An Economist Predicts The Downfall Of The Eurozone

[Hydrogen]

The downfall of the euro

The finance ministers of the Eurozone are negotiating on the implementation of the rescue package agreed two weeks ago. The only problem is that no one seems to know what was actually agreed. The text of the agreement was extremely vague. This is for the simple reason that political cohesion has nearly vanished from the Eurozone.

This is extremely troubling, as political will, or cohesion, is the glue that keeps currency unions together. When it disappears, currency unions break apart. That’s the unanimous lesson of previous currency unions.

In this blog we detail why the Eurozone has reached its present perilous state, and why it’s unlikely to survive the coming crisis.

“The Greeks are coming!”

The unfortunate fact is that if European leaders had let Greece fail and the banking crisis run its course in 2011/2012, most of the problems now haunting the Eurozone would, most likely, have been resolved by now.

In 2011, the balance sheet of the ECB was practically unimpaired, political cohesion supporting the euro was strong, and the world economy was growing relatively fast—since Chinese stimulus was still effective. Now, seven long years later, the balance sheet of the ECB is distended, European political cohesion is under stress, and global growth is stagnant—with Chinese stimulus impotent.

What would have been a regional banking crisis seven years ago has now turned into a monster threatening the whole global financial system. We have described the dire straits of the European banking section in our previous blog.

A likely trigger for the next stage of the ongoing Eurozone crisis will be a bank run in some corner of the Eurozone. It may be either silent (through “repo” markets, etc., as in 2008) or more obvious with savers visibly withdrawing their money.

If the first significant bank failure occurs in a strong euro member, such as Germany, its initial effects may be contained. But it will breed even greater mistrust of the European banking sector, and, at some point, bank runs will commence on a larger scale and in weaker member states where the outcome will be anything but benign.

The options for the euro

The European banking union has the resources to handle the failure of few small-to-medium sized banks, but not a “systemically important financial institution” (“SIFI” in Fed language). That’s why the responsibility for bank recapitalization will, once again, fall on national governments.

This leads us to the crucial questions determining the fate of the Eurozone, which we outlined in Q-Review 3/2019:

• Will the ECB be able to provide support for sovereign bond markets through QE and the banking sector, and will it be enough?
• Will national authorities co-operate and accept the terms associated with possible bailout loans?
• Will national political leaders, in turn, continue to support the euro?

Currently, the ECB is running “unlimited QE”, and so the support for the European sovereign bond markets is in place. This is crucial as many Eurozone countries have a very high sovereign debt burden (see Figure 1).



Figure. The sovereign (public) debt as a share of GDP in selected countries of the Eurozone. Source: GnS Economics, European Commission
National authorities have also co-operated and agreed, at least on paper, about bailout loans. How strong the current commitment is remains to be seen.

The risk exists that if eventual bailout loans are conditional upon demands for austerity, citizens of bailed-out countries might see EU institutions as oppressors because of such externally-imposed austerity. Citizens of creditor countries, on the other hand, would object to having their taxes used to bail-out banks of other “profligate” countries.

Political mutiny, manifested through radically-populist parties, would almost certainly erupt.  Demands for a euro exit, in Italy for example, could lead to a collapse in political support for the euro more broadly.

The extremely risky “get-out-of-jail” card

If Germany, Finland, the Netherlands, or other “northern” countries agree to significantly increase the budget of the Eurozone in the range of 20%-30% of Eurozone GDP, and to issue Eurozone bonds, they might be able to muster enough firepower to stem the crisis. However, there’s extremely limited support for this in most of the stronger nations, and for good reason, as it would impoverish the whole continent!

For example, in Finland there’s absolutely no support for further federalization. The political backlash would likely be overwhelming.

Realizing a true federal union without the broad and popular support of the citizens of Europe would also be an extremely risky endeavour. It would also violate the constitutions of many member countries as well as Article 125 of the Treaty of the Functioning of the EU, or TFEU, setting the stage for an existential constitutional crisis in the EU. That is why this option continues to be a very unlikely outcome.

Also, if the ECB and/or national governments suffer losses from their loans to other countries of the Eurozone, this would indicate clear violations of Articles 123 and/or 125. This could also precipitate a constitutional crisis in the European Union and make the recapitalization of the ECB far from certain.

The end is near

The unfortunate fact is that the European common currency, euro, has been an ill-conceived project from the beginning. If the history of previous failed currency unions teaches us one thing, it’s that you never ever establish a common currency among countries with very different cultural and political backgrounds without a Federation. It’s unfathomable that we need to learn this lesson the hard way, again!

