Making the Euro Work

Unlike Gold Bullion , neither the Euro nor the Eurozone can continue to exist
in their current form... IT WAS A BUSY weekend for finance officials in Europe,
writes Greg Canavan for The Daily Reckoning Australia . That's a sure sign that
things are getting serious. Weekend meetings in the northern hemisphere are all
about getting a soothing message out before markets open in Asia on the Monday.
We saw plenty of Sunday press conferences in the US during the dark days of
2008. Last week was a shocker for Europe. The Irish bailout plan did nothing to
assuage the markets' fears about the financial contagion spreading to Portugal
and then Spain. Bond yields in those countries rose significantly last week,
making it more expensive for their governments to borrow funds. So what went on
over the weekend? Well, European Union finance ministers signed off on a €85
billion 'rescue' package for Ireland. More on that in a moment. It was also
proposed that Europe's current bailout fund, due to expire in 2013, be replaced
with a permanent 'European stabilization mechanism', and that rules relating to
private creditors and possible (probable) future debt restructurings be brought
into line with IMF regulations. According to a Bloomberg article, this means
"Investors won't automatically take losses to share the cost with taxpayers as
German Chancellor Angela Merkel initially proposed to the consternation of bond
traders." The aim, of course, is to inject a shot of confidence into the market.
Banking is a confidence game. It relies on someone lending to someone who lends
to someone else, and so on. Once the chain of lending is broken, usually because
of a loss of confidence, that's when the game is up. This is what is happening
– in slow motion – in Europe. The market is slowly but surely losing
confidence in the current structure of the Eurozone and the European Union (EU).
But the determination of EU officials is heroic. They won't let the Euro
experiment fail without an almighty fight. Hundreds of billions of Euros that
don't yet exist will be pledged to maintain the status quo. But it can't
possibly work in the long term. Let's look at Ireland's bailout package to see
why. According to the Financial Times , of the €85 billion total,
approximately €50 billion will supplement the Irish government's finances
(depleted because of their prior attempts to bail out their banks). Bank
recapitalizations will absorb €10 billion, while the remaining €25 will go
to the banks if needed. (And yes, they'll need it.) Now, in addition to being
saddled with an extra €85 billion in loans – and at roughly 6% interest –
the Irish people will be subjected to a four-year austerity package that aims to
cut €15 billion in spending. So how the economy will achieve sufficient growth
to pay down its debts is anyone's guess. More importantly, will the Irish
population actually allow the EU's plans to play out? This is where we come to
the reason why the Euro experiment, in its current form at least, is doomed...
What is happening in the peripheral countries of Europe now is similar to what
occurred on a global scale in the Great Depression. In the lead up to the 1930s'
depression, the global economy boomed on the back of massive credit expansion.
The reasons behind the credit boom are complex but basically, the rules of the
classical Gold Standard gave way to what became known as a gold exchange
standard after WWI. This allowed both the Bank of England and the Federal
Reserve to pursue very easy money policies, particularly in the second half of
the 1920s. When the bubble burst, in 1929, the fact that currencies were still
tied to gold meant that the adjustment had to be borne internally. That is,
wages, prices and so on were required to fall to correct the imbalances built up
during the boom. Democracies are not especially equipped to deal with 'internal
adjustments', which is another name for deflating an economy's price structure
to bring it back into balance. It can be done after minor booms (eg, 1921) but
not after massive credit binges such as was experienced in the late 1920s. And
in the 1930s there was no social safety net. So, with the Gold Standard
demanding 'internal adjustments', it's not surprising to note that Britain
abandoned gold in 1931, the US in 1933, and France in 1936. By abandoning gold,
these countries effectively devalued their currencies and tried to shift the
necessary adjustment from an internal to an external one. But when everyone
tries to do the same thing, it loses its effectiveness. This was one reason
(amongst many) why the Depression lingered. Perhaps you can see the parallels in
Europe today. Greece, Ireland, Portugal and Spain are all experiencing
depression-like conditions, because they are tied to the Euro. The Euro allowed
them all to party hard under low interest rates, but it's now enforcing a long
and painful hangover by depriving them of the ability to devalue their debts
unilaterally. Under the current system, these countries cannot default on their
debt and devalue the currency. Sticking with the Euro ties them instead to a
painful internal devaluation – of falling wages, falling prices, falling real
estate and business values. But without debt restructuring as well, this too is
likely to fail. In a few years time, their debt-to-GDP ratios will still be sky
high. This whole rescue business is about protecting the banks from defaults.
The idea is to get the banks to build up their capital bases, so they can begin
to absorb some losses. But that will take years. In the meantime, do you think
these countries' people will stand by and accept austerity measures while
bankers and those who lent to the banks receive taxpayer-funded bailouts?
Ireland has done so for a few years now but the political situation there is
looking fragile. Last week, the markets lost faith in the ability of the EU, ECB
and IMF to hold the Eurozone together. This latest series of announcements may
take some pressure off for another few weeks, or even months. But the Euro and
the Eurozone cannot continue to exist in their present form. Gold Investment –
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