The European Default Line
What the heck is going on in Europe, and why are the peripheral countries putting up with it?
Let’s review what has happened over the past dozen years. When the Euro was created, Eurozone countries signed on and began using the common currency. They all agreed to follow certain rules, such as maintaining annual deficits of less than 3%, etc. Sensing that Greece and Portugal were now fungible with Germany, investors poured money into the peripheral countries. Hundreds of billions of euro rushed into these countries, mostly from European banks, leading to bubbles all over the place.
The European banks knew what they were doing, it was caveat emptor. They invested in real estate projects, made construction loans, funded small businesses, and stuffed themselves with zero percent BIS sovereign bonds. They thought they couldn’t lose.
But the banks lost. Fine, welcome to investing. But rather than take the hit, those banks were bailed out by their own governments, who told Ireland, Greece, and Portugal, no no no, you can’t default, you can’t leave, we’ll lend you more money so you can make your payments. You just have to follow a few rules, like ratchet up your taxes and slash your spending, so you can pay us back.
So rather than the banks losing money that was foolishly invested, the citizens of the PIIGS countries are on the hook, effectively forever. Sure, Greece will get a break on the bonds it issued, but there was no choice about that, the game had gotten so far out of hand that Greece had no hope of ever paying the money back. But Ireland and Portugal are slated to pay back every dime.
Not only are the PIIGS citizens in debt for probably the rest of their lives, but also they're stuck with a horribly strong currency that makes it all but impossible to compete with their neighbors. Devaluing their currency is the only thing the weak countries can do short of slashing jobs and lowering salaries, and they’re already teetering on the edge of a depression.
Yesterday I attended a presentation by a prominent European economist from one of the strong European countries. He claimed Greece would have no reason to leave the Eurozone, since their imports were two times larger than their exports. If they were to revert to their old currency, the cost of imports would soar, he said, and they don’t have an export sector large enough to benefit from a weaker currency.
But that is exactly wrong! Of course they have no export sector, the Euro is too expensive for them, that’s the whole problem. With a weaker currency they could rev up exports and manufacturing, add jobs, and finally compete. The devaluation would increase exports, while at the same time reducing imports and bringing their current account back in line.
C’mon, PIIGS, default already. Jettison the Euro—it was a bad idea anyway, it’s time to move on. And by all means, don’t agree to make the rich countries’ banks whole when they get burned on a sure thing.