The massive economic blow caused by the Covid-19 will, most likely, bring an end to the euro. This is something we all should acknowledge and prepare for. It will be the biggest financial earthquake ever, requiring some serious hedging and planning. We have outlined such practices in our Crisis Preparation series.

To end on a positive note, when the euro is gone, former member economies will be ready to accelerate. It will, naturally, not start for a while, but when many export-dependent nations recover their most important macroeconomic stabilizer—their own currency—this will help foster recovery.

And, we should never mourn the passing of those institutions whose time has come!

https://gnseconomics.com/2020/04/21/the-downfall-of-the-euro/

....



Finally. An economist willing to address the elephant(s) in the room.  

Sorry for posting doom and gloom in these stressful times. The main reason behind addressing negatives are in the hope of better information and preparation for future crisis. "An ounce of prevention can be worth a pound of cure." Knowing history can help prevent bad history from reoccurring.

I think its good to have open discussion on these topics. It can be good to have 2nd, 3rd even 4th opinions from different sources to hear different perspectives and views. Yielding more raw information and data to draw conclusions from.

Until I saw the chart image posted above, I hadn't realized eurozone nations like greece and germany boast significantly higher debt as a percentage of GDP, in contrast to the USA. I feel like this type of information should have been made public knowledge years ago. That could make it easier to get problems under control. Rather than have them snowball into larger crisis.

Anyways I don't know what type of discussion this can contribute to, if any. But here it is if anyone is interested.

[suchmoon]

Until I saw the chart image posted above, I hadn't realized eurozone nations like greece and germany boast significantly higher debt as a percentage of GDP, in contrast to the USA.

The top blue line is Italy, not Germany. Germany's debt-to-GDP ratio is ~60%. US is currently around 105% and rising rapidly.

[LoyceV]

The unfortunate fact is that the European common currency, euro, has been an ill-conceived project from the beginning. If the history of previous failed currency unions teaches us one thing, it’s that you never ever establish a common currency among countries with very different cultural and political backgrounds without a Federation. It’s unfathomable that we need to learn this lesson the hard way, again!

My bigger fear is they'll use this crisis to create said Federation. EU member states are currently all drawing their own plans, closing borders as they please, while EU is grasping to remain relevant.
Losing euro will be expensive, but it's probably for the best in the long run. Unless you work at ECB of course, then you'll do whatever it takes to keep your job rescue the euro.

[Febo]

People in Eurozone can freely use Bitcoin. Simply because none of them is emotionally linked to Euro. This is way different in USA or China or UK or Switzerland or Russia or, ....  I see this as a big advantage Euro zone have. Future for Europe is only united. Divided is way to irrelevant to compete with China USA and India. United research is the key. If every European country will research its own tank is a huge waste of resources.

[LoyceV]

People in Eurozone can freely use Bitcoin. Simply because none of them is emotionally linked to Euro. This is way different in USA or China or UK or Switzerland or Russia or, ....

Young people in Europe are are just as used to "euro" as Americans are to the dollar, only the adults "bonded" to their national currency before the euro.

I see this as a big advantage Euro zone have.

I don't think that matters at all. I'm not emotionally linked to my debit card, phone wallet or cash, but I can use all of it to buy stuff.

Future for Europe is only united. Divided is way to irrelevant to compete with China USA and India. United research is the key. If every European country will research its own tank is a huge waste of resources.

You don't need to share a currency to share resources. It's the shared currency that's causing friction between the North and the South of Europe now.

[suchmoon]

You don't need to share a currency to share resources. It's the shared currency that's causing friction between the North and the South of Europe now.

Don't worry, as the US example shows, a civil war and a couple hundred years later there will still be many other things to cause friction besides shared currency.

[LoyceV]

Don't worry, as the US example shows, a civil war and a couple hundred years later there will still be many other things to cause friction besides shared currency.

So what used to be called "war" within Europe will now be "civil war" if we all pretend to belong to the same Federation?

[petuel]

The unfortunate fact is that the European common currency, euro, has been an ill-conceived project from the beginning. If the history of previous failed currency unions teaches us one thing, it’s that you never ever establish a common currency among countries with very different cultural and political backgrounds without a Federation. It’s unfathomable that we need to learn this lesson the hard way, again!

My bigger fear is they'll use this crisis to create said Federation. EU member states are currently all drawing their own plans, closing borders as they please, while EU is grasping to remain relevant.
Losing euro will be expensive, but it's probably for the best in the long run. Unless you work at ECB of course, then you'll do whatever it takes to keep your job rescue the euro.

in this current situation the uk will be in the most comfortable position - still holding on with some EU connections, but whole country is ready to take a break from the union like 'til the end of the year (and does not depend on euro)

[bitbunnny]

People in Eurozone can freely use Bitcoin. Simply because none of them is emotionally linked to Euro. This is way different in USA or China or UK or Switzerland or Russia or, ....  I see this as a big advantage Euro zone have. Future for Europe is only united. Divided is way to irrelevant to compete with China USA and India. United research is the key. If every European country will research its own tank is a huge waste of resources.

