As Ludwig Von Mises long ago predicted, there is only one choice left for Europe. To save the eurozone economy, the euro currency must be destroyed…
“Politicians like to gloss over reality, but we confront them with the facts.”
– Hugh Hendry, Eclectica Asset Management
Some ways back in these pages, we questioned whether the Federal Reserve, in trying to plug a massive credit contraction hole, might be tossing a mattress into a volcano.
It turned out to be the right analogy, but the wrong tosser. The eurozone is the region with serious volcano issues (and not just by way of Iceland).
It wasn’t supposed to be this way (according to the powers that be). Last weekend, European heads of state finally got their acts together in offering up a Greek rescue package. The proposed rescue – which the U.S. taxpayer had a hand in too, by way of IMF commitment – was supposed to restore calm and show a fiscally united front.
The actual effect was the opposite. Instead of calm, there was fresh panic. The sovereign debt volcano, rather than being sated by last-minute terms for a Greek bailout, grew angrier. The euro hit new 12-month lows on the panic… then broke even further through the psychologically key $1.30 level… and is plumbing fresh new depths as I write to you.
Nor was it just the euro that took a wallop. Risk assets all over the world went into freefall. For a brief window of time, everything seized up, like a middle-aged man clutching his chest on the tennis court.
The scary thing, when it comes to Greece, is less about “present pain” and more about “future precedent.” What is happening there could happen in other countries too – on a larger scale. Weare witnessing a template for sovereign debt destruction.
Taipan Daily warned readers of this possibility in late January, dubbing 2010 (if you’ll recall) “the year of political risk.” As your editor wrote in that missive, “2001 Will Be the Year of Political Risk” some months ago:
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HOT SPOT #2: EUROPE. Skeptics have long argued that the euro is not actually a currency. It is an experiment. The hope of the euro experiment was that 16 different countries could band together, under one united monetary policy, while yet preserving wholly separate cultures, political structures, and economic climates. This was always a nutty idea, and the experiment is now under severe stress. With the Greek sovereign debt crisis consistently getting Page One headlines in financial newspapers worldwide, investors have awakened to the utter helplessness of the ECB (European Central Bank). What happens if Greece implodes? What if happens if Spain or Portugal is next? If Germany and the other rich countries refuse to help (i.e. whip out the checkbook), will the PIIGS (Portugal, Italy, Ireland, Greece, Spain) simply be left to die in the abbatoir? How could German political leaders even think of writing a check to Greece without a deluge of outrage at home?
According to Greek economics professor Savvas Robolis, Greece now has “explosive unemployment” in its future. “Panic is slowly taking hold in the minds of the [Greek] people,” he says.
Robolis further fears the harsh austerity measures of the IMF threaten to put Greece “on ice,” meaning that severe cutbacks and punitive measures could kill off any chance of growth in the weak Greek economy.
In more ways than one, the troubles for Greece are troubles for us all…
Nein! (No More!)
To add some further color, the whispered word on trading desks is that Germany is to blame for this week’s big freak-out.
Initially, investors reacted negatively out of concern that the Greece rescue package was too little, too late… out of fear that the Greek populace (of whom a very large portion are civil servants) would not accept it anyway… and out of conviction that far more money would have to be spent.
The negative “concern” became full-blown panic, though, at least partially on rumor that German politicians were drawing a bright hard line that said: “No more bailouts after this one.” Teutonic stubbornness reduced the odds that Portugal or Spain would see a rescue check – which, of course, increased the risk that they might fail.
The prudent investor’s attitude is “better safe then sorry” with these things, and credit default swaps on Portuguese and Spanish debt thus exploded higher on talk of German intransigence. (Credit default swaps, or CDS, are a sort of catastrophe insurance; the higher the swap, the greater the implied odds of catastrophe.)
The troubles this week also trace back not just to sovereign debt contagion – with Greece a sort of patient zero – but leveraged hedge fund contagion.
It seems that some clever funds – too clever for their own good – were caught by surprise trying to pick a bottom in the Greek bond market. Having gotten their fingers smashed, these funds suddenly had to sell other assets from the portfolio to reduce overall risk. Along with fresh bad news from China, this then set off a domino chain of forced selling that stretched all the way to Brazil, Japan and parts beyond.
Greek protesters, many thousands strong, have already rioted in the streets, throwing makeshift firebombs at police. Sadly, three people have died thus far. In Spain, the bankers tremble as fearful investors dump their shares – getting out ahead of time in case of a full-on bank run. In both Germany and the United States, taxpayers are seething that they didn’t want to throw more rescue money down a rat hole, but feel coerced and left without a choice.
