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Thoughts from the Frontline

And Then There Is Disaster C

August 11, 2012

Choose your language

They say that breaking up is hard to do.
Now I know, I know that it's true
Don't say that this is the end.
Instead of breaking up
I wish that we were making up again.
– Neil Sedaka, 1962

I have contended for some time that Europe is faced with two choices: Disaster A, which is the break-up of the eurozone, or Disaster B, which is the creation of a fiscal union, which keeps the euro more or less intact. Over the last few months I have come to realize that there is indeed a third option, which now looks increasingly possible. This is rather sad, as the third option is just an even worse Disaster C. Each choice carries with it its own unique set of problems, but the outcome of any of the choices will be that the people of Europe face a serious recession, if not a depression. This will impact global growth for more than a short time and, depending on the choice, could plunge the world into a crisis as bad as or worse than the recent credit crisis. In today’s letter we look at all three choices, meanwhile musing on how we arrived at the bottom of such a deep hole, shovels flailing.

Breaking Up Is Hard to Do

“Breaking Up is Hard to Do” was written and sung by Neil Sedaka. It was a #1 hit exactly 50 years ago this week. And while that song was written for a different era, it could be the theme song for much of Europe today.

“Don't say that this is the end. Instead of breaking up, I wish that we were making up again.”

And indeed…

Discuss This


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Peter Melia

Aug. 13, 2012, 1:37 p.m.

We have a working example of the results of any country exiting the Euro, and one single actual history is worth all of the other theories put together.
  Actually we have two historical examples of currency switches.
  In 1992 the UK, where I then lived, was ejected from the European Exchange Rate Mechanism.
  It was followed by the predictable panic, with the predicted huge financial losses, the then Government turned the situation around very quickly, and the British economy roared away, to become one of the strongest in the world, until a succession of governments of leftish conservatives and even leftier labourites eroded the advantage.

That is the first example, that of leaving a Euro-like structure.

  Here is another, that of entering a Euro-like structure, in fact, entering the Euro itself. I lived in France at the time, and took part in a European-wide, seemingly seamless transition from national currencies to the Euro. As I recall, the incoming exchange rate Franc to Euro was set at about 6.9555, every country had a different entry exchange rate.
Everything for sale was labelled in both the old and the new currency. Bi-currency hand calculators were for sale at extraordinary low prices (they had two screens, on above the other, you entered a currency in one screen and the conversion immediately appeared in the other).
  The transition was seamless.

  Now, why should not these two historical examples be repeated.
  Why shouldn’t a country exit the euro as the UK, effectively, did, and switch currencies as all the European countries did?
  Why should disasters occur on exiting, when none occurred on entry?

  Perhaps you might like to explore the following two “thought experiments?”
  Thought experiment 1. 
Suppose, late on one friday soon, Germany announced that from that moment on, it’s currency would be called the “Mark”. Then details would be revealed of how the notes and coins were already being transported to banks all over Germany.
  The exchange rate between the Mark and the Euro at that moment was set at 1:1, that is, 1 Mark equalled 1 Euro.
  What would happen?

  Thought experiment 2  
Suppose, late on one friday soon, Greece announced that from that moment on, it’s currency would be called the “Drachma”. Then details would be revealed of how the notes and coins were already being transported to banks all over Greece.
  The exchange rate between the Drachma and the Euro at that moment was set at 1:1, that is, 1 Drachma equalled 1 Euro.
  What would happen?

EPual Jacobsen

Aug. 13, 2012, 12:27 p.m.

You cannot fail to address 25 % unemployment.  A generation on the dole.  Unemployed aged 18 - 25 who is hiring you at age 26 with no experience and a bumper crop of fresh CVs from University right behind you.  Technology alone will have surpassed them they won’t know how to function on new computer systems.

Either A.  plan for uprising of some nature, and/or B.  plan to build many prisons, or C.  Incorporate them in your financial planning as permanently unemployed and unemployable.

Germans may want Euro, but they may change their mind when they find out that must pay for Greece’s unemployed generation for 60 years.

steven graham

Aug. 13, 2012, 6:01 a.m.

What was missing from the following paragraph:
The entire Greek bailout was really about using “European” taxpayer money to pay off German and French bank debts. Ditto for the other early bailouts. Now we are down to saving the euro (with the Spanish bailouts), which is an even more costly proposition.

was that was what happened in the US and the bailout of the big investment banks here-
When is doubt- always rip off the tax payer….

Paddy Secretan

Aug. 13, 2012, 2:02 a.m.

Excellent analysis of the options. France is defiitely the proverbial “elephant in the room”. Nobody I have come across can bring themselves to believe that France will give up one cintilla of sovereignty to save the Euro. France will do what she always does - fight to get her way, fight to get advantages over everyone else, and when things don’t tun out as she likes, ignore the rules and continue to do exactly what she wants!

