Tuesday, July 24, 2012

Spain's Way Out Of A "Punishment" Union

Spain is in the grip of an economic depression with unemployment at 24% and youth unemployment at 50% due to the "popping" of their property/housing construction bubble.

The bubble was caused by Spain joining the Euro in 1999 and adopting Euro-wide interests rates that were below the rate of inflation in Spain at that time. That meant that there was an incentive for people to buy homes or apartments that were appreciating at 6% where the cost of money was only 3%. It paid for borrower to borrow money! And they did! This caused a huge property/housing bubble in Spain and Ireland. Anyone with half a brain could have foreseen this. All this is due to the Euro "project". 

Now their banks, and even regional and national governments are insolvent. In fact, there's nothing but insolvency everywhere and a huge capital flight and slow motion banking panic is underway. Now, the solvency of the entire European banking system is gone due to the cross holdings of these bonds (Spanish, Portuguese, Irish, Greek, and Italian) by Northern European banks. Those bonds are deeply underwater but banks are "pretending" that they are worth 100 cents on the dollar.

Now the "reverse" of bubble conditions has hit and the Euro project has trapped Spain (and other countries) in a depression.  With no way to devalue their (own) currency to stimulate their economy, they are suffering from the flip side of the bubble--outright depression. And they are being forced to be in an even deeper depression by Germany who, true to their nature, are demanding more "discipline" by cutting government spending even as the country is spiraling into a 1930s style depression.

Something has got to give.

According to Ambrose Evans-Pritchard at The Telegraph, he says that it's time for the southern tier of European states to seize the initiative and force an end to their "punishment union."  Here's how it could happen according to Evans-Pritchard:

It is time for Spain and the victim states to seize the initiative. They cannot force Germany, Holland, Finland, and Austria to swallow eurobonds, debt-pooling and fiscal union, and nor should they try since such a move implies the evisceration of their own democracies.
What they can to do is use their majority votes on the ECB's Governing Council to force a change in monetary policy. Germany has two votes out of 23, with a hardcore of seven or eight at most. The Greco-Latin bloc can force a showdown. If Germany storms out of monetary union in protest, that would be an excellent solution.
The Latins would keep the euro - until the storm had passed - allowing them to uphold their euro debt contracts. There would be less risk of sovereign defaults since these countries would enjoy a pro-growth shock from monetary stimulus and a weaker Latin euro against the Chinese yuan, the D-Mark, and the Guilder.
The currency misalignment eating away at EMU would be cured instantly. There might even be a stock market rally once the boil was lanced. It would certainly be a better outcome than the current course of deflationary Troika regimes and loan packages for economies trapped with the wrong exchange rate, destined to end with one country after another being thrown out of EMU in a chain reaction.
For Germany it would entail a revaluation shock and stiff losses for German banks and insurers with large holdings of Club Med debt.
If Germany wished to soften the blow, it could do exactly what Switzerland is now doing by holding the Swiss franc to CHF 1.2 against the euro by unlimited intervention. It could fix the D-Mark rate against the Latin euro at whatever was deemed bearable, for as long as needed.
So, if the "Latin" southern European countries forced a change in monetary policy that was deeply abhorrent to Germany, then it might force a split of the Euro into a Southern Euro and a Northern Euro.   In all likelihood, it must happen as the current situation is totally untenable.   No politician can ask their people to accept a depression-forever scenario now being enforced by Germany.

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