Tying Drowning People Together Does Not Help

From Bloomberg….

Germany and France may be forced to contemplate the bailout of entire nations rather than just individual banks as European government budgets buckle under the weight of recession.

German Finance Minister Peer Steinbrueck became the first senior policy maker to broach the topic this week, saying some of the 16 euro nations are “getting into difficulties” and may need help. French officials are also concerned about market tensions as the cost of insuring Irish, Greek and Spanish debt against default rises to records and bond spreads widen.

Of course, if political leaders are talking in vague terms about bailing a few countries out, you know that the problems are much wider then that. As Edward Hugh correctly notes…

Well basically, because I think that Europe’s leaders are still in general denial on the scope of this problem. We are not talking simply of little cases, like Greece and Ireland, we are talking about potentially much harder chestnuts to crack, like Spain, and Italy, the UK, and even Germany itself. Remember Germany’s economic is now contracting at an almost astonishing pace, and German bonds are getting harder to sell all the time.

The full extent of the problems in the German banking system, as defaults mount in Spain and Eastern Europe, is yet to be measured.

I strongly disagree with the overall reasoning of Mr. Hugh’s post even though I think the above point is excellent. He takes it as a given that Europe must hang together or they will hang separately. I feel that tying everybody together is a good way of ensuring that everyone drowns.

People have taken all the wrong lessons from the failure of Lehman’s. People have noted how much pain that event caused and have sworn that it must never happen again. But it does not follow that because the collapse of Lehman’s caused a lot of pain that the alternative must somehow have been better. Has letting the zombies stay afloat at all costs really been less costly in dollar terms?

Just consider the fix that Europe is in. Spain is like California expect that Spain’s economy is even more dependent on housing then California was. Sarkozy is throwing huge amounts of money (for a nation the size of France) around in an attempt to keep the French unions off the street. Eastern Europe is so horrible it does not bear thinking about. Not only are they highly indebted and facing huge demographic problems, they also face currency risk on a large scale. This from the Times…..

All this means that doubts over whether the governments and companies of Central and Eastern Europe will be able to service their debts are very much to the fore. Much of the borrowing in these countries during the bubble was not done in their own currencies but in others, such as the euro and the Swiss franc, which means that there will almost certainly be defaults.

The zloty, for example, has lost a third of its value against the euro since last summer, with Hungary’s forint down 23 per cent and the Czech crown down by about 17 per cent in the same period.

I could go on and on. The economic news is horrible everywhere you look. But it is really, really horrible in large swathes in Europe. To the extent that Mr. Hugh and others who are arguing that Europe needs to hang together have a point, it is that there are very real questions about whether any of the parties can separate their economic fortunes from each other in any practical way.

But there is no way that Europe can keep the existing edifice intact. At the very least, they need to cut Eastern Europe lose. Possibly the richer Western Europe might be able to keep itself afloat for a while longer in that case. Working under the assumption that every government in Europe can be prevented from defaulting is simply not realistic. It may be that they will all effectively default. But trying to ensure that no one defaults will ensure that they all fail in the end.

Edit: Having written this while I should have been going to bed and with the aid of the head cold, it leaves a lot to be desired. Crucially, I failed to really articulate why Mr. Hugh’s reasoning is flawed. Perhaps I shall improve on this later. But for now I leave you with this thought: One of the reasons that Germany is in such a pickle is that it fell into an economic model where it had to lend money to others (Spain, Eastern Europe, and others) in order to create enough of an export market to fuel German economic growth. How is lending more money to preserve its export markets (and hence its economic growth) going to help matters?

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