Ruminations, January 18, 2015

If the euro goes, can the European Union be far behind?

As long as all financial players (the United States, the European Union, Japan, China and Switzerland) are playing the same game, no matter if the rules are silly or not, no one gets hurt. Well, in the financial currency game, Switzerland has decided to scoop up its francs and go home.

Last Thursday, the gnomes of Zurich decided to abandon the pretense that the European Central Bankers knew what they were doing and accordingly stopped propping up the euro. The result was a shock to financial systems around the globe – especially those that were heavily involved in foreign exchange.

How did we get here? Let’s take a step back. Institutions and world financiers like to put money in safe investments. Given that the euro has been under pressure and the U.S. continued quantitative easing (more about that, later) the Swiss franc looked like a good place to park cash. (Switzerland has never joined the European Monetary Union – that ought to tell you something.) This made the franc’s value soar and the price of Swiss exports higher. So, in 2011, the gnomes of Zurich stepped in and decided to peg the franc to the euro at 1.20 francs to the euro. This meant that whenever the euro went below that value, the Swiss would step in and buy euros. The lower the euro went, the more the Swiss would have to spend the francs to prop up the euro.

Last week, the Swiss decided that this was costing them too much and stopped the purchases altogether. Foreign currency folks were caught with their pants down. The franc jumped by 30 percent against the euro and 18 percent against the dollar. Considering that currencies normally move by fractions of a percent, this was major. According to the Wall Street Journal, Citigroup and Deutsche Bank each lost $150 million overnight.

Quantitative easing (QE). QE has been described as a way for the Federal Reserve to print money. Technically, the Fed purchases treasury notes and mortgage-backed securities and then adds them to bank reserves so banks can loan out more money at lower rates. In essence, the Fed uses its credit to increase the amount that banks can loan – effectively increasing the money supply.

The idea behind this is that by providing banks with the funds to loan more to the public and corporations, the increase will stimulate the economy. So far, critics say it has not worked but has increased the potential for runaway inflation. The Fed says, things would be a lot worse without QE and inflation is relatively mild.

Who to believe? With some $4 trillion in treasuries on their books and virtually little movement in the economy (no one really wants to borrow) one would have to question the Fed’s premise. And then one would have to look at others’ use of QE – like Japan, which has had a stagnant economy unaffected by QE. Of course, with $4 trillion on the Fed’s books, banks could quickly seize on this money and dramatically increase the money supply and, therefore, create high inflation (the Fed says it has a secret plan to stop inflation should it start).

With Europe’s economy faltering, the European Central Bank is about to implement its own version of QE (whether or not it violates the Maastricht Treaty – the agreement that established the euro – or not.). The Swiss had this in mind when they dumped their support for the euro because QE would have driven the price of the euro lower and cost the Swiss even more.

Why would the European Central Bank even consider QE? Because they don’t know what to do and there is comfort in doing whatever everyone else is doing.

Greece. Here we go again. Since the beginning of its fiscal fiasco, Greece has had two contentious bailouts and now has a line of credit of $277 billion from the Euro Monetary Union (different than the European Union) and the International Monetary Fund and has been under an austerity plan. Now there is concern that it will not be enough – and Germany, which has been largely paying supporting Greece is getting tired. With a Greek election coming in less than two weeks, Syriza, the leading party according to polls, is pledging to stop all austerity programs. The logical step would be for Greece to abandon the euro and go back to the drachma. Yes, it would be disruptive in the short run but in the long run, it would improve Greece’s trade position and mitigate any austerity programs. What’s holding Greece back? The hubris of the Euro Monetary Union.

The political swing away from the European Union. In 2012, Mohamed Merah killed 7 people in Toulouse including Jewish children and their teacher. The recent attacks against Charlie Hebdo have increased the appeal of Marie Le Pen’s Front National Party in France. Le Pen makes her case that the immigration policies of the European Union have been bad for France and that France should adopt its own economic programs devoid of any EU oversight. Her party has been gaining in recent years and will now be even stronger. French President Francois Hollande, in the wake of the Hebdo killings, held a mini summit at the presidential palace and invited Le Pen – who normally wouldn’t get a call from the mainstream French governing parties.

And in Germany, German Bundesbank President Jens Weidmann criticized the European Central Bank’s plan to inaugurate quantitative easing. And over in Dresden, the Patriotic Europeans against the Islamization of the West Party (Pegida) has had rallies which have attracted more than 25,000. The Alternative for Germany Party, an anti-euro, anti-bailout and anti-immigration party began in 2013 and has gained almost 10 percent of the vote. (The European Union backs open immigration.)

In Great Britain last week, Prime Minister David Cameron held talks with German Chancellor Angela Merkel about restricting immigration. The United Kingdom Independence Party (UKIP), a euro-skeptic party, placed fourth in the last elections and seemingly has made progress since then.

The euro and the European Union. The euro was a mistake. Since its implementation, Europeans have spent time and treasure defending it instead of repairing their economies (Youth unemployment in Greece and Spain is close to 60 percent – more austerity to save the euro anyone?). Even Christine Lagarde, former French Finance Minister and currently managing director of the International Monetary Fund has admitted as much. In an interview with the Wall Street Journal last December, she said that it was “assumed that by moving to a single currency everything else would follow, and the fiscal union would be a given.”

Well that hasn’t worked and the sooner the currency is revised or eliminated, the sooner Europe will recover. Perhaps the Swiss have hastened that day.

Was the European Union a mistake, too? It has not achieved political unity. It made a start with the establishment of the common market after World War II and current discussions with the United States for a transatlantic trade accommodation has the potential for enormous economic benefits – especially for those countries in dire economic straits such as Greece, Spain, Italy, Portugal and others.

The euro, in its current form (i.e., at least four or five countries should exit from it) should go and go quickly. The problem with the EU is that it is an intellectual fiction and the leaders of the EU are loathe to admit that it too may have been a mistake. It is likely to be around for a while although diminishing in importance.

Quote without comment
British-American historian Walter Laqueur in an interview with Der Spiegel, July 26, 2013: ”It appears that there is a hidden law in history, where institutions, once they are established, become self-propelling and continue to exist, contrary to all expectations or fears, or at least much longer than expected. There is always a retarding, persevering moment before the collapse arrives.”

Brophy Monday 19 January 2015 - 09:27 am | | Brophy Blog

No comments

(optional field)
(optional field)
Remember personal info?
Small print: All html tags except <b> and <i> will be removed from your comment. You can make links by just typing the url or mail-address.