The Inevitable Collapse of the Euro

An increasing number of reports have come out recently describing how governments, banks, multinational corporations and investors alike are preparing for a collapse of the euro. Meanwhile, European politicians are latching on to every conceivable measure to keep the single currency afloat and allay fears of a collapse. Our (elected and non-elected) leaders seem to be determined to prop up the euro at any cost, for “if the euro fails the idea of European integration fails”. Nonetheless, the real question is not if the euro will fail, but when.

Prior to the euro, there was a clear divide between those European countries that generally pursued responsible economic policies and those that pursued more “loose” policies. The difference, plain for everyone to see, was the strength of the currency. For instance, due to its stability the Deutschmark was the strongest European currency and was used in international transactions. Other currencies such as the Spanish peseta and the Italian lira were much weaker comparatively. As a result of this system, reckless spending and subsequent inflation were invariably exposed and kept in check by the devaluation of the currency in question relative to stronger European currencies. Nonetheless, Mediterranean countries traditionally ran much higher public deficits than Northern European countries.

This begs the question why these countries were admitted into the euro in the first place, despite their failure to meet the so-called convergence criteria of the sixty percent limit of public debt to GDP or the three percent limit on public deficits. Not only were these criteria not automatically applied, the Council of the European Union could still decide to admit countries to the Eurozone if a qualitative majority was reached. Belgium and Italy were admitted in this way, while other countries only met the criteria through accounting tricks. Even Germany did not meet the criteria[1].

The introduction of the euro brought with it major benefits for the southern countries. Though article 104b of the Treaty of Maastricht adopts a no-bailout principle, the implicit (now explicit) backing of the richer European countries reduced the interest rates southern countries had to pay on their government bonds. At the same time, interest rates on government bonds issued by the northern countries went up to compensate for the increased risk. This took away another incentive to curb deficit spending as budgetary discipline didn’t lead to higher interest rates to the extent that it used to. European banks bought Greek and other bonds because the ECB accepted them as collateral for their lending operations, wiping out any risk of non-payment in case of default. Therefore, issuing new government bonds is now practically the same as printing money, increasing the amount of euros in circulation and thereby inflation, lowering consumers’ purchasing power in the entire Eurozone

Money market interest rates in the southern countries fell, too. Coupled with the loose monetary policy pursued by these countries this caused a real estate bubble even before the introduction of the euro. The bursting of this bubble was a major blow to Spain’s economy. The single currency also boosted exports from northern countries to the peripheral countries as those goods had become cheaper. The resulting spending spree served to further increase the gap in competitiveness between highly competitive countries like Germany and southern countries, which were not competitive due to strong labor unions, inflexible labor markets and high wages[2]. The money that went to these indebted countries as part of the EU rescue package added fuel to the fire by pushing up wages and prices, besides contributing to a further rise in inflation in the Eurozone.

Moreover, the Mediterranean countries effectively run the Council of the European Central Bank, which consists of the directors of the ECB and the heads of the national central banks of all of the member states. Since all hold the same vote and decisions cannot be vetoed, the fiscally conservative northern countries are in the minority against the southern countries which tend to have higher debts and inflation. In other words, the Latin countries are in control, leading to a similar tendency of deficit spending by the ECB and, again, inflation. After all, no incentives have been built into the system to pursue fiscally responsible policies. The southern countries are literally living off of the wealth of their rich northern neighbors.

In addition, profits accrued from interest-bearing assets held by national central banks are remitted to the ECB which then remits them back to central banks based on population and GDP – not the assets owned by the central banks from which they came. As such, the system represents a redistribution of wealth from richer central banks with more assets and smarter investment strategies to banks with fewer assets and/or less optimal investment strategies. The Bundesbank, for example, recorded €68.5 billion in profits in the ten years prior to the introduction of the euro compared to €47.5 billion in the ten years thereafter[3].

In reporting on the sovereign debt crisis, mainstream media habitually leave out the fact that Goldman Sachs helped Greece get into the euro by helping the government cover up its true debt. Derivatives and fictional exchange rates were used to disguise loans as swaps, circumventing EU admission criteria. Furthermore, Greek, Spanish, Portuguese and Irish finance ministers were bribed by Jacques Delors, then Commission president, who promised “large increases in EU structural funds in return for their signatures on the [Maastricht] Treaty”[4].It thus turns out that, behind the scenes, there were lots of powerful helping hands involved with the birth of the euro..

Today European banks and governments are more intertwined than ever, making the collateral damage of default incalculable. French and German banks hold most of the Spanish debt while also being particularly exposed to Greek, Irish and Portuguese debt. Spanish, Italian and Portuguese banks are now buying their own governments’ bonds as French and German banks are seeking to offload them.

For the abovementioned reasons it is to be expected that the power-hungry bureaucrats in Brussels, the politicians and the bankers will try to keep the Ponzi scheme going as long as possible, increasing the pain all Europeans will feel when the house of cards that is the euro finally comes crashing down. However, we are already way past the point of no return and the sad truth is that nothing can be done to fix the euro anymore. The final trigger will either come from rioters in the southern countries refusing to go along with ever-increasing austerity measures or from people in the northern countries demanding that their governments stop subsidizing the south.

The early years of the euro were like a party where everybody got drunk on cheap booze. Now, however, we are dealing not only with the hangover; we are finding out that we went way over our budget and that we welcomed some shady characters to the party that never should have been invited in the first place. The time has come for us to realize that the party was a bad idea from the start. The euro is a dead horse. The sooner we acknowledge that, the better.