Walker's World: The euro endgame

By MARTIN WALKER, UPI Editor Emeritus  |  Nov. 28, 2011 at 6:32 AM
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LONDON, Nov. 28 (UPI) -- Pessimists in Europe now assume the euro will collapse before Christmas. Optimists think it can limp on until the last week in January, when Italy has to persuade the markets to buy $43.7 billion of its debt.

Even if that feat is achieved, and assorted Italian patriots are campaigning for the country's still-wealthy citizens to buy it themselves, in the final week of February another $65.5 billion of Italian debt has to be sold to the markets.

Asian and U.S. banks and investors are dumping euro-denominated bonds and obligations. The Fitch ratings agency claims that U.S. money-market funds have cut their exposure to European banks by more than 40 percent in the last six months. U.S. banks and pension funds appear to be dumping their nearly $400 billion euro holdings.

It all looks very grim and the whole European economy is sinking fast into recession. The old continent's governments have launched a series of austerity measures that promise to cut public spending by up to 2 percent of gross domestic product (depending on whether those harsh pledges can be kept). Leading indicators, like the Purchase Managers Index, suggest that even the mighty German economy is shrinking.

Being outside the troubled eurozone is no guarantee of relief. Britain, which is still able to borrow easily and cheaply on the international markets (and its bond yields last week were even cheaper than those of Germany), will slide into its double-dip recession next year, the Organization of Economic Cooperation and Development predicted.

Its closely watched analyses suggest German economy will shrink 1.3 percent in the final quarter this year, with France and Italy also contracting.

The real question is what we mean by the loose term "euro collapse." There are four main possibilities and two open questions.

The first form of collapse would be limited and manageable, in which one or two small countries are forced into default and leave the euro, at least temporarily. The obvious candidates are Greece and Portugal. Since the euro-zone's on rescue funds are committed to seeing Greece through its borrowing needs for the next two years (providing Greece delivers on its promises of further draconian spending cuts), Portugal might be the more vulnerable to the markets.

Such a limited departure would trigger the first open question, which is whether the first such breach in the dam would lead to several more and the contagion spreading fast to other euro-zone members in domino effect. Certainly some form of credible financial firewall would have to be erected to protect Spain and Italy.

The second form of collapse would be for all the weaker members to leave the euro at the same time. These would be Portugal, Ireland, Greece, Italy and Spain. Again, the open question of contagion arises, which could draw in Cyprus and Belgium and even France.

Either each of these countries tries, during the inevitable days of panic and capital flight and currency controls, to reintroduce the old national currency or they seek to develop to make this orderly be moving together into a new euro-south currency, worth perhaps two-thirds of the traditional euro.

The third possibility is that Germany alone, or possibly with its stronger partners like Holland, Finland and Austria, withdraws and returns to the super-Deutschemark. However much some Germans may like this prospect, it would be grim for Germany's tireless exporters, who would see their currency soar in value and price at last some of their goods out of any market.

The fourth possibility, which depends on the second open question, is that somehow the euro holds together, grits its collective teeth and goes through some tough years of recession and austerity and ruthless reform of their welfare systems and labor markets and emerge, lean but solvent, at the other end.

This scenario, which is what German Chancellor Angela Merkel seems to believe, isn't altogether impossible. It is based on the assumption that when the full disaster of a euro collapse looms, with its implication of a new Great Depression, then other governments and institutions around the world would see it in their own interest to rally to keep it solvent.

The Beijing government, dreading the loss of its largest export market, pledges some of its $3.2 trillion war chest (10 percent would suffice) to buy French, Spanish and Italian debt. The United States takes similar action. The most painless way would be for the Fed to agree to buy all euro-denominated debt from U.S. institutions and hold it on its own balance sheet. That would stop a dollar run or a further damaging dump.

This could then trigger a virtuous circle, in which the Bank of Japan and of England follow suit, and so does the Gulf Co-operation Council of the oil-rich Arab states. The International Monetary Fund and the governments of the Group of 20 all agree to help buy up other foreign holdings of euros that come onto the market.

It is a slim prospect, given the inevitable outcry against such a bailout by the U.S. Congress and its begs the question: Why not take the easier path of allowing the European Central Bank to do what the central banks of the United States and Britain and Japan have long done, which is stand as lender of its last resort for its own currency? Germany says "No." But why should the world have to step in where Germany fears to tread?

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