The Four Paths Forward For The Euro Area

Tyler Durden's picture

From what seemed like a very low bar on expectations, last week's summit headlines surprised modestly on the upside, even if the details remain far from clear - and implementation even murkier. Political talk of wanting to break the link between sovereign and banking risk was well-received by markets - but we remind all that talk-is-cheap with these Euro-pols. As Goldman noted this weekend, "we do not see the outcome as a game changer", rather can-kicking until one of four possible endgames are realized. The absence of any explicit commitment to plans for fiscal or political integration; the lack of reference to any pan-European deposit insurance; and Ms. Merkel's limited concessions (to ensure passage of the growth compact) to the terms on which the existing pool of EFSF/ESM resources are offered leaves the underlying issue - the terms on which mutualisation of financial risk is offered by Germany in return for mutualization of control over fiscal decisions throughout the Euro area - remaining inharmonious. German tactical concessions at the summit do not change their basic position on this issue: that discipline, reform and consolidation must be achieved and cemented first before mutualization of financial obligations is possible. Looking to the future Goldman sees four paths for the Euro are from here - and short-term too many crucial issues are left unresolved.

Huw Pill, Goldman Sachs: European Views

Looking to the future, we see four paths (albeit ones that are connected by cross streets) for the Euro area from here, around which scenarios for the market outlook can be developed:

  • The Cultural Revolution. While unlikely, it is possible that European politicians recognize the error of their previous ways and collectively jump to a more constructive approach, exploiting the strengths of the consolidated Euro area in pursuit of a solution, rather than focusing on the weakness in individual countries that represent obstacles to one. In short, the European leadership could start to ‘think continental’ (to use a phrase originated by Alexander Hamilton in not dissimilar circumstances). In principle, this would offer a rapid and effective resolution of the crisis. But the likelihood of this outcome is low. The European authorities are inevitably in thrall to their national political constituencies (which, after all, elect them): thinking national rather than continental is the therefore the most likely result.
  • The Long March. More realistically, one can characterize the June EU summit as another step forward in the long and slow process of necessary adjustment and governance reform in the Euro area, bringing national constituencies along in a step-by-step manner. Announcement of plans for banking union can be seen (for good reason) as part of the development of the new institutional architecture needed to make the Euro area workable. But however necessary, these measures are far from sufficient. Only over time will successive summits, each resulting in individually modest forward steps, lead to an accumulation of institutional advances sufficient to underpin the Euro adequately. The slow cumulative construction of a workable governance structure has been (and will remain) initially under-appreciated by the markets, but eventually be recognized, leading the market to support convergence rather than divergence across economies within the Euro area. Of course, aside from the politics of institutional reform, this ‘long march’ is likely to prove economically challenging: economic activity in the periphery will be hamstrung by the lack of a more comprehensive resolution, especially as the underlying necessary adjustments to competitiveness, external imbalances and public finances will proceed slowly, if at all, in this environment.
  • The Great Leap Forward. We are skeptical that either financial markets or domestic political constituencies will have the patience for a ‘long march’ lasting as long as a decade (as Ms. Merkel has repeatedly predicted). More realistically, intensifying market pressure is likely to short-circuit this process, forcing Europe to an earlier decision point. For example, should Spain be denied market access and be forced into an explicit external financing program, additional fiscal demands will be placed on the rest of the Euro area, weakening the public finances of Italy and, via a domino effect, France and ultimately Germany. Relying on a slow, cumulative improvement in governance is inadequate in these circumstances. The ‘Big 4’ countries will quickly be presented with the question of whether or not they are prepared to take the steps necessary to underpin the Euro. Measures will need to be taken quickly and aggressively: acting outside the existing institutional framework will be required. Germany and France will have to decide to whether they are prepared to take substantial steps forward in economic and political integration in order to preserve the Euro. Muddling through will no longer suffice. In these circumstances, we think such a ‘great leap forward’ is the most likely response.
  • Disintegration. That said, we cannot rule out the possibility that, faced with an ‘existential threat’, the political process does not allow such a ‘great leap forward’ to be taken. At that point, Monetary Union would become untenable—and a rapid and costly unraveling of the Euro area would result.

Using these four paths as a framework, we see the most likely scenario going forward as follows:

the European authorities continue their ongoing ‘long march’ of cumulative reform until, at some point—probably not imminently, but over the coming one to three years—market and/or political dynamics force the choice of whether to make a ‘great leap forward’ on the key Franco-German axis that has driven European integration since the 1950s.