Giovanni Isaksen

Aug. 12, 2012, 10:10 p.m.

Although it seems like it happened a long, long time ago in a galaxy far, far away the fact that we (the ‘advanced’ economies of the world) are facing a planet full of competitive market economies, often with lower wage structures, is the successful outcome of a plan we devised at the end of WWII to make sure WWIII doesn’t happen (One of the most successful human endeavors to date really). Yes it is painful now for us to lose jobs to those ‘poorer’ countries with less worker protection and less concern for the environment but compared to the Mutually Assured Destruction kids of the sixties and seventies grew up with, it’s the best thing since sliced bread. As someone who grew up with at least a handful of MIRVs pointed at my backyard I can tell you this is the good problem. See ‘A Boy And His Dog’ here:

I am not saying there haven’t been huge mistakes made but our current situation as bad as it is, is the one preferred by those who survived WWII along with those impressionable youths (including yours truly) who grew up in the cold war.

The whole Euro experiment, as flawed as it is, was a serious attempt to avoid Europe being the cause of WWIII or the next 100 years’ war. Everything I’ve read points to the fact that the Euro experiment was designed to eventually drive those countries into a United States of Europe; kicking and screaming if need be but in the end USE.

John McCullough

Aug. 12, 2012, 2:59 p.m.

“We watch the incessant squabbling with unease, wishing they would just settle things and move on. They never deal with the real issues, as that would mean facing too much personal angst and maybe even lead to an admission that the problem is not just with the other party.”

Is there anyone who does not feel this comment is applicable to us in the US. Perhaps we will have the luxury of seeing our future unfold from a distance. There are differences, but the end of the welfare state is the major underlying commonality, driving all before it.

Jack Rivkin

Aug. 12, 2012, 11:07 a.m.

You mention Argentina and there is hyperinflation. Friends visiting this past week indicated that grocery prices are going up daily and there is now a limit on how much one can spend on one visit to the grocery store without filling out forms for the federales. It is also one of the few countries with a sanctioned black market for currency. Latest rate is 6.6:1 and rising.  This is spreading north.

Paul Weaver

Aug. 12, 2012, 6:30 a.m.

Fear can cause paralysis and indecision. It takes strong brave clear thinking people to take charge . How? Not like Hitler, rooted in tyranny and dictatorship but like Churchill, acting in the service of the people, plugging away with reasoned argument and clear thinking in parliament. Lets hope this person/persons can be found sooner rather than later.
Europe is one problem but the other is the USA.  The roots of much of this started there first.  Starting with Enron and the dot-com crash followed by the Subprime banking scandal. Did Senator Carl Levin ever get a satisfactory answer from Goldman Sachs over whether it was morally correct for the firm to sell its clients products described internally as “crap”? Now the prosecutors have scrapped plans to bring criminal charges against Goldman! Our Banks and hierarchy seem free to carry on much as before after creating Sovereign Debt - passing on the “crap”.
Paul Weaver
Winchester, UK

David Bollich 20966321

Aug. 12, 2012, 5:55 a.m.

Regardless of the idiocy of another massive can-kicking, Plan C changes the investment outlook for a couple of years or so.  Get back on the merry go round.

Ismael Castella Clerch

Aug. 12, 2012, 4:48 a.m.

First of all, congrats for your thoughts Mr. Mauldin.

Your thoughts have strongly reminded me of the ones that Mr. Xavier Sala i Martin (Harvard doctorate and Professor at Columbia University, one of our “universal catalonians”) warned a few weeks ago: The real elephant in the room is ... France.

Greece, Spain, Italy ... all of them are a funny & sunny “park promenade” when compared with what’s-below-the-surface in France.

Most surprisingly ... interest rates for French long term sovereing went NEGATIVE a few days ago. First time ever!

Crazy picture. Crazy markets. Crazy debt ratings!

Just a few macro-data about France:

Public spending: 56% of GDP ... and counting. Average in OECD countries, 43%. In Spain, 41%. Germany and UK, 50%.

Civil servants: 90 per 1000 inhabitants. In Germany ... 50.

Public debt: >90% ... and quickly rising, because public deficit is running at 5.2% of GDP speed.

Income tax on “rich” tax-payers: 75%

Competitiveness: Unit labor costs have grown 21% during the last decade. Whilst in Germany ... they’ve grown 5%.

Labor market efficiency as per World Economic Forum (Davos) assessment: 113th spot in a 144 countries list.

French universities among world’s best 35: None. Among best 100: Three. For UK: 2 in top ten, 10 in top 100.

The ticking bomb in Europe doesn’t speak neither Greek nor Spanish or Italian. The countdown sounds like “dix, neuf, huit, ...”. The elephant in the room speaks French.

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