Printing money only way out for Europe

Late-night walks made the boyfriend talkative. “I was wondering,” he started as we were walking on the sea face. 

“About what?” I interrupted. “So what is it that is bothering you?”

“The euro.”

“What about it?”

“It seems that the governments of countries like Greece, Ireland, Italy, Portugal, Spain and even Belgium have borrowed a lot of money over the years. The worrying thing is that most analysts now seem to suggest that these countries will not be able to repay all the money they owe. John Mauldin, a hedge fund manager recently wrote, ‘What has yet to be absorbed by the markets is that the cost of bailouts, present and potential, is likely to be in the €3 trillion range.’ That clearly is a lot of money.”

“So?” I asked.

“I was wondering where all that money is going to come from.  Can you explain?” he asked.

“Do you have the time?” I said.

“For you, I always have the time,” he said, trying to throw in the right mush at the right time.

“Europe as we know is in a mess. One part of Europe, basically the Southern European countries, has borrowed too much and will have to be rescued. The other part of Europe with countries like Germany, Netherlands, Finland, Austria, etc have lived responsibly and are largely in a good position when it comes to debt.”

“Okay. So what now?”

“From the look of it, the good Europe is trying to rescue the bad Europe, but wants its price for it.”

“What price?” he asked.

“The good Europe led by Germany wants bad Europe to practise austerity by slashing jobs, curtailing the government, reducing pensions, etc, to keep their expenditure under check and bring down their fiscal deficit. Fiscal deficit is the difference between what a country earns and what it spends.”

“So what’s the problem?”

“All the measures to cut expenditure are not going to go down well with the citizens of the country. When a country is in a recession, asking it to cut spending only makes it worse. Take the case of Spain, its current unemployment rate is at an all-time high of 21.5%. Among the youth, this number touches almost 40%. The government is now trying to create jobs by spending money, but at the same time it’s under pressure to reduce its fiscal deficit from more than 9% of its gross domestic product to 3%, by 2013.”

“So?” he asked. 

“Cutting back on expenditure to lower fiscal deficit might lead to fewer jobs, lower growth and lower taxes and thus might lead more borrowing, which defeats the whole purpose of austerity anyway. The same logic works for a country like Greece as well. But there is great pressure from good Europe to practice austerity.”

“Where will all this lead to?”

“One thing people have been talking about is that the Southern European countries will get so fed up with these austerity measures that they will leave the euro — ‘storm out of it’, as the Economist newspaper put it.”

“Yeah, true!” he remarked. “But why would any country want to do that?”

“For the simple reason that nobody wants to be told by an outsider all the time what to do and what not to.”

“And?”

“Pressure from the voters might be another reason.”

“But how will it help?”

“Theoretically, it might help a country to export more.”

“How would that be?”

“A country storming out of the euro will have to launch its own currency. Of course, the value of this currency will be much lower than that of the euro, which will make exports more competitive. With greater exports, the country can hope to pay off some portion of the accumulated debt.”

“Will that happen?”

“Unlikely. The primary reason being that wages of German workers haven’t gone anywhere in the last 10 years, making Germany very cost competitive and the second-largest exporter in the world.  Also, hoping to export more would also mean competing with the likes of export powerhouses like China. As a report brought out by the Economist Intelligence Unit puts it, “In many areas, wages are still likely to be higher than in competing countries, such as China or even Turkey or Morocco.””

“That doesn’t sound good.”

“Worse, any country opting out of the euro will almost be a pariah and no investor will want to touch the financial securities issued by such a country to finance its fiscal deficit. So, if Greece leaves the euro and goes back to its own currency — drachma — the only way it will have to meet its expenses is to print drachma, which would mean higher inflation.”

“And what other troubles do you envisage?”

“All the existing debt that the country has will continue to be denominated in euro. And the only way to pay that off would be to earn euro through exports, which may not really take off. There might also be bank runs as citizens might withdraw their savings from banks and put it into banks of other countries which still have euro as their currency. So any country leaving the euro will have to deal with a very tough situation.”

“What happens if Germany decides to leave the euro?”

“The move will go down well with the German electorate, given that they see themselves as having lived responsibly through the era of easy money. On the flip side, it would hit German exports, which have benefited tremendously, as the EIU puts it, “from having access to markets within a single currency area.” Also, the smart money will move into the new currency launched by good Europe, leading to its rapid strengthening and thus making German exports expensive.”

“So how do you see things finally panning out?”

“Well, the only way out for the European Union now is to do what Ben Bernanke did — print money to pay off the creditors of the countries in trouble and save the euro.”

“Will that happen?”

“Not immediately, because right now Germany doesn’t like even the smell of printing money. As Mauldin puts it, “Germany seemingly wants the rest of Europe to behave like Germans, except that they also want them to continue to buy German products... while Germany exports its way to prosperity.””

“But will they come around to it immediately?”

“Well, if they want to save the euro, that is the only way out! And they will come around to it,” I said. “That’s why I am still invested in gold.”

The writer can be reached at
chandniburman@yahoo.com