Sketching this baseline scenario raises two questions:

  • When will the Euro area switch from the slow, cumulative path of the ‘long march’ to confronting the pressing question of whether to take a ‘great leap forward’? We believe Euro area can continue on its current ‘long march’ for some time yet. The institutional machinery of monetary union—notably the balance sheet of the ECB and the ability of its TARGET2 balances to accommodate intra-Euro area cross-border stresses elastically—has proved remarkably robust to market pressure: by its nature, monetary union has greater resilience than the fixed exchange rate systems with which it is often compared. Moreover, for different reasons, the key players are not facing immediate pressures: ample liquidity in the Euro area is keeping French government bond yields at close to historical lows, while the German economy continues to show resilience at the lowest level of unemployment seen n for a generation. And procrastination is the path of least resistance for European politicians, lending inertia to the process. This makes a continuation of slow, incremental reform—rather than a comprehensive and rapid resolution of the crisis—more likely. But this approach does not come without its own costs. Macroeconomic performance in the periphery is set to deteriorate further in 2012H2, as market dislocation continues to weigh on credit creation and economic activity. And market participants are losing patience with the slow pace of adjustment: this adds to the tensions in financial markets.
  • When facing the existential choice of whether to take the ‘great leap forward’, will France and Germany be prepared to do so? Yet ultimately we doubt that the ‘long march’ can be pursued to a conclusion. Other forces—such as a fiscal policy mis-step in France that undermines investor confidence or a populist political shock in the Italian elections—would force an ‘existential crisis’ for the Euro. At that point, we believe Germany and France will demonstrate the courage and commitment to move forward. Failing to do so in those circumstances would not merely imply acquiescence with the status quo, but rather a disintegration of the Europe built over the past 60 years, something neither country is likely to countenance. Yet making this step will not be without its own political challenges, especially in Germany where taxpayers are understandably reluctant to take on yet greater burdens that such a leap forward would imply.

Viewed in this light, the decisions taken at last week’s EU summit are best seen as part of the cumulative and incremental process of institutional reform inherent to the ‘long march’. While elements were surprisingly positive and important in themselves, in our view these decisions do not represent the ‘great leap forward’ required to resolve the crisis. They leave too many crucial issues—not least, the central question of how mutualization of financial risk and the debt overhang is traded off against loss of national fiscal sovereignty to German-inspired Euro area-wide fiscal and regulatory institutions—still unresolved.


Source: Goldman Sachs

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otto skorzeny's picture

China factory activity hitting lows not seen since March 09 should be good for 300+ points on Dow and $2+ tacked onto a barrel on Mon. Does this mean the ChiComs won't be riding to Eurotrash rescue?

FinLen's picture

squid fixng to stay long...?

knukles's picture

News for Squid:
Kunkles says it don't mean shit 'cause nothin's changed.
And it didn't take him until the weekend to figure that shit out.

i-dog's picture


Fiscal integration is a smokescreen (and a completely separate agenda!): They just need to live up to the commitments they made to each other in their treaties.

I'd suggest they change from an upper limit of 3% deficits to an upper limit of 0% deficits ... but that's just me.

Rich Bagg's picture

China's numbers are rigged for a certain outcome.  Low factory output is a reason for Chinko Stimulation.  Call it Operation ChinkStim.



Manthong's picture

The present approach is more like the slow drip.. drip.. drip.. of Chinese water torture.

Right-on Left-off's picture

In the immortal words of Yogi ... 'When you come to a crossroads, take it.

And just another example of Yogi's enlightened view ... de ja Vu all over again.

RobotTrader's picture

Futures pinned near the highs


Asia is rocketing, gold and oil advances are still contained.

Looks like the lows are definitely in.

chinaguy's picture

Hey RT, what happened? You used to be cool...that said, I wish to fuck I'd bought "roo roo reman"  (loo loo lemon) a year ago when you were pointing out its upside.

BTW - Dennis "Chip" Wilson named Loo loo Lemon expressly because he though it would be funny to hear the Japanese try to pronoun it......

LowProfile's picture


Looks like the lows are definitely in.

...For the USD.

First, they print EUR.  This pushes big money into Treasuries and the USD.  PMs take it in the nuts, because they will burn $$$ to give it one last try to push them down.  Last best chance to get on the gold train, choo-choo!  Stocks get smacked, but not as hard as PMs because they manipulate stocks up vs. down with PMs.

Then they print everything else (yen, pound, etc.).  This makes the FED squeal in pain, and THEN...

The FED prints.  Like you've never seen it print.

Then the reset button gets mashed like it's never been mashed.

The system is recapitalized with gold.

