Brusca: The Euro's Death...and a German End Game?

Unless you live under a rock you know that the euro-Zone has undergone a series of crisis and that the more of them that are “solved” or the more that “the worst is put behind us” the more that there is still plenty in front of us.

In the new World Economic Outlook (WEO) from the IMF, in a report that spams (oops, I mean ‘spans’) over 150 pages, only 504 words were devoted to the section, “What Went Wrong in the Euro Area?" This is its topic sentence:

“The euro area crisis is the product of the interaction among several underlying forces. As in other advanced economies, these forces include mispriced risk, macroeconomic policy misbehavior over many years, and weak prudential policies and frameworks.”

In other words the IMF is not going to get too detailed and it is not going to point fingers. Neither is it going to get to the nub of the problem. The IMF is an organization devoted to fixing things. Since it must work through its members who provide the capital for its various schemes do not look for the IMF to upset the applecart.

The references made by the IMF laud LTRO and generally applaud can-kicking (as in "down the road") without reference to real fixing. Indeed, there is no reference to what is really wrong in the Zone: None at all. It mentions Eurozone break up as a throw-away line under the heading "tail risk."

What if the euro is broken? Would the IMF tell us? Probably not: it has nothing to gain from doing that. Telling might offend a good deal of its constituency and precipitate a market meltdown.

But the best analysis of the crisis is that the euro is broken and that it is probably not able to be fixed. And if that‘s the case don’t the EMU members know it and aren’t they themselves preparing for the end game?

Only Germany seems to act as though the end may near while the rest of the Zone is in denial. But Germany has to be careful. The quid pro quo for allowing a united Germany was forming the Eurozone so that Europe’s interests would meld together, cooperation would grow and conflict would diminish. Well, that didn’t happen, did it? Since Germany got something in return for forming the Zone, it can’t be the country to cause it to break up by being the first to leave.

The Zone unified currencies but did not unify or align the economic interests of its members. Great conflicts have arisen in the Zone with Germany now seen as an e-Zone tough pushing snake-oil austerity on weaker members that lost their way. Is Germany trying to force someone to say "uncle" and quit?

The unfixable problem in the Zone is that national inflation rates have diverged so much that competitiveness differences are too great to mend. All of the talk about bailouts and band aids is like a magician’s misdirection to keep you looking at the symptoms instead of at the disease. Trade imbalances, fiscal deficits and debt issues all lead back to the loss in competitiveness as the root cause. Fix that and you fix growth, rack up tax revenue, sustain employment, and shrink excessive trade deficits.

Yet, no one has offered a solution to fix that. Every time a problem flares, there is another kick-the-can plan, LTRO being the most recent. Loaning funds to banks that invest in their own country’s beleaguered sovereign bonds makes no sense and fixes nothing that is wrong.

Germany has been preparing for the day of reckoning in several ways. It has revived its domestic crisis-era Soffin bank bailout fund. It has been using the time of the delay before and after Greek bankruptcy for its banks to reduce their exposures in troubled markets. The LTRO funds allow local banks to step up as German and other banks step out. Reducing cross border exposure comes closer to making the sovereign debt problems domestic although it entangles troubled banks with sovereign risk. Germany and the EU continue to keep the pressure on nations to hit their promised targets even as recession makes them harder to hit. If this isn’t turning up the pressure to make something pop I don’t know what is.

While Germans are opposed to LTRO they do not complain too loudly because for now the program suits their purposes.

Since EMU’s compositional competitiveness differences are too large to fix with deflation and too big to live with the only solution left is country by country devaluation: That means the end of the euro.

The Germans can see it. The IMF does not go there in its report preferring to emphasize symptom fixes. The only surprise left is figuring out what the end game will look like. But we know what it won’t look like. It won’t look like EMU.


—Robert Brusca Ph.D. has been an economist on Wall Street since 1977. He is now Chief Economist for FAO-Economics in New York City.