The problem here is simple and everyone knows the story by now. Germany benefited from a weak Euro relative to what it otherwise would have experienced had it not been a part of the EU. Their growth and exports skyrocketed and the lesser nations from an economic and financial standpoint (often referred to collectively as the PIIGS) borrowed from Germany essentially to finance current account deficits as they took advantage of much lower interest rates due to their affiliation with Germany via the Euro. These PIIGS lived up to their name in eating up every source of financing they could.
You can read articles about Greek public sector workers earning more than twice as much as the private sector, national railroads taking in $100M in revenue yet paying out $400M in wages alone annually, Italians taking 2 hour naps and lunch breaks during the day instead of trying to boost growth and increase productivity, immigrants flooding Spain and then leaving as the housing market started to go bust further exacerbating the decline in real estate prices, and I could go on. The biggest question is; what happens now? Where does it go from here and what does it all mean?
The problem here is no one wants to pay back what they owe. Everyone, just like in the U.S., wants lower taxes and more entitlements. In Europe it is no different. The Greeks in particular borrowed much more than they can possibly repay and they do not want to give back what they owe. Here are the two basic ways this crisis will likely play out.
1. The German people suck it up and work harder while paying higher taxes to bail everyone out. I don’t think this will happen as Merkel will get booted and so will anyone who supports this idea. It is clear that the majority of German citizens are vehemently opposed to this idea, as I would be too if I were German. They might let the ECB print a little more or offer some more support short term, but at some point enough is enough. Greece has been unsuccessful at collecting taxes and while Spain and Portugal have taken some solid steps toward reigning in their deficits, it’s not enough. Too much can go wrong.
For example, Finland refusing to cooperate or contribute any capital to additional bailouts or Greece making demands on deals they have no right to make. Both are currently a reality. This scenario “solution,” if it could actually play out, would see some ECB bond buying and austerity that leads to deflation and a prolonged recession. Spending cuts lead to a decline in growth and rise in unemployment as government jobs are cut and there is less money to go back into the system to promote GDP growth. The Germans aren’t going to support everyone at zero cost to them which is why cuts will continue to be a part of any bailout package. That is clear. There’s no way out of this mess.
This “solution” will hurt the German economy as well as no one in Europe can buy their exports. We have already seen German and French growth grind to a halt Q2 2011. Finally, we have seen both France and Germany distance themselves from the EU by proposing every country balance their budget by 2013. Realistically, only two countries can balance their budgets by 2013. Yes, you guessed correctly, the two countries are France and Germany. This brings us to “solution” 2.
2. The cuts and austerity measures implemented by Portugal, Greece, and now Spain (probably Italy too) will drive deflation as previously mentioned. Cuts and a balanced budget pushed for by France and Germany seem to be overtaking any ECB bond buying or German backed European debt ideas. The other countries will not be able to deliver on getting their house (budgets) in order fast enough. Germany will eventually get fed up and distance itself from the EU and Euro and any temporary support from the ECB could dissipate soon thereafter.
They (the Germans) are a proud people and while they call themselves Europeans they do not associate themselves with weakness, laziness, irresponsible fiscal practices, inefficiency, etc. They won’t let their identity be taken from them by lowering themselves to the likes of an Italy or Greece. If I were German, that is how I would feel and would be very reluctant to give my hard earned money and future earnings to the Greeks or Italians or anyone else for that matter.
I do not see inflation coming out of Europe. I see no growth and a deep recession or depression brought on by some much overdue spending cuts. Printing money endlessly to fund spending is a long term death wish as well. Countries cannot infinitely borrow and spend more than they take in. Regardless of whether or not we (the U.S.) print soon, I see a recession at some point because of our own irresponsible fiscal policies as well as Europe’s as we will have to cut spending to close our own $1.2T deficit and raise taxes.
However, our inept fiscal “management” will stay back stage while Europe blows up first as their situation is farther along than ours. The depressions and recessions in Europe (already prevalent in Portugal and Greece) will lead the way to a long overdue global slowdown as the developed nations of the world try to clean up this mess.
The book “This Time is Different” points out the pain crises like this have caused nations in the past. Most previous defaults deal with developing nations. Developed nations last defaulted in significant amounts during the Great Depression. I believe we have a 50% chance of a depression, not a recession. Stimulus or printing money will not solve our long term problems. Eventually, the music will stop and we all will be scrambling to find a chair as unemployment rises, growth slows, purchasing power declines.
Bottom Line: You cannot borrow more than you can pay back and if you do, you will pay for it eventually either via war, severe or hyperinflation, deflation, depression etc. The market won’t disappear and we will get back to the “good times” eventually. However, the 90s were an aberration where everyone made money like in the roaring twenties, and we all know what happened there. We have a solid 5-10 years of pain before we can get our house in order and get back to a “normal” economy, if there is such a thing.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.