Long time ZH readers now happy happy happy.

genr8n's picture

"China's numbers are rigged for a certain outcome." Yes, the official ones are but these are the less official HSBC Markit PMI results. The 48.2 number isn't as bad as the comments on massive build up in inventories, labour force reductions and demand slumps in EZ and Nth American markets. Awaiting the BoC policy response now.

genr8n's picture

Elsewhere ...on the Eurozone and US markets -

chinaguy's picture

Thanks, forget JH often publishes the day before........

chinaguy's picture

This year's BIS report does not paint a pretty picture...and they are in a position to know...


zorba THE GREEK's picture

According to this article, the EU/EZ/EMU crisis can go on

for years without coming to a head. That would mean that 

it is quite possible that the U.S. could hit the wall before Europe,

or that Japan or England could melt down first. It could also mean

that this whole financial crisis fiasco could be drug out for a very long

time causing the general populace to become complacent so when the

house of cards finally does come crashing down, most people will be

caught unprepared and suffer the full brunt of the consequences. 

For those of us who see it coming, this could be an extended opportunity

to prepare for the eventual collapse by accumulating PMs. 

Treeplanter's picture

The ESM has no funds and may never get them.  The ECB can print but that no longer has much kick.  And the Krauts and Vikings have no use for a Wiemer euro.

ekm's picture

This guy knows Europe inside out. A real maestro. Strongly recommend to be followed.

Short quote:

"The Bundestag vote on Friday night on the fiscal pact and ESM was a farce. It laid down that ESM money would go to the governments, not the banks, and would be conditional on Troika-style packages. The documentation was overtaken by events, because Merkel had agreed on diametrically different terms in Brussels."

genr8n's picture

Soros was right .. as soon as Germany starts suffering (unemployment rising, growth stalling, business confidence falling) German public will believe that there aren't enough seats in the "life boat" for all of the EZ.

otto skorzeny's picture

the Germans are running out of people to sell their crappy/overpriced cars to. plus the chinese will quickly catch on to copying/bettering the German milling machines, etc

genr8n's picture

The best I've read so far (pulls together a lot of indiviual comments read since Thursday). Also means that the Soros downturm in Germany will be in full force before Germany actually commits to anything -

Lore's picture


The GS piece is kowtowing and self-serving. Ann Barnhardt is right. SAVE YOURSELVES. KNOW WHEN TO SAY 'NO.'

TahoeBilly2012's picture

Regarding comment on China overtaking German carmaking...YOU HAVE LOST YOUR MIND!

JLee2027's picture

My own prediction is a sudden disorderly Greek default, followed by a banking system crash and partial bank and stock market failures worldwide. The sooner the better as far as I'm concerned.

gatorengineer's picture

As long as the greeks done show up at the summit (trough), there isnt a problem....

Peter Pan's picture

Economic developments, budget deficits, huge national debts etc are moving at a faster pace than the bickering politicians of the Euro area who mostly have compounding national debts. Therefore, I expect that the countries of the Euro will be making the right noises publicly but privately they will be preparing for the break up.

This may be a good thing as it might precipitate a massive debt write-off and at a subsequent time it might allow for a more well thought out RE-UNION of the Euro area. That's if they don't kill themselves in the post-breakup period.

Then again the USA might spawn enough disension between them so that the US Dollar does not have one more competitior.

Vince Clortho's picture

Or alternatively, privately they are planning on turning all their citizens into debt slaves of the Central Planners.

Gief Gold Plox's picture

After reading all the "historical", "breakthrough" and "ground -breaking" announcements coming out of yet another pointless summit all I have to ask is: "Where's the fucking money?"

Nothing has changed. Nadda. Changing the acronym behind which to hide the fact does nothing to alleviate the underlying condition. EU: Still broken. Still broke.

Additionally, I'd like to take this opportunity to welcome Slovenia to the bailout party list. Not just quite there yet, but they will be. soon enough.

Vince Clortho's picture

"Where's the money"?


It is currently rumored to be stored in a soon-to-be-announced new acronym.

Enough money to solve every financial problem.  That is my current understanding of economics.

luckylongshot's picture

Typical Goldman propaganda, follow their advice and Goldman end up owning you. The facts are quite simple- the problem is a combination of too much debt and the privately owned fractional reserve banking system. The solution is to either get the private groups that own the system to write off enough debt so that economies can start to grow again or to take away their control of the system and return it to the public so there is a feedback loop and money spent paying interest stays in the countries that are paying it.

Element's picture

Ellen Brown: Government by the Banks, for the Banks: The ESM Coup D’Etat in Europe

July 1st, 2012 Kommentare deaktiviert

" Last Friday the national (mis)representatives of Germany commited a coup d’etat in broad daylight against the constitution of Germany and their target group (a.k.a. the Germans). Germany as a so called democracy is history, now starts – as for other European countries as well – a whole new chapter. "

Vince Clortho's picture

How long will it take the German people to understand that Merkel sold them out?

lewy14's picture

Hah. Nice to see someone who gets it.

