Update: Three days after our article, we saw the tweet below & its chart: It now shows nearly equal probability of Germany leaving the Euro as of Greece leaving the Euro. Interesting, isn’t it?
- Tuesday, July 27, 2015 – Holger Zschaepitz @Schuldensuehner – Is Gexit the new Grexit? While #Grexit index has dropped by half, probability that Germany leaves the Euro has risen
The first act of the Greece-Germany play is over. Greece has capitulated to German demands and the Greek Parliament has ratified what Prime Minister Tsipras had agreed with Germany. Now the second act begins. At this stage, it is still not clear whether Greece will ever be able to begin a recovery, whether Greece will even remain in the Euro-EU or whether the crisis will spread to the rest of Southern Europe.
We are firm believers in Simplicity. There is usual a simple reality underneath the mess on the surface, a simple truth that is more important than the cacophony of complicated verbiage that is heaped on top. Today, we discuss this basic simple and profound truth that lies at the crux of the mess in Europe.
This simple truth is revealed by the simple graph below:
(courtesy Ben Bernanke’s Blog)
Germany is a massive exporting machine. The ability to export its manufactured goods is an existential requirement for the German economy. The German political leadership knows this and puts all its energy & power to maintain this machine. What could be the principal impediments to the maintenance of Germany’s export machine?
- Tariffs against German exports by other countries to protect their industries & to reduce German exports
- Rise in German currency vs. currencies of importing countries that makes German goods uncompetitive
The establishment of a single Euro currency based Eurozone permanently removed these two impediments. The single Eurozone removed all tariffs for intra-European trade and the common Euro currency made the German currency equal to that of the old Greek Drachma, Italian Lira and French Franc.
This was manna from heaven for Germany and starvation for industries & workers of Southern Europe. There was no earthly way in which they could compete with German industry on an equal footing. In addition, the consumers of Southern Europe got a much stronger currency with which they could buy high quality German goods and borrow at much lower rates than they could before.
The result is the story in the graph above. The economies of Southern Europe have been hollowed out with production shifting to highly efficient German industries and German workers. That is why youth unemployment in 50% in Greece, 25%+ in Spain and why youth in France cannot find jobs. If an economy tends to import more and more while producing less and less, the economy builds up higher & higher levels of debt. At some point, the exporting machine starts providing loans to the importing economies to enable them to keep buying the exporter’s products.
If you recall, we saw this in 1999-2000 when sellers like Cisco, Lucent, Nortel began providing vendor financing to fiber companies to keep buying their products. This worked for awhile until finally demand for fiber slowed down to a point that a number of fiber companies disappeared. With their disappearance, Lucent & Nortel also disappeared and Cisco stock eventually cratered to about 10% of its 1999 value.
The difference in Greece is that German companies did not provide loans to Greek entities to buy their products. The loans were provided by eager German, French, Spanish & Italian banks. As with the housing crisis in the US, these European banks got overloaded with debt that initially looked good but soon became non-performing. This threatened a banking crisis in Europe within two years of the 2008 banking crisis. Nobody had an appetite for that.
So a bailout was organized for Greece by Europe & IMF. But this was an AIG-like bailout. Recall that the monies put into AIG didn’t really go to AIG. They were used to pay off the other financial institutions that were counterparties of AIG in the CDS mess.
That’s exactly how the Greece bailout worked in 2010. The monies given to Greece in that bailout were used mainly to pay off the loans of European banks. That averted a new banking crisis in Europe. What did Greece get from this bailout? More debt and punishing austerity that contracted the Greek economy and made it impossible for Greece to ever pay back its debts to Europe & IMF.
As an aside, the AIG bailout worked very well because the bailout was in the form of equity and not debt. And it worked very well because the operating businesses of AIG were strong and unimpaired. So AIG continued to make money and with the stock rally the US Government was able to sell its AIG shares at a handsome profit.
But how can you get equity into sovereign countries? Recall that used to be called colonization of Asian, African & Latin American countries. That colonization is what made Western Europe the rich continent it is today. But can Germany annex Greek Islands or the Greek naval base in the Mediterranean? Those days are long gone or gone to Russia ruled by Vladimir Putin.
The only alternative is to keep loaning money to Greece none of which will ever be paid back. Western Europe doesn’t import labor from poorer European countries like Greece. So a million Greek workers cannot migrate to Germany to work in German factories to send remittances back to their families in Greece. The single currency makes it impossible for Greece to export much to Germany and Greece is not really an exporter anyway. And the new 23% tax increase on foreign tourists makes travel to Greece much more expensive thus hurting the best of Greek industries, tourism.
This is insanity but it is the classic peril of vendor financing. An exporter has to keep financing the purchase of the exporter’s goods by importers that are unable to repay the financing. This has continued so far because the financing comes not from a private sector but from the taxpayers of the exporter.
Now the taxpayers in Germany are beginning to revolt. That is why this third Greek “bailout” has been so difficult for Merkel & Schauble of Germany. The real danger is not small little Greece but the establishment of a precedent for Spain, Italy and even France. Because the entire Southern European bloc is reeling under the same stress – massive unemployment, falling growth, increasing debt load. None of these Southern countries will ever pay back the massive debt load they are carrying. That means debt forgiveness beginning with Greece could easily lead to debt forgiveness for Spain & Italy.
That essentially means monies that belonged to Germans & Northern Europeans will be permanently transferred to Greece and Southern Europe in the name of keeping export machine alive meaning protecting German jobs. This is unsustainable and everyone knows it.
And Greece is just the tip of the iceberg. So Germans want to inflict massive punishment on Greece to scare off Spain, Italy and even France. This punishment is taking the form of a virtual colonization in which the Greek government cannot act without prior permission of Germany. But Greeks still refuse to leave the Euro because a bad life in Germany’s Eurozone is probably much better than awful life outside the German-Eurozone.
Remember how Europe’s colonization of Asia & Africa ended. Not because Asians & Africans rose and threw out their European rulers. Because, at some point, European colonizers realized colonization wasn’t worth the trouble or cost and walked out. So when do Germans get tired of sending their hard-earned monies to Greece & Southern European countries? Meaning when does Germany get out of the Eurozone?
Perhaps when the Germans force the European Central Bank to stop its Quantitative Easing or when the global bond markets stop buying Southern European Government debt despite ECB’s QE?
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