The concept that seventeen independent rich and poor European countries could come together in a monetary union and perpetuate the “euro” currency has always been a fraud. The real story behind the formation of the euro was the “Grand Bargain”. The governments of the PIGS (Portugal, Italy, Greece, and Spain) receive colossal bribes in the form of the ability to borrow unlimited amounts of money at the same low interest rates the Germans pay; for agreeing to buy enormous amounts of German goods. The PIGS generously performed their side of the bargain. It is the Germans that after running-up vast surpluses are now economically destroying the PIGS by terminating the bargain.
The European sovereign debt crisis did not start 18 months ago when Greek borrowing costs began rising from 3% to the current 75%. The crisis began in 2009 when German politicians passed a constitutional balanced-budget “Golden Rule” at the height of the global credit crisis. The Golden Rule prohibits German politicians from passing a budget with a deficit of more than 0.35% of Gross Domestic Product (GDP). This was a radical departure from the unenforceable “Stability and Growth Pact” of the seventeen nation euro that limits deficits to 3% of budgets.
For a monetary union to be sustainable, it must be operated on the basis of ‘symmetrical obligations’ among the members. Germany’s decision to cut-off spending of its trade surpluses to finance the PIGS trade deficits has created a deflationary spiral in Europe. Over the last two years there have been numerous incremental European bail-out programs aimed at stopping the Greek debt crisis from spreading to the other PIGS. Each successive program forced deeper “reform” cuts to PIGS spending. “No reforms, no bond purchases” has been the message of the German controlled European Central Bank (ECB) and the German controlled European Financial Stability Fund (EFSF).
Following periods of short term relief, each program failed.
Every year there are a numerous countries that get into financial trouble. The usual answer is to devalue their currency to become more competitive. This creates lots of pain for holders of country’s debt; but quickly the nation becomes a “cheap” tourist venue and eventually businesses start relocating to the country to enjoy “cheap” labor. The PIGS have lost this option. It still costs virtually the same amount to stay in a nice hotel and enjoy a cold beer in Athens as it does in Berlin. Without the ability to devalue their currencies; the PIGS are being forced to increase “austerity” reductions in government spending to satisfy the next ECB or EFSF bail-out.
The introduction of the euro currency was sold to the citizens of the PIGS as an opportunity for economic “convergence”; whereby Portugal, Italy, Greece, and Spain would benefit from learning how to be as competitive as Germany. But in the nine years since the euro launch the PIGS have suffered 30% losses in competitiveness to their northern neighbors. This has destroyed hundreds of thousands of private sector jobs. The increasing austerity requirements of the bail-outs in Greece have resulted in an addition 20% cut in public sector jobs.
With job shrinkage accelerating in the PIGS; it is only a matter of time before rising protester violence forces these nations to quit the euro and bring back the Portuguese “escudo”; Italian “lira”; Greek “drachma”; and Spanish “peseta”. In the perfect world of an orderly devaluation, the losses to bondholders and banks would be approximately $3.5 trillion and make 70% of European banks insolvent. But the history regarding devaluations has been one of chaos and violence. In a disorderly devaluation the losses will run closer to $6 trillion and 85% of European banks will be insolvent.
The euro was never sustainable concept and the German Golden Rule has now accelerated the destruction of the Portuguese, Italian, Greek, and Spanish economies. There is a lesson for Americans to learn from this European wipe-out. Those who live on borrowed money; will eventually die by borrowed money!
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On October 15th Chriss Street will publish his latest book: “The Third Way”