Thursday, 19 July 2012

09:50 – The latest IMF report on the eurozone is out, and it makes truly scary reading for anyone who’s invested in the euro, financially or emotionally. Basically, the report concludes that the euro is doomed unless the eurozone takes certain specific actions. That’s a superfluous qualifier, because those actions–debt pooling, eurobonds, and so on–are steps that Germany and the rest of the northern tier are never going to take.

Germany is as aware as anyone that there is no solution to this crisis, short of Germany agreeing to pay everyone else’s debts. Not just current debts, either. Germany would be expected to continue funding deficit spending in the southern tier permanently. The probability of Germany, along with Finland and Holland, agreeing to such a “transfer union” are somewhere between zero and less than zero. So, the euro is going to crash. Or, more precisely, the southern tier is going to crash, whether they’re on the euro or revert to using local currencies.

One of two things is going to happen: either Germany will revert to the D-mark, or possibly to a new currency. Call it the Northern euro. In the latter case, Finland and Holland may join Germany in a currency union, and perhaps a political union. (Everyone is now painfully aware what happens when a currency union exists without a political union to support it. But the cultures and economies of those three countries are similar enough that a currency union might be workable for at least a couple of decades before stresses started to tear it apart.) The second option is that the debtor nations will depart the euro and return to sovereign currencies, leaving Germany, Finland, and Holland with perhaps Luxembourg and one or two other nations using the euro.

German politics is bi-polar about this. On the one hand, if Germany keeps the euro and other, profligate nations leave it, the debts they owe Germany will continue to be denominated in euros, which will remain a “hard” currency. Germany would hope to get at least some of those debts repaid, in hard euros. On the other hand, Germany has in effect co-signed for hundreds of billions of euros in loans to southern tier nations that have no prospect of ever being repaid by those nations. Germany will be on the hook to repay those loans, which of course are euro-denominated. That means that if Germany departs the euro, which would immediately crash to something like 5% to 10% of its former relative value, Germany would be able to buy cheap euros to pay off those debts.

Forget all that stuff about “war guilt” and “European solidarity”. The simple truth is that for Germany, as for everyone else, it ultimately comes down to money. Who will get stuck paying all these bills? Until now, it seems that Germany’s policies have been intended to force weak nations into leaving the euro. But it seems to me that things are shifting now, with the ever-increasing commitments that Germany finds itself tied to. At some point soon, one of two things is going to happen. A weak nation will abandon the euro, which will start the dominoes toppling. Or Germany will finally give up, and abandon the euro itself.

In fact, given that for all intents and purposes the euro is already a zombie currency, it’s possible that both things will happen. Germany will go back to its sovereign currency, and so will everyone else, leaving the euro as a currency without a country.