In response to an FT article by Martin Wolf on 6th December 2016, entitled ‘More perils lie in store for the eurozone’
You certainly got that right Mr. Wolf! More perils do lie in store for the eurozone. You have also done a pretty good job of describing the lie of the land right now. Where I depart from your analysis is highlighted by your comment:
“The political and economic impact of breaking up the eurozone is so great that the single currency may well soldier on forever”
In my view this is not an option. No fiat currency ever has, and no fiat currency ever will. The gradual erosion of value is baked into the cake of all fiat currencies because it is baked into the cake of our human nature and our resulting political reality – politicians make promises they cannot keep, spend money that they don’t have, start wars they cannot possibly afford…and lie about it…all the time.
The end repository for this lying, if it gets that far without blowing up in the stock market or somewhere else, is the currency – the buck has to stop somewhere if you’ll pardon the pun. The fundamental basis of ANY currency is ‘confidence’, no matter what you call it or what it’s made of – gold, paper or moon rock – money is ‘confidence’ or it is nothing. ‘Lies’ are what ultimately kill confidence.
In the case of the euro, the lie was built in at genesis – the currency came out of the oven half-baked in the first place. We’ve been over this many times, so it’s enough to say that monetary union without fiscal union, and just as importantly, without a single bond market, was doomed from day one. The founders knew this, or at least they were warned but chose to ignore it. I believe that they chose to go for monetary union, knowing that they couldn’t ‘sell’ fiscal union back then…but believing that they would be able to sell it later. This was hubris, and hubris will always find its nemesis, which in this case will appear in the bond markets.
In July this year, Keith Dicker of IceCap Asset Management, said something prescient, which, irrespective of whether he knew this at the time, has started playing out over the past few weeks. With hindsight, July was also the bottom in the yield of the most important asset in world markets – the US 10 year Treasury. He said this:
‘A mere 1% rise in long-term interest rates, will create losses of approximately $2 trillion for bond investors…the fun really starts when long-term yields increase by 3%, and then 6% and then 10%. This is the point when certain government bonds simply stop trading altogether, and losses pile up at 50%-75%...Most investors today have no idea what is happening in the bond market, and have exposed themselves to incredible amounts of risk…And more importantly, because a global crisis in the government bond market has never occurred in our lifetime – advisors, financial planners and big banks continue the tradition of telling their clients that bonds are safer than stocks….As a result, the most conservative investors in the word remain heavily invested in the bond market and are therefore smack dab in the middle of the riskiest investment they’ll ever see”
So my divergence with your analysis is one of inevitability. The central banks and the politicians have backed themselves into a corner. Unless this mess is tackled consciously, it will resolve itself through a sovereign debt crisis - possibly triggered by a banking crisis, but not necessarily. Whether this starts in Europe, Japan or the emerging markets I do not know – what I do know is that when something can’t go on forever – it doesn’t.
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Postscript:
There seems to be a growing number of people who see through all the politics. This reader nailed it in very short order:
“After twenty years, and dismal growth, we surely have enough empirical evidence to settle the founding argument as to whether the Eurozone would enforce convergence or slowly die from divergence - it is the latter.
The Eurozone can't reform (the theoretically applicable reforms are politically impossible), and it can't go on, therefore it will fail. The members of the Eurozone can't leave, there is no exit mechanism defined and none easily definable, therefore they will remain until a terminal crisis destroys their options (or "populist" voters damn the rules and withdraw irrespective).
As is wisely said of all financial crises, an unsustainable situation will last longer than you would consider possible, and then fall apart more quickly than you can imagine. It will be very, very messy and we are best standing about as far away as is possible”
Admirable pith!