Yes, people in.Eurozone can freely use Bitcoin and not just in Eurozone but in whole European union..But that has nothing to do with Euro or emotional attachment or lack of it. It's about the EU politics that doesn't have any special restrictions towards cryptocurrencies unles they are used in illegal purposes. And, yes, Europe has much different and more liberal approach to Bitcoin compared to US or China.

[suchmoon]

So what used to be called "war" within Europe will now be "civil war" if we all pretend to belong to the same Federation?

Yes, and you will need to remain civil when Germans invade. But look on the bright side: plundering and pillaging will be so much easier because looted cash will be usable in the invading country without any currency conversion trouble.

[abhiseshakana]

The European Union was originally formed to distribute welfare between member countries. This welfare distribution is carried out through strong economic cooperation between member countries and market freedom and individual freedom are paramount. However, the reality of the current crisis experienced by the European Union is that it shows that there is an imbalance of welfare among EU member states.

Basically the essence of liberalism is a moderate control of the actors involved through compromise and peace. By being willing to reduce each other's demands for the sake of creating a peaceful and calm condition. Conflict can be avoided through the creation of a common interest in trade and economic cooperation. Capitalism, which initially had a good impact, namely uniting postwar European countries, showed the existence of liberalism which was able to unite the differences of each country. But on the other hand, liberalism has a negative impact on the existence of the EU itself. When the market is too free and uncontrolled, it can cause current conditions.

The economic crisis in the Eurozone region which was triggered by the magnitude of government debt actually began to take root since 2000, where the debt ratio of governments in European countries increased significantly. Increased state debt due to ongoing budget deficits. This condition clearly contradicts the Maastricht Treaty rules, which stated in this rule that the state debt must not be more than 60% of GDP and a maximum deficit of 3% of GDP. In theory, if it passes that number, it will create regional economic instability.

European Zone must also implement a joint fiscal policy such as a joint monetary surplus. There must be an institution that has the authority to be able to regulate fiscal policy throughout the eurozone and has the authority to regulate government spending, increase the amount of state revenue through taxes, and make laws and regulations. This means that each country must surrender its sovereignty to a superpower institution to make fiscal policy.

[davis196]

A agree that maintaining the euro is impossible without a European federation,which means more political and financial centralization,which on the other hand,is something the majority of the Europeans don't want.
Anyway,the rumors about the collapse of the Eurozone are highly exaggerated.Most of the country leaders there realize that a possible collapse of the euro would lead to a bigger collapse in their national economies.
So maintaining the euro would bring more benefits for them.
It seems to me that the article author is kinda trying to say "euro is rotten but the US dollar is just fine" between the lines.Something that simply isn't true.

[HeRetiK]

The downfall of the euro

The massive economic blow caused by the Covid-19 will, most likely, bring an end to the euro. This is something we all should acknowledge and prepare for. It will be the biggest financial earthquake ever, requiring some serious hedging and planning. We have outlined such practices in our Crisis Preparation series.
https://gnseconomics.com/2020/04/21/the-downfall-of-the-euro/

Counterargument: The Eurozone will likely recover faster than the US due to earlier and stronger measures combined with overall more stable healthcare systems. This will enable Eurozone countries to reboot their economies safer and faster than the US.

My bigger fear is they'll use this crisis to create said Federation. EU member states are currently all drawing their own plans, closing borders as they please, while EU is grasping to remain relevant.
Losing euro will be expensive, but it's probably for the best in the long run. Unless you work at ECB of course, then you'll do whatever it takes to keep your job rescue the euro.

Yeah, an European Federation would be bad news but I doubt it will ever come to that anytime soon. The EU is going through too divisive times for such measures.

Having grown up in a smallish EU country with both national currencies and the Euro, I absolutely don't want to lose the latter. There's just too much friction when hopping borders or doing business when every little country has their own little currency and the banks take their own little cuts whenever money moves to and fro. No thank you.

[salamat700]

The unfortunate fact is that the European common currency, euro, has been an ill-conceived project from the beginning. If the history of previous failed currency unions teaches us one thing, it’s that you never ever establish a common currency among countries with very different cultural and political backgrounds without a Federation. It’s unfathomable that we need to learn this lesson the hard way, again!

