. That is to see that the "Northern" countries only increase their external surpluses and countries in the "South" their deficits. And since there is no union with a federal budget that would institutionalize fiscal transfers from North to South, consequently the euro zone would be condemned

In the euro zone, we will therefore move towards a kind of constrained and massive indirect monetization from the ECB despite the hostility of the Bundesbank, the Bundestag and the German Federal Government.
Mory Doré

Yes but now, we are not in the economic and financial environment of 1992 and the importance of intra-European financial commitments is now disproportionate to the situation in early 1990

- First, highly indebted countries in the south (Italy, Spain, Portugal, Greece) that would come out of the Euro zone and would return to their previous national currencies would be forced to default on public and private debt held by non residents of other countries of the Union given the additional cost (new currencies depreciation against the euro) of the foreign debt denominated in euro

- Conversely, if countries such as Germany with large external assets in the Southern countries left the Euro zone, then they should face severe assets impairment in Euros due to the fall of the European currency against a new German mark. German banks already weak in terms of shareholders funds will not recover.

We have seen that :

  • we were no longer anticipating an exit of fragile countries from the Eurozone (economic cost, socially and politically unbearable for these countries)
  • We do not anticipate either a unilateral exit of Germany (substantial macroeconomic cost with a significant loss of competitiveness and high financial cost regarding the commitments of German banks in the peripheral countries of the Euro zone)
  • We do not anticipate development of a two-tier Euro zone based on economic considerations : Northern Zone fiscally virtuous and Southern Zone trying to catch up with its competitive handicaps. that would be the end of Europe as it would be about splitting the six founders of Europe: Germany and the Benelux countries on the one hand and France and Italy on the other)
  • Finally it is now unrealistic to anticipate the establishment of a true political union with fiscal federalism and therefore systematic budget transfers from the richer to poorer. This solution will never be admissible in Germany

So what is left ? Well, the survival of the euro. But how the euro zone will survive and what will it look like ?

It is a commonplace to say that the best way to ward off the debt crisis is to find paths of growth, but strong growth is impossible since the financing of the economy is uncertain, as the banking systems must come back to solvency and a good number of economic agents must deleverage.

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And in Europe, but not solely in Europe, as long as the horizon of politicians economic decisions will be confused with the horizon of the election cycle, all major structural reforms which we are told, for example in France for 20 years (status, tax ...) will never happen, and it is these that are able to create the conditions for a strong and sustainable growth

In the meantime, we need to mobilize resources and funding to reduce the unsustainable debt. It is agreed that this is not shocking when it is about rescuing a country facing a liquidity crisis (as in Italy, Spain and Ireland), but it is more questionable and ineffective in the case of bailouts of countries in solvency crisis (such as Greece and to a lesser extent, Portugal). But all this is another debate which will require political leaders to consider the implementation of emergency and non-conventional measures. The question will be how we can sustainably bring some economies of the Euro zone back to solvency ?

Returning to our subject. There are 3 ways to mobilize resources:

1/ There is first of all resources used by the EFSF, which has guarantees provided by the member states of the euro zone. These resources are borrowed on markets, they are limited and will be built up gradually as the fund will periodically carry out issuing programs on the market with ease depending on the environment. And anyway, this type of resource is not at all appropriate for the refinancing of some important outstanding sovereign debt (Italy and Spain)

2/ There are also resources created out of nothing and that only the central bank can issue. It would be here for the creation of money to buy government debt (this is called according to time and media printing money, monetization or QE for quantitative easing). Unlike borrowed funds, there is no technical limit to money creation as the central bank issues a debt itself. The only limit is financial because uncontrolled money creation written in the central bank liabilities and the accumulation of financial assets of varying quality in the balance sheet of the central bank may eventually cause a sharp devaluation of the currency .

Central Banks : the global financial system trashcans ?

Institutionalized monetization condemns central banks to become the international financial system trashcans and, despite German opposition, it is likely to be the same for the ECB.

But that do not scare people so far and, without asking too many questions, many politicians and economists believe in this excessive monetization solution: the ECB prints money and use it to buy from banks and insurers all European government papers that they do not want into their balance sheets. Although I saw the panic in financial markets during the session of 28/12, because that they had discovered that the ECB balance sheet had reached a size historically high.

The Big deal, that’s now over 3 years that the central bank balance sheets beat record after record in terms of balance sheet size. Several manifestations of this phenomenon:

  • quantitative easing similar to the FED or BOE, which is about creating money from nothing to buy toxic bank and sovereign debt ;
  • the ECB Long term refinancing operations (LTRO) of lending to banks through extraordinary tenders (See the 489 billion Euros in the 3 years tender offers of 21/12/2011)

Anyway, for now, the ECB refuses to play that role. And Mario Draghi, reiterated that the peripheral debt buybacks should be temporary and limited and that they should be routinely sterilized.

3/ Between the borrowed funds in the markets and the resources from money creation of a central bank, there is monetary resources such as the IMF sitting on the famous SDR for Special Drawing Rights. Be aware that each country has a position in the IMF regarding its economic weight of SDR. These rights were created in 1969 to play the role of additional reserves for the states. Thus Germany has 13 billion SDRs, France has 10.7 billion and for the entire euro zone, this amounts to 50.4 billion SDR (with a Euro-Dollar parity today around € 1.15 for 1 DTS, it is a total of 58 billion €). There is a rule that sets the quota to 10 times the funding limit, this means that the entire euro zone has a theoretical capacity of up to 580 billion €. So when you hear on a given broadcasting channel that the IMF is lending € 400 billion to Italy, you must understand that without institutional reform of the IMF and without additional resources, it is based on these drawing rights in the Euro zone that this amount is allocated (so nothing too spectacular after all).

But we will likely see a strengthening of the IMF monetary resources: increase in the quota of countries with consistent reserves and surplus, indirect money creation powered by the ECB

In the euro zone, we will therefore move towards a kind of constrained and massive indirect monetization from the ECB despite the hostility of the Bundesbank, the Bundestag and the German Federal Government

Being an indirect monetization but orchestrated by the ECB, the Frankfurt Institute will require strong counterparts from the states and the implementation of sustainable restrictive fiscal policies.

And since these restrictive fiscal policies could stifle the economy, the central bank will agree to offset this pro-cyclical with more accommodating monetary policy for a long period will not oppose a significant and orderly drop in the euro-dollar parity.

Mory Doré , December 2011

Article also available in : English EN | français FR

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