Bail Or No Bail – How Much Trouble Is The Euro In?

The big news out of Europe this week was the announcement of a 50% write-down of Greek bonds held by European banks in another massive bailout of the embattled country. Problems with this approach began to surface quickly. The biggest and most challenging is the temporary injunction issued by the German Constitutional Court on October 28 barring any deliberations by a panel created by the German parliament. The injunction prevents the panel from green-lighting decisions about using taxpayers funds in the bailout program. Widespread expectations are that the current German Chancellor, Angela Merkel, will lose power as a result of her support for the bailout program.

The Eurozone created several economic asymmetries between Germany and other European countries. Germany is an export powerhouse replete with high wages and low production costs. The euro imposed a monetary straightjacket on all countries, irrespective of what monetary policy was best for which country. Low interest rates set by the European Central Bank (ECB) wreaked havoc by sparking real estate bubbles and debt-financed consumption. Now the PIIGS (Portugal, Ireland, Italy, Greece and Spain) are dealing with the consequences while Germany is being essentially forced to foot the bill.

On top of all the public and private debts accumulated thanks to the ECB’s low-rate policy, there are vast amounts of monies promised to aging beneficiaries of Europe’s social welfare programs. The number of active workers will shrink, and the number of retirees will rise, hampering the ability of governments to fulfil their obligations. Northern Europe has been subsidizing Southern Europe’s excess consumption for years. The PIIGS countries have run large current account deficits throughout the existence of the Eurozone. These structural pressures may simply be too much to bear.

No matter how much bailout money is committed to the program, unless massive structural changes occur, the Eurozone economy will continue to deteriorate. The big danger is that the wealthier northern countries like Germany will start experiencing problems due to contagion spreading from the PIIGS in the south. Ultimately, the Eurozone is doomed to experience a break-up, likely precipitated by Germany or Greece leaving the euro. Once that happens, the economies of all European countries will likely enter a prolonged readjustment phase. In other words, a new recession, which will likely drag the rest of the world down into it as well. The inevitable end result will occur sooner or later whether the participating countries like it or not.

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