The Euro is a horribly flawed currency rushed into production based on wishful thinking without an adequate plan B in case things did not work out. The Euro allowed states like Greece to merrily borrow enormous sums of money at German interest rates. It was like giving an open tab to an alcoholic. Now we are dealing with the inevitable mess.
Europe deserves what it has got, but there is one silver lining to it all. The crisis is forcing governments to finally begin to deal with out of control government spending, chronic deficits, and even-hopefully- uncompetitive economies. In the past-especially in the Med. countries-politicians would continually raise salaries by government fiat to win votes. This would quickly make their economies uncompetitive, so politicians would engage in periodic rounds of devaluation to lower their countries costs. The effect was high inflation. This is why Spain had 14% interest rates in 1991, and why the Italian Lira got up to 1500 Lira to the dollar.
But now the party is over and countries can no longer devalue to get out of the mess. Finally they are being forced to liberalize markets, cut costs and reform the system. They are valiantly trying at all costs to avoid any meaningful reform, and play a game of chicken both with the European Union, and bond holders. But, sooner or later they are going to have to face the fact that their economies are overpriced, over regulated, over buruocratize and over spending, and they will have to do something about it or default and leave the Euro. Germany will not continually bail them out, and the bond markets sure are not going put up with business as usual in the PIIGS.
Measures until now have been too little and too late, but at least something is beginning to be done. In the US, however, nothing is being done. It may appear that the US is in a better position than Europe, because Europe is beginning to go thru the pain of confronting its problems. The US can afford to deny its problems, and allow them to grow ever greater. The analogy is of the heroine addict who is trying to go clean and going thru the pain of withdrawal, while the other addict merrily goes on getting high. Superficially it may appear that the guy shooting up is in better shape, but the other addict, if he can successfully get clean, will end up doing much better. This is similar to the US and Europe. If Europe can go thru the pain and implement real reform, it will be much better off than the US, which simply ignores its growing problems.
Peter Schiff explains it very well:
Whose Fuse is Shorter?November 23, 2011 – 12:13pm — europac adminBy:
Peter SchiffWednesday, November 23, 2011
With fiscal time bombs ticking in both Europe and the United States, the pertinent question for now seems to be which will explode first. For much of the past few months, it looked as if Europe was set to blow. But Angela Merkel’s refusal to support a Federal Reserve-style bailout of European sovereigns, as well as her recent statement the she had no Hank Paulson-style fiscal bazooka in her handbag, has lowered the heat. In contrast, the utter failure of the Congressional Super Committee in the United States to come up with any shred of success in addressing America’s fiscal problems has sparked a renewed realization that America’s fuse is dangerously short.
Chancellor Merkel has been emphatic that European politicians not be given a monetary crutch similar to the one relied on by their American counterparts. Her laudable goal, much derided on the editorial pages of the New York Times, is to defuse Europe’s debt bomb with substantive budget reforms and, as a result, to make the euro “the strongest currency in the world.” Much has been made of the poorly received auction today of German government bonds, with some saying the lack of demand (which pushed yields on 10-year German bunds past 2% — hardly indicative of panic selling) is evidence of investor unease with Merkel’s economic policies. I would argue the opposite: that many investors still think that Merkel is bluffing and that eventually Germany will print and stimulate like everyone else. It is likely for this reason that yields on German debt have increased modestly.
In contrast, the US is crystal clear in its intention to ignore its debt problems. With the failure of the Super Committee this week, it actually became official. American politicians will not, under any circumstances, willingly confront our underlying debt crisis. While the outcome of the Super Committee shouldn’t have come as a great surprise, the sheer dysfunction displayed should serve as a wakeup call for those who still harbor any desperate illusions. Some members of Congress, such as John McCain, have even come out against the $1.2 trillion in automatic spending cuts that would go into effect in January 2013. Expect more politicians of both parties to cravenly follow suit.
Over the next decade, the US government expects to spend more than $40 trillion. Even if the $1.2 trillion in automatic cuts are allowed to go through, the amount totals just 3% of the expected outlays. In a masterstroke of hypocritical accounting, $216 billion of these proposed “cuts” merely represent the expected reductions in interest payments that would result from $984 billion of actual cuts. These cuts won’t make a noticeable dent in our projected deficits, which, if history can be any guide, will likely rise by much more as economic reality proves far gloomier than government statisticians predict. Finally, the cuts are not cuts in the ordinary sense of the word, where spending is actually reduced. They are cuts in the baseline, which means spending merely increases less than what was previously budgeted.
In the meantime, the prospect of sovereign default in Europe is driving “safe haven” demand for the dollar. So, contrary to the political blame game, Europe’s problems are actually providing a temporary boost to America’s bubble economy. However, a resolution to the crisis in Europe could reverse those flows. And given the discipline emanating from Berlin, a real solution is not out of the question. If confidence can be restored there, each episodic flight to safety may be less focused on the US dollar. Instead, risk-averse investors may prefer a basket of other, higher-yielding, more fiscally sustainable currencies.
The irony is that Europe is actually being criticized for its failure to follow America’s lead. This misplaced criticism is based on the mistaken belief that our approach worked. It did not. Sure, it may have delayed the explosion, but only by assuring a much larger one in the future. Once again, many have mistaken delay for success.
However, if Merkel’s hard line works, and real cuts follow, Europe will be praised for blazing a different trail. As a result, the euro could rally and the dollar sink. Commodity prices will rise, putting even more upward pressure on consumer prices and interest rates in the United States.
Any significant reversal of the current upward dollar trend could provide a long awaited catalyst for nations holding large dollar reserves to diversify into other currencies. My guess is that Merkel understands the great advantage the US has enjoyed as the issuer of the world’s reserve currency. I believe she covets that prize for Europe, and based on her strategy, it is clearly within her reach.
There is an old saying that one often does not appreciate what one has until it’s lost. The nearly criminal foolishness now on display in Washington may finally force the rest of the world to cancel our reserve currency privileges. The loss may give Americans a profound appreciation of this concept.