My bigger fear is they'll use this crisis to create said Federation. EU member states are currently all drawing their own plans, closing borders as they please, while EU is grasping to remain relevant.
Losing euro will be expensive, but it's probably for the best in the long run. Unless you work at ECB of course, then you'll do whatever it takes to keep your job rescue the euro.

in this current situation the uk will be in the most comfortable position - still holding on with some EU connections, but whole country is ready to take a break from the union like 'til the end of the year (and does not depend on euro)

And in that case, Brexit can be proven to be working well for Britain as the country will not anymore be dragged by the weakness of Euro and member-countries of the Eurozone. I am seeing many bad developments within this big block of countries, and I am seeing a slow but sure strong dominance of Germany (seen as an important financial savior by eurozone countries) politically and economically.

[wxxyrqa]

Undoubtedly, today the European Union has faced an unprecedented economic downturn, the scale of which reaches almost 10%. According to the statement of the European Central Bank, Eurozone GDP may already be reduced from 5 to 12% in 2020. Nevertheless, today, which countries like France, Germany and others, are trying by any means to support their people, allocating social assistance for people and businesses. thus, in a certain sense, they support business, but they also throw all their strength in the first place to saving their people, by any means preventing the virus from spreading. Thus, after the virus is defeated, people will be ready to work, and the business, which was supported by the state, will also be able to continue to work. Therefore, countries that have a strong financial base and have strict quarantine will most likely survive the coronavirus pandaria and rebuild their economies. I believe that in Europe the situation will be much better than in the United States of America, since it is the liberal system of government that can be harmful in this situation.

[DoublerHunter]

^ It is not only Eurozone that has this dilemma since the economic recession started many countries experience a downfall on their currency but if it will be an advantage to end the euro then it must be done with a careful study since some of the countries in the eurozone may demise their economy. If TFEU is also the reason why other countries can't progress more especially in this time of pandemic might as well eurozone must end earlier for each of the members who have a stabilized economy may still help others once they are able to recover quickly from this pandemic and economic crisis. Nevertheless, I probably not conclude that by ending Euro will be for the betterment of all the Eurozone members since I have no idea what was agreed in TFEU.

[Febo]

And in that case, Brexit can be proven to be working well for Britain as the country will not anymore be dragged by the weakness of Euro

UK never used Euro. UK uses GBP. They were never really part of EU. It was the last time for them to decide if they want to be in or out. Being a bit in and a bit out was dragging EU back for decade.

Yeah, an European Federation would be bad news but I doubt it will ever come to that anytime soon. The EU is going through too divisive times for such measures.

Strong EU federation is the only hope Europe have. Every single country is nothing alone compared to strong India, USA and China. Together can compete. EU need to develop space and military program together. All hi tech technology. No use that every country research its own battle tank or fighter jet. No use if every European country send a spaceship to mars. Together we can!

[coolcoinz]

And in that case, Brexit can be proven to be working well for Britain as the country will not anymore be dragged by the weakness of Euro

UK never used Euro. UK uses GBP. They were never really part of EU. It was the last time for them to decide if they want to be in or out. Being a bit in and a bit out was dragging EU back for decade.

Does that mean that countries which did not accept EUR are not really a part of the EU? If it's so, there's a lot more countries like that within the EU.
I begun to expect the fall of the EU when countries that were supposed to accept the common currency did not do it. Later, we've witnessed a big clash within the EU when Germany and France wanted to open their borders for migrants, but Hungary and Poland opposed them. Italy and Greece initially followed the plan but then changed their minds as the migrants flooded the gates.
IMO they should have stopped at Schengen and keep the open borders without trying to establish a central government and a common currency.

[mu_enrico]

Strong EU federation is the only hope Europe have. Every single country is nothing alone compared to strong India, USA and China. Together can compete. EU need to develop space and military program together. All hi tech technology. No use that every country research its own battle tank or fighter jet. No use if every European country send a spaceship to mars. Together we can!

I disagree with this view, competitions make countries specialized and become efficient. What you need is a free-market where goods and services can be traded with minimum restrictions. No need to create a government on top of legitimately elected governments, telling them to do stuff, etc.

Indeed (IMO) the European Union is a failed project and we should learn about this as a centralization vs decentralization case study.

[HeRetiK]

I disagree with this view, competitions make countries specialized and become efficient. What you need is a free-market where goods and services can be traded with minimum restrictions. No need to create a government on top of legitimately elected governments, telling them to do stuff, etc.

A few things of note here though:
1) Introducing a common currency removed a lot of friction for exchanging goods and services within the Eurozone
2) The much hated normalization of product standards on EU level vs national level serves the same goal

And most importantly:
3) EU representatives are democratically elected by the citizens of its member states