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Home > Macroeconomic Issues Viewpoints > No Quick Fix for the Eurozone

Macroeconomic Issues Viewpoints

No Quick Fix for the Eurozone

by Joseph Trevisani

Introduction

Joseph Trevisani has 20 years of experience in Forex trading and management and is the Chief Market Analyst at FX Solutions. He worked for 12 years as an interbank currency trader, trading desk manager, and proprietary trader at Credit Suisse in New York and Singapore, and at the Bank of Bermuda in Hamilton, Bermuda. He has appeared on CNBC and Fox Business News in New York and CNBC in London and Dubai as a currency analyst and is frequently quoted in the Wall Street Journal, Reuters, Bloomberg, Dow Jones Newswires, the Associated Press, the Chicago Tribune and Futures magazine. He has written economic and currency analysis for Forbes.com, SFO, Active Trader, FX Street, and the Aim Bulletin; his Market Directions column appears on Real Clear Markets, Seeking Alpha, Futures magazine, and other websites. He has a Bachelor’s Degree and Master’s in International Politics and Finance from Columbia University in New York.

There has been plenty of speculation that sovereign debt could trigger the next global financial catastrophe. How concerned are you?

No one could watch the events unfolding in relation to Greek debt without being concerned. The Europeans have bailed out Greece in the short and medium term, which means the Greek government will be able to fund itself for two years. Greek 10-year sovereign debt rates have subsided to 7.82% (as of May 19, 2010), though they are still paying a large premium over German Bunds, 2.76%, the European benchmark.

As part of the deal with the Germans and the International Monetary Fund, the Greek government has had to agree to keep up a very severe austerity program for at least the next three years. There are two problems with this. First, how does any democratic government stay in power while implementing perhaps the fiercest austerity program Europe has seen since the Second World War? Second, austerity programs are no friend to GDP and the Greek economy will find growth extremely hard to come by. This makes it even harder for Greece to pay off its debts.

If you contrast Greece with Ireland, the Irish 10-year bond is around 4.6% (as of May 19), which is significantly higher than German sovereign debt, but nowhere near as penal as Greece. Moreover, Ireland has implemented a serious austerity program that has a certain credibility with the markets. They are not entirely out of trouble, but they are on the right road.

Is the weakness with the eurozone fundamental or something that can be fixed?

It has been said before and it is worth repeating. The fundamental problem with the Maastricht Treaty was that it created a common currency area unsupported by any central fiscal authority. We all understand that that was simply not doable at the time of the Maastricht Treaty and is probably still not doable today, so you have to go with what is possible. At least, that is what the politicians decided to do at Maastricht. They knew it was a weakness, but they did it anyway. This flaw runs through every European institution.

There has been talk of a European Monetary Fund (EMF). Do you think this could come about and what function would it serve?

You have to look at the very real differences between the International Monetary Fund (IMF) and a possible EMF. In some ways the proposal we saw in May 2010 to set up a $1 trillion stability fund to be run in conjunction with the IMF is an attempt along these lines. The fund as suggested has obvious problems when it comes to who gets to provide how much. It seems ridiculous to ask Portugal and Spain to contribute a significant sum in order to further bail out Greece. If the upshot is that the Germans ultimately end up having to provide most of the funding, this only provides a fig leaf to Europe’s euro problems.

One has to have some sympathy with the German public here, who are getting more and more outraged by the idea that German prudence should have to bail out southern European profligacy. Moreover, the eastern European countries who, a year ago, were racing to try to meet the economic conditions required to allow them to join the euro, are probably now all seriously rethinking and re-evaluating the benefits to them of joining the euro and giving up their own currency.

They already enjoy most of the advantages of being part of the eurozone without the straitjacket of being part of the euro. Of course, if they stay with their own currencies, they do not escape the costs of cross-border trading, which are significant, but they are very much more in control of their own destinies. I believe that it is very probable that they will come down on the side of maintaining their own currency once they have watched the euro drama play out a little further. The freedom of action that comes from having your own currency ultimately offers you far more than you gain by eliminating the pain of cross-border currency trading.

Is it even possible for Greece to default from the euro given that so many Greek mortgages and business loans are now denominated in euros and are held by European and other banks?

It is such a difficult, but interesting problem. Home mortgages in Greece are all now in euros and it is quite clear that if Greece were to return to the drachma and allow it to depreciate heavily against the euro, the Greek mortgage market would blow up and the government would be precipitated from the frying pan to the fire. At this point I simply do not know if there is any practical way for Greece to get out of the euro, but the fact of the matter is that membership of the euro does not qualify Greece to be treated on the same footing as Germany. Greek 10-year sovereign debt interest is almost three times that of Germany (May 19, 2010). The two-speed Europe is starkly in evidence here. Moreover, it is very clear that a serious austerity program that runs for years has a hugely damaging effect on the economy and, with lower tax revenues, Greek long-term debt will look increasingly unpalatable and those interest rates could again march upwards unsustainably. What is the five-year schedule for rolling over Greek bonds? The economy is certainly not going to generate sufficient profit to pay for this and without still more bailout money—probably in the shape of a big tranche of funding from the May 2010 stability fund—the euro will tank big time.

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Further reading

Books:

  • Kindleberger, Charles P., and Robert Z. Aliber. Manias, Panics and Crashes: A History of Financial Crises. 6th ed. Basingstoke, UK: Palgrave Macmillan, 2011.
  • Mackay, Charles. Extraordinary Popular Delusions and the Madness of Crowds. 1841. Online at: www.gutenberg.org/ebooks/24518
  • Oberlechner, Thomas. The Psychology of the Foreign Exchange Market. Chichester, UK: Wiley, 2004.

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