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Europe Begins Its Endgame. Watch and Learn, for Europe’s Problems Are the World’s.

Summary: The endgame for Europe (in its current form) probably has started. Like birth, nobody knows what comes next. Will the process be easy or difficult? Fast or slow? Produce an angel or monster? Here we make some guesses.

Pay attention, as Europe’s travails mirror those to come for the world.

Contents

  1. The present: rising stress
  2. What comes next?
  3. The lesson Europe offers to the world
  4. For more information

(1) The present: rising stress

In a troubled marriage the first mention of divorce can spark its dissolution, as the partners protect themselves by grabbing assets and consulting attorneys. Something similar afflicts the Eurozone. The G-20 conference was advertised as the last chance to save the Eurozone. After it passed with no strong action, Greece’s PM proposed a referendum — in response to which Germany’s PM threatened to eject Greece from the EMU.

Now they have taken the next step, making contingency plans. “French and Germans explore idea of smaller euro zone” (Reuters). “Merkel’s Party May Adopt Euro-Exit Clause in Platform, CDU’s Barthle Says” (Bloomberg). Italian bond yields have spiked up in response to the increased risk of default. Next will come capital flight from the PIIGS to safer lands. Such things will destabilize Europe. If continued the current structure will collapse, forcing either unification or fragmentation. Most experts bet on the latter, although anything is possible.

(2) What comes next?

The news media describe the European crisis — like they do almost everything — as a morality tale. Strong northern Europeans sell their fine manufactured goods to their swarthy southern neighbors (loaning them the money to do so). We consume these tales like children. In fact all these nations did well until they joined the EMU. Only after 2000 did the debt for goods trade develop, the inevitable result of a monetary regime designed for Germany wrecking the competitiveness of the southern members of the EMU.

The outcome might disappoint those in the audience hoping for a victory of goodies over baddies. The likely fragmentation of Europe might mean devaluation and default by some of the PIIGS. Freed of their excessive debt burdens and mad German-imposed austerity programs, competitiveness restored by their new (and devalued vs. the Euro) currencies, their economies might recover. That assumes that they manage the process well, using the turmoil as an opportunity to make vital reforms.

What of the heroes of the north, liberated from their weak and feckless southern cousins? Their exports will fall due to the lost southern markets. Their currency (perhaps a super-DeutschMark) might rise in value — like the Japanese Yen and Swiss Franc — to levels making their exports uncompetitive in much of the world (a too-strong currency is an anvil tied to a nation). Their banks will require massive government support, as some of the PIIGS default (in some fashion) on their bonds.

Economics, like medicine and engineering, is a practical science – not a morality.

(3) The lesson Europe offers to the world

The G-20 Summit statement of November 2008 (in the midst of a global collapse) nicely described the problem within Europe and of the world:

Major underlying factors to the current situation were, among others, inconsistent and insufficiently coordinated macroeconomic policies, inadequate structural reforms, which led to unsustainable global macroeconomic outcomes. These developments, together, contributed to excesses and ultimately resulted in severe market disruptions.

In the three years since nothing has been done to solve these problems, either in Europe or the world. Now events force Europe to take action. Events will similarly force global action, eventually.

(a) The madness of the “everybody must save” policy goals, and the lack of necessary global policy coordination

From “Europe is choking on imbalances, will the global system be next?, George Magnus, 9 November 2011

{about deflationary policies}:
European countries give top priority to deficit adjustment through more austerity – witness current deliberations in Italy and France.
The US debt ceiling crisis resulted in deficit cutting proposals now reaching a critical deadline at the end of November.
And many emerging countries, including China, have continued to restrain nominal and real exchange rate adjustments, while pursuing restrictive economic policies to contain inflationary pressures.The asymmetry of policy adjustment is only ‘sustainable’ in the sense that for as long as it continues, the outcomes will be negative for growth, financial stability and trade and capital movements. This is the result of advanced nations looking to deleverage and raise savings, while key emerging nations pursue economic models based around high levels of savings.
The creation of the G20 in 2008 was a notable milestone in bringing together most of the world’s biggest creditors and debtors. But apart from the coordinated 2008/09 response to the financial crisis, much of which had been pre-determined nationally, its subsequent record doesn’t amount to much of consequence. The recent Cannes Summit showed all too clearly, in spookily reminiscent tones of the London Economic Conference of 1933, that the G20 lacks the leadership to draw up an agree and implement an agenda to unwind imbalances. The financial crisis has sapped the US ability to lead, left China’s unwillingness untouched, and further undermined the capacity of Europe on both counts.

(b) The madness of vendor financing

The current structure of Europe cracks under the slowly rising stress of vendor financing: export-based prosperity for some, debt-financed consumption by others. Unless reformed, this can only end badly. The global economy has similar imbalances. In 2010 the trade surpluses of China, Russia, and East Asia (China being half the total) were almost equal to the US trade deficit of $560 billion. OPEC, Germany, and Japan accumulated another $518 billion surplus. These numbers continue year by year, accumulating stress that will eventually break the current global financial order.

We should watch and learn from Europe’s experience in the months to come. We, and the rest of the world, may follow them sooner than we expect.

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