Beginning of the End for the Euro?

Includes: ERO, EU, FXB, FXE
by: Lollapalooza

We have known about the looming debt bombs in the so-called PIIGS countries (Portugal, Italy, Ireland, Greece and Spain) for years. In fact, the now-ubiquitous acronym has been around since the 1990s, when it referenced the same countries, minus Ireland (the original PIGS). These southern European countries have also been referred to as the “Olive Belt” and “Club Med.” With Greece’s recent notice of looming default and its credit downgrade to junk status, the problems have finally come home to roost.

Based upon the reactionary strikes and riots in Greece this week, there appears to be sufficient upheaval to question the future of Euro, especially if similar situations unravel in the other PIIGS countries.

This potentially dangerous chain of events is even more ominous considering the timing in the midst of a global recession, when peoples’ morale is already low. Eurozone countries like Germany don’t want to be on the hook for Greece’s fiscal irresponsibility and the Greeks feel it is unfair to be charged a perceptually punitive interest rate on bailout funds on top of demands for higher tax rates and spending cuts. For those familiar with Charlie Munger’s mental models, the Reward-Punishment Super-response Tendency and the Deprival Super-reaction Tendency are both clearly evident.

If the debt bombs in other troubled eurozone countries lead to similar outcomes as in Greece, there will likely be serious discussions about altering the Euro in some manner, and rightfully so (although this would be extremely complicated because the Euro is so deeply embedded in the global financial system). There is a very simple problem at the core of the Euro. Member countries are allowed to set their own fiscal agendas, but do not have the power to borrow, or “print,” money in their own currencies.

The U.K. has often been tossed into the conversation about sovereign debt problems in Europe. However, there is one immensely important differentiating factor between the U.K. and the PIIGS. The U.K. still has its own currency and thus, has the ability to devalue its currency to meet its fiscal obligations. This is extremely powerful.

When faced with fiscal challenges, most countries have three choices: 1) Raise taxes; 2) Cut spending; or, 3) Print money. The first two choices are typically avoided because they are so politically unpopular. No one wants to run for election on a platform of higher taxes and reduced government spending programs because there will be specifically identifiable losers who are sure to make noise. Printing money is a much more politically acceptable solution because there are no specifically identifiable losing groups—everyone loses (although an argument could be made that inflation is a form of silent regressive taxation).

This unfortunate set of circumstances will be very interesting to watch as it has huge implications for the future of the Euro. The countries providing bailout funds will complain about the socialistic nature of helping the countries who are perceived as fiscally irresponsible. The countries receiving the bailouts will surely complain about bailout provisions that are likely to demand tax hikes and budget cuts on top of higher interest payments. Meanwhile, troubled non-Euro countries continue to run the printing press through these challenging economic times.

Disclosure: No positions

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