Dollarization of Greece?

We now know that the Euro is based on a flawed design. The region has no centralized fiscal policy with vastly different political philosophies and social institutions, and no way to credibly sanction wayward countries. Therefore, there is no reason why the types of upheavals we now see will end. The lack of fiscal discipline is core to the problems of the Euro. 

In the late 1990s, Ecuador was facing a similar situation.  The country dollarized the economy, removing fiscal and monetary discretion from the politicians.  After a short period of intense economic hardship, the country has been on a steady path of growth. Even with the recent loss of fiscal discipline, as seen by the actions of the current U.S. administration, the size of the U.S. economy provides the stability that individual small countries cannot do for themselves. Greece and the other at-risk EU economies should consider dollarization.  It's radical, somewhat old fashioned but it can work.

Spain. The Next Greece?

Spain's private debt is now at 200% of GDP.  Unlike Greece, the country's structural deficit is anticipated to be around 3% of GDP, providing some short term flexibility to the government.  The way to think of this problem is to do so in two parts.  In the long term, high levels of public spending will reduce private sector growth, lower creditworthiness, and increase the cost of funding the public account. In the short term, cuts in public spending attenuates the multiplier from consumption, increases the burden on social welfare (at least in Europe), which further depresses growth.  The trick is to re-inflate short term growth without the cost becoming a drag on the long term creditworthiness of the public account.  This means moving, in the short term, more private wealth to the public, but with an unbreachable agreement of a 'payback' when Europe gets over the economic hump. Whether this can be done in the political climate (re: elections in France and Greece), is not certain.

New Normal in Europe

The last attempt to cut another Greek rescue deal falls short on two counts. One, while it proposes a schedule of payments tied to performance benchmarks on deficit reduction and public sector restructuring, there is no way to properly audit the measures taken.  The speed at which new funds will be injected into the Greek public sector will forestall any attempt to properly develop governance mechanisms as these take time. Second, the payments are front loaded, which reduces the pressure to implement the reforms as time progresses. 

More fundamentally, this rescue attempt, as have others in the past, ignores a fundamental problem. That natural endowments, institutions, traditional sources of wealth creation, and standards of living vary greatly across the Continent.  There is no natural geographic or cultural entity called Europe.  Therefore, the rate at which economic development can expect to progress will greatly vary across the region.  For example, Greece is predominantly an agricultural economy.  Joining the EU shifted its trajectory of capital accumulation toward non-agricultural assets.

The rationale for the EU is that integration will improve trade and lift the standards of living for everyone.  But the initial public relations to get buy-in set up the expectations that this will happen quickly.  If the heady post-Berlin Wall period of East/West German integration was any indication, such expectations are wildly optimistic.  This was not helped by the initial integration funding provided to help the less developed members 'catch up' to their richer neighbors.  Rather than investments in enhancing the sources of wealth creation and fostering entreprenuership to exploit these assets, the sudden injections of cash merely fueled private spending to unsustainable levels.

The EU also made it possible for the flow of unrestricted speculative capital to those countries without the capacity to properly absorb it productively. Recall the real estate bubble that led to the current recession in the U.S. Imagine similar dynamics occuring in less financially sophisticated and accountable economies.  Capital ended up in real estate and large government projects that trickled down into unrestrained private and public consumption.

This is the new normal.  Until such countries as Greece decouple from the union, the haves will subsidize the havenots for the foreseeable future, and the havenots, feeding on the largess of their richer neighbors, will have little incentive for fundamental change.  The haves might feel self-righteous about all this but the havenots are the ones that really suffer because their trajectory toward economic wellbeing has been hijacked by well meaning 'do-gooders'. It's a turbocharged version of European socialism, but across countries...

Negative Yield on German Debt

This week, Germany sold €3.9 billion of six-month Federal T-bills at an average yield of -0.0122%%. This has good and bad implications. It reinforces the fact that Germany continues to be a safe haven for investors and a bulwark economy against the effects of the Euro Crisis. Germany's conservative approach to monetary and fiscal policy in recent years is paying off. The bad news is that investors' safekeeping money under the pillow suggests a general bleakness in expectations. Such beliefs quickly translate into the real economy because when risk capital drys up, so does entreprenuerial opportunity and the possibility of new job creation. A similar phenomenon occurred in Japan in the 1990s. Record high household savings rates, reflected in negative yields on Japanese Federal bonds exacerbated years of zero job creation.

Central Banks' Efforts to Cheapen US$ Swaps

Today's move by central banks around the world to increase the liquidity of the US$, by reducing the transactions costs of currency swaps, effectively lowers the 'price' of the US$ to European banks that are now under pressure to serve as lenders of last resort to the public purse.  It is not quite a debasement of the US$, but the move can potentially wiped out billions of dollar denominated public debt.  It's akin to printing a lot of money to pay the bills.  It does not address any of the structural problems caused by runaway government spending.  But it is a clever move with the potential long term consequence of domestic U.S. price inflation. It's payback for the European worker's funding of the U.S. consumer's spending habit.  Merry Christmas!