It’s a horrible situation… everyone is angry. The Greeks are angry at being put on a brutal starvation diet. The Germans are angry at the perception of having to be their profligate brother’s keeper. Other eurozone nations are angry at being caught up in a downward debt spiral, as fears of continent-wide insolvency threaten to become a self-fulfilling prophecy.
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Roll Out the Presses
There is perhaps just one thing left to do: Destroy the euro.
Jean-Claude Trichet, the head of the ECB (European Central Bank), should swallow hard… admit his failure… and print like a madman, devaluing the currency in order to “monetize” the vulnerable eurozone countries’ debts.
The ECB does not want to do this, of course. Trichet is such an inflexibly stiff rod, a directive like that could snap him in half. For such paragons of fiscal rectitude as the keepers of the euro, the idea of intentionally vaporizing the currency (in the name of monetizing toxic debt) is an awful one.
But the palatable choices have essentially run out now. It is too late to play the fiscal responsibility card. One cannot play at prudishness and moral rectitude after sobriety and virginity are already long lost. If something is not done, the vulnerable eurozone countries could be crushed under the weight of their ill-accumulated debts like a field mouse beneath a cinder block.
The Austrians Called It
What we are seeing now for the eurozone is a clear instance of the Von Mises prophecy. (Ludwig Von Mises is the father of Austrian economics. We have quoted him – and his prophecy – many times in these pages.)
To go to the well one more time – and probably not for the last time! – many decades ago Von Mises taught and predicted as follows (emhasis mine):
There is no means of avoiding the final collapse of a boom expansion brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.
Note the Hobson’s choice presented, i.e. a choice that isn’t really a “choice” at all.
Once past the point of no return in terms of accumulated debt, the only real options are to destroy the economy or destroy the currency (in the name of saving the economy from debt-laden doom). The currency destruction comes about as the authorities “monetize” debt that would otherwise crush them.
Another way to put it is “inflate or die.” The eurozone is now faced with the compact directive to “inflate or die.”
Japan will eventually face the same music. And so too will the United States…
An 18-Year Flashback
There is also a bit of déjà vu here as far as the United Kingdom is concerned. That’s because Britain went through a phase some 18 years ago with similarity to what the eurozone faces now.
In 1992, Britain was part of something called the ERM, or European Exchange Rate Mechanism. The ERM was a kind of fiscal strait jacket. As a member of the ERM, Britain had to keep its currency, the Pound sterling, within a certain agreed-upon range.
The trouble was that the prescribed range for the ERM meant Britain’s currency was too strong. An overly strong pound was killing the weak British economy. (Sound familiar yet?)
Back then, British politicians were just as pig headed as the talking heads in the broader eurozone today. They swore up and down that Britain would not drop out of ERM… that the British pound would not be devalued… that the pound would hold its value, no matter what.
Well, those politicians didn’t know what they were talking about. They didn’t understand that fiscal strength requires preventative maintenance – that you keep a strong currency by avoiding debt build-up in the first place, not irrationally denying it after the fact.
And so – we are still talking about 1992 now – along came a speculator named George Soros, looking for trades to make in his legendary Quantum fund.
In a nutshell, Soros saw that the British politicians were being stupid. He saw that the British pound would have to be devalued, for the sake of the weak British economy… and that stubborn British politicians wouldn’t be able to maintain membership in the rigid ERM band just because they wanted to.
And so Soros shorted the daylights out of the pound… and made a billion dollars in a single day doing so, earning the nickname “The Man Who Broke the Bank of England.” The tabloids hated Soros after that – they accused him of taking 12 pounds sterling from every man, woman and child in Britain – but really all he did was do the country a favor.
(Some British economists admitted that, had they stuck to the artificially strong ERM trading band even longer, much greater damage to the British economy would have been done.)
The euro, and the eurozone, are now in a similar place as to 1992 Britain (on a much larger scale). Europe’s pols are just too dimwitted and stubborn to see it.
When politicians try to deny reality on too large a scale or for too long a time, reality always wins out. No matter how big and powerful the government entity in question, gravity wins out in the end. That is why traders and speculators can make a great deal of money through tactical alliance with the right side of history.
A Lesson in Financial Physics
Von Mises’ prophecy – in which the accumulation of debt over massaged credit cycles leads ultimately to destruction of the economy or destruction of the currency, with no third option to choose from – is not a grand morality exercise. It is more akin to a keen observation as to the effects of gravity and the laws of financial physics.
The inevitability of financial physics further explains why your humble editor – and plenty of others – saw the euro’s fate written on the wall quite some time ago. (The late Milton Friedman, for example, predicted the euro would not survive its first true crisis, for the same essential reasons we see in play today.)
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