Last Call

Via The Kroog, Martin Wolf at the Financial Times sees the Greek Fire burning through the eurozone and quickly on the failure of Greece to meet its targets.  Austerity has failed, and the only choices left are a permanent bailout system at the expense of the EU countries like Germany that will eventually collapse the Euro, or massive sovereign debt restructuring that will most likely lead to the same result.

Debt restructuring looks inevitable. Yet it is also easy to see why it would be a nightmare, particularly if, as Mr Bini Smaghi insists, the ECB would refuse to lend against the debt of defaulting states. In the absence of ECB support, banks would collapse. Governments would surely have to freeze bank accounts and redenominate debt in a new currency. A run from the public and private debts of every other fragile country would ensue. That would drive these countries towards a similar catastrophe. The eurozone would then unravel. The alternative would be a politically explosive operation to recycle fleeing outflows via public sector inflows.

 

Events have, in short, thoroughly falsified the premises of the original design. If that is the design the dominant members still want, they must remove some of the existing members. Managing that process is, however, nigh on impossible. If, however, they want the eurozone to work as it is, at least three changes are inescapable. First, banking systems cannot be allowed to remain national. Banks must be backed by a common treasury or by the treasury of unimpeachably solvent member states. Second, cross-border crisis finance must be shifted from the ESCB to a sufficiently large public fund. Third, if the perils of sovereign defaults are to be avoided, as the ECB insists, finance of weak countries must be taken out of the market for years, perhaps even a decade. Such finance must be offered on manageable conditions in terms of the cost but stiff requirements in terms of the reforms. Whether the resulting system should be called a “transfer union” is uncertain: that depends on whether borrowers pay everything back (which I doubt). But it would surely be a “support union”.

The eurozone confronts a choice between two intolerable options: either default and partial dissolution or open-ended official support. The existence of this choice proves that an enduring union will at the very least need deeper financial integration and greater fiscal support than was originally envisaged. How will the politics of these choices now play out? I truly have no idea. I wonder whether anybody does.

And as I have been warning in the Greek Fire series for over a year now,  the end result will be the end of the Euro as a currency.   The larger effects will almost certainly include another serious hit to the global financial system as well.  The individual banks in countries like Ireland, Greece, and Spain owe German banks serious money, and if they default, the whole thing is going to come apart...either that or Germany's going to have to eat billions of euros in debt restructuring, causing basically the same thing.

The Greek Fire situation just got a whole lot worse, folks.  Count on it.