Monday, May 10, 2010

The End of the ECB and the ECU -- Just a Matter of Time

Anyone who thinks that the European Central Bank is independent after this past weekend is simply not paying attention. The ECB was blackjacked into a number of policy changes that violate the very charter that created its founding. The long suspicion that the Euro would not survive its first major recession seems to be headed toward reality. The ECB was not the only casualty of this weekend's agreement. The ECU nations also agreed (with IMF money thrown in) to a $ 1 Trillion Dollar rescue package for Eurozone countries in trouble.

It won't work.

First of all, if the policy changes in the One Trillion "Rescue Plan" are really brought into force, it means economic disaster for the countries being rescued. Their economies will enter a period of long term decline. How can it be avoided? Austerity, in the midst of a recession, is a prescription for disaster. That is what lies ahead for Greece, Portugal, Spain, and Italy.

What is the future for Germany and France? We saw something of their future as we watched yields on German and French bonds rise (while the Euro fell) today amidst the spirited rally that swept world equity markets. Germany and France are not very good credits anymore, because they have underwritten the profligacy of the weakest of the Euro countries. That weakness is now the weakness of German and French sovereign debt. In time, a crisis will arise in the German and French sovereign debt markets. The US donated $ 50 billion to this foolishness (by way of the IMF).

There is some mild hope for the US and Britain, because they can drastically devalue their currencies and pump up inflation as ways to deal with their own debt crises. The debt crisis will reach Britain (sooner) and the US (later) -- but it will arrive in time. The US and UK have more flexibility, but they too may founder on foolish policy decisions. They certainly have made many such foolish decisions since the Fall of 2008.

What you are likely to see is a race to the bottom as countries withdraw from international trade all together, reminiscent of the 1930s. Everyone will attempt to curb imports and expand exports (even within the Eurozone). It will not be pretty.

The Euro countries are in desperate straights. The Eurozone was forecast, prior to this weekend's bailout, to grow at a mere 1 percent next year. The bailout package should reduce this +1 to some kind of negative number. This means fiscal situations will get worse not better, throughout the Eurozone. The Eurozone will have a lot more debt and an increasing inability to fund that debt. Overall bankruptcy, in one form of another, is the future of the Eurozone if the "bailout" package is really implemented.

But, what is the chance of implementation? Greek workers have scheduled a nationwide strike for Wednesday. Germany's largest and wealthiest province, NRW, just handed the Merkel government a stunning defeat Sunday, causing the Merkel government to lose their majority in the German upper house of Parliament, which narrowly passed the much smaller Greek package put forth by the Merkel government just last week. The issue in the NRW: opposition to the ECU bailout program for Greece. Polls show that 70 to 80 percent of German voters oppose the bailout. Which German political party is going to step and push this package?

Will the Spanish, the Portuguese, and the Italians sign on for the austerity measures that this agreement will call far? Not likely.

One way or another this package is probably not really going to be implemented. The Germans and French will begin to get nervous as CDS spreads on German and French debt began to widen. They will be peering into their own futures as they watch the CDS market value their sovereign debt. Popular opposition to austerity programs will kill any real chance of slowing spending in countries like Greece and their southern European neighbors. Tax revenues will fall throughout the Eurozone and especially in the weaker countries.

The Euro is now doomed. It will not survive and the Eurozone will plunge into long term economic stagnation and sky high unemployment for decades to come.

The European bailout is the ultimate in "kicking the can down the road." The problem is that the road is straight down hill and can is gaining momentum. It will soon not be catchable at all. Only economic growth and a reduction in entitlements and public employees can bail out the European welfare states and that is no longer in the cards.

The right answer to the problems of Greece, Spain, Italy and Portugal is to let these countries have a partial bankruptcy, offering their creditors a workout of 25 to 30 cents on the dollar (or whatever makes sense), establishing a clean balance sheet and beginning anew in the credit markets. That solution would permit economic growth and would not drag Germany and France into the mix (although German and French banks would take quite a hit, which they should take -- after all, they made bad decisions -- they should pay for those bad decisions).

There is still hope for the US, but there is no hope for Europe.