The Money Printing Press Cannot Fix Europe

 |  Includes: FXE, SPY
by: James Wood

It may seem a significant number of Seeking Alpha readers believe the problems of Europe can be fixed by the printing press. This is not so. This article summarizes the reasons why the printing press is not likely to be used in a vain attempt to fix the problems of Europe.

First and foremost, there is no peso, lira or drachma. There are only euros. Spain, Italy and Greece cannot print Euros.

Second, Europe is a Monetary Union where multiple members agree to use one currency, the euro, and abide by certain rules. However, each country maintains its own debt structure, internal financial policies and controls its own budget. When a country runs out of money, it cannot print it. It must go to the European Central Bank (ECB) which can lend it to them, if the member countries are in agreement. If the member countries are not in agreement, the borrowing country, say Spain, will not receive the money.

Some readers will say, well then the ECB can print the money. While this is true in physical terms, the Northern member countries will not be in agreement. Here are two powerful reasons why the Northern countries will oppose unlimited printing of Euros to help bailout bankrupt Southern countries.

1. Inflation damage to the Northern countries. Massive printing of Euros will create inflation, just what the proponents of the printing press want - to ease the Southern countries' problems. While this might be of some short-term benefit to the Southern countries, it will damage the financially sound Northern countries. For example, it will cause depreciation of the euro against the dollar meaning that every Northern European will pay more for imported goods. One of the US Fed's most sacred objectives is to avoid inflation in the US. Every central bank has this objective for its citizens. In short, why will the Northern countries do something that purposely causes unnecessary inflation that harms its citizens and their economy? The answer is that the Northern nations will not purposely harm themselves at the moment of truth.

2. Northern countries lose their money lending to Southern countries. The problem of the southern countries is not one of liquidity, but rather of solvency. See Details Here. Southern Europe does not have a short-term cash problem that can be solved by short-term borrowings. This means they fundamentally do not have the capacity to repay the loan. They are bankrupt in practical terms. The money the Southern countries borrow from the ECB represents capital of the monetary union, which means each country absorbs the pro rata losses and gains of the ECB. Again, why will the Northern countries knowingly lend money to a Southern country that is broke and cannot be repay its debts? When the Southern countries go bankrupt, they run the risk of bankrupting both the ECB and the Northern member countries. The Northern countries are not going to bankrupt themselves in a futile attempt to bailout the Southern countries.

Spain is not equivalent to the US for the purpose of this conversation. Spain is the equivalent of say Texas. Texas cannot force New York to take unwanted losses or cause unwanted inflation. Furthermore, the ECB is not really the equivalent of the US Federal Reserve and US government. The US government can really take decisions and impose them on Texas. But the European Monetary Union structure is weaker in this sense. Ultimately, the rich Northern nations will take the crucial decisions because they are the lenders, not the near bankrupt Southern nations, the borrowers, who cannot repay their loans.

In short, the European Monetary Union is a financial straight jacket that limits what they can practically do. The Southern countries cannot print unlimited funds without the agreement of the Northern nations. The Northern nations know that printing money will go against their own interests. At the moment of truth, the Northern nations will not agree to unlimited printing of Euros that ultimately is harmful to the financial solvency of the Northern nations.

This potential collapse of funding for the Southern nations can quite possibly play out in a matter of days. That is to say, it could be a week, month or a year before this denial of support comes from the Northern countries to the Southern countries. But when it does come, in a matter of days we may have an explosive negative impact on the markets. This Southern European problem will probably work like a "trigger" to ignite other related problems such as a run on Southern European banks, major international bank defaults in the world derivatives markets (particularly credit default swaps), and a dramatic downturn in world stock markets (SPDR S&P 500 Trust ETF: SPY).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.