Short pitch to the deflation/disintegration proponents:

What part of banking union do you not undertand?

What happened is pretty simple - follow me here - Spanish and Italian politicians sold out their banks to the Germans, and in return the German politicians sold out their people to the Italians and Spanish.

Follow the money: German taxpayer -> ESM -> lever up with a banking license -> EUR Trillions in firepower via ECB leverage -> funding Italy and Spain directly (bond buying) and indirectly (bank recap -> buy more sovereign Spanish and Italian debt).

Note the Spanish and Italian banks get to live, but they become controlled by Brussels (their new supervisor will be run by the ECB) and Brussels in turn by Frankfurt. 

Fiscal union? Political union? Who needs them! If the politicos can't keep up with the bankers, the bankers just forge ahead. Simple.

The continental banking culture isn't going to let peoples or their representatives get in the way of building the biggest hedge fund on earth (EUR Capital Partners LLC). ECB gets an off balance sheet SIV (the ESM) which which it can torque around all kinds of assets (and the boys at Deutsche Bank et al can front run!) Quite a gadget (as Oppenheimer might say. The physicist. Not the fund.)

The Zero Hedge consensus view is half right, half wrong.

Half right: yes, we are debt slaves to the global banking culture. Bad news, folks. They won a major round.

Half wrong: no crash, no reset, no gold standard. Instead, serious melt up in risk assets. Robo's right - buy stocks.

Oh, and Goldman is misdirecting the muppets again. This is a game changer. Can't have them piling into equities until GS has loaded up itself.

When Merkel says No Eurobonds as long as I'm alive what she's really saying is guys we have to call this something else - because there isn't enough opportunity for graft and skim with Eurobonds!

Element's picture

Forget private debt slaves, there is now no genuine private lending liability, the private is now the public, there is no private, they just pre-nationalised the entire default-path 'option'.

But I disagree about your outcome assessment, this is going to be a monumental catastrophe of unimaginable scale, and severity.

The chances of this resulting in peaceful, orderly continuance of TPTB status-quo, is now nil.

This is an outright direct assault of EVERYTHING formerly the overtly legal and constitutional norm, within Western societies.

Yeah, there will be a bum-rush into stocks, big deal, its all fucked, that's nothing but a rancid cesspit of algo-skim and mal-investment.  Society and states are going to grenade here, then detonate, then go ka-boom, then really go A-bomb ... in ways that adjectives fail to convey.

They've really blown the entire system to bits, the 'Western world' just capsized.

Create the problem, provide the solution, ... the only one on offer ... shove it down everyones throat ... and they have.

It's flat out blackmail, and purest form of klepto-gangsterism, where any public objection to it, in any form at all, is going to be attacked and violently suppressed by all the measures of a Centralist Police State .


The Rothschild NWO stalking-horse has now fully emerged from its closet.

A stalking horse is a person who tests a concept with someone or mounts a challenge against them on behalf of an anonymous third party. If the idea proves viable and/or popular, the anonymous figure can then declare their interest and advance the concept with little risk of failure. If the concept fails, the anonymous party will not be tainted by association and can either drop the idea completely or bide their time and wait until a better moment for launching an attack.

Racer's picture

And the only path the people are on.....

getting their food from rubbish bins because they can't afford to buy food because of what the banksters have done

Treeplanter's picture

Lucy has the can.  Good luck with that kick, Charlie.

bankruptcylawyer's picture

ALL the world needs is ONE actual supply or demand shock that isn't caused or solved by 'lack of paper money' and Europe is entering a catastrophe. 


This history of war in Europe (rooted in the existence of different cultures and languages rather than merely the different kingdoms) is not going to be miraculously wiped out . 

Mutually assured destruction might keep certain european countries from annihilating one another, but theres plenty of other types of conflict besides annihilation and plenty of countries that don't have nukes. 

Europe is far too depedent on the presence and threat of U.S. troops to be robust in its path 'forward' with the idea of the Eurozone and EU. the likelihood is that poorly planned and poorly built social organizations break down . 

Plenty of articles had been written about the great "league of nations" after world war I. 

I think you can safely say the EU and the Euro with it is headed down the path of full destruction at some point in the next twenty years and very different Europe lies ahead. 

Lost Word's picture

Do I remember correctly or is it correct that the ESM law is the same as, or very similar to the TARP law ? No legal options for the little people ?