The markets are breathing a collective sigh of relief as the major global players, with the exception of the Chinese, are now sitting at the same table determined to forge a path through this political and economic malaise. Gold is trending lower as the risk trade is reduced. It is a relief that the U.S. administration has dispatched their boy wonder, Messrs Geithner, to Europe, whether he can calm nerves and create a political consensus is the question.
The European Project is at a fork in the road, do they bind themselves together politically and fiscally and socialise the burden where rich pick up the tab for poor or do they withdraw into their domestic political worlds and turn their backs on what is arguably the greatest economic union in the history of the world.
The nexus of the issue is the same as it has always been, can you have an economic union without political union. The answer would seem to be..... maybe, as long as nothing too serious happens, but the moment the economic cycle shifts down a gear, domestic populations suffering from economic contraction will go tribal and look after their own first.
A thought provoking paper by the UBS economist, Paul Donovan, articulated the choices facing Europe in a paper "How to break up a monetary union" written in February 2010. His central thesis is that in its current form the Euro just does not work, especially a one size fits all interest rate policy.
Here are some excerpts from his excellent report.
The euro stays.
We do not believe that European Monetary Union will break up. The costs of breaking up the Euro, at this stage, far exceed the benefits. Far better, in our view, to default within the Euro than to incur the political, economic and possibly social costs of trying to survive outside.
Monetary unions do break up.
Notwithstanding the fact that we think the Euro survives intact, it is relatively clear that (in economic terms) the Euro does not work. That is to say, parts of the Euro area would have been better off (economically) if they had never joined. This is not an argument for departing, but it raises questions about the factors that make monetary unions economically successful, and what happens when those factors are absent.
That the Euro area is not an optimal currency area is generally agreed upon.
The European economies are sufficiently diverse that external shocks hit different economies with differing degrees of severity. The asymmetrical nature of any shock is also likely to persist for longer. This is something that has been well understood for some time.
Indeed, fourteen years ago UBS economists concluded that “a monetary union extending beyond the core six [European] economies would not work properly in economic terms.”
The analysis identified those economies that could realistically be called an optimal currency area, those economies that could satisfy the Maastricht criteria (on a relatively liberal interpretation), and those economies for which there was a strong political will in favour of monetary union. The analysis suggested that Greece, Spain, Italy and Portugal failed to meet real economic or financial criteria. Ireland and Finland were felt to meet the financial and political criteria, but also failed to meet the real economic test.
Germans should pay for Greek pensions.
The concept of fiscal transfers across different regions within a monetary union normally suggests a degree of political union, though this does not have to be the case. What it does suggest, at least for now, is that popular complaints in Germany (and elsewhere) about paying for social security in other parts of the Euro area appear misguided. Monetary unions entail sense of economic community. This means that wealthier areas should, indeed must subsidise those parts of the monetary union that are at an economic disadvantage. Fiscal transfers are the price that has to be paid for a monetary union of any meaningful size.
The most optimistic scenario for the Euro probably lies in some kind of parallel to the experiences of the U.S. in the 1930s. Then, a fragmented banking system, with powerful regional central banks, failed to deal properly with an asymmetric shock to the economy (and to the financial system). The problem fostered significant regional differences in economic performance. This motivated financial reform, and a greater fiscal transfer mechanism to turn a sub-optimal currency area into a sub-optimal currency area with the mechanisms to smooth the consequences of shocks.
Writing in the Financial Times in December 2001, then EU Commission President Prodi declared, “I am sure the euro will oblige us to introduce a new set of economic policy instruments. It is politically impossible to propose that now. But some day there will be a crisis and new instruments will be created”. This may not be the crisis, but it has probably brought Europe closer to the point where institutional reform is required. For any monetary unions to survive, the costs must not persistently outweigh the benefits.“ Report Ends.
The answer will undoubtedly be more debt and then leveraged debt, structured in such a way that the immediate relief will be given to credit starved economies. It would seem that the German leadership is too politically weak to "sell" the German public such deal, as it would mean that they would have to trust their less well behaved European brethren to abide by the rules and perhaps pay their fair share of tax in the future. Trust is in short supply. An international front is now required to sell the deal, thus the American presence, Messrs Geithner.
Before making up their minds the German people would do well to take on board George Soros's wise words in his recent opinion piece as published by Nation of Change.
The euro exists, and the global financial system’s assets and liabilities are so intermingled on the basis of the common currency that its collapse would cause a meltdown beyond the capacity of the German authorities – or any other – to contain. The longer it takes for the German public to realize this cold fact, the higher the price that they, and the rest of the world, will have to pay.
Mark O'Byrne is away this week and next preparing for the LBMA Montreal conference, Stephen Flood authored this report in his absence.
Gold is lower again in U.S. dollars and is trading at USD 1,778.19, EUR 1,288.45, GBP 1,125.01, JPY 136,422.70, AUD 1,838.65 and CHF 1,554.01 per ounce.
Gold’s London AM fix this morning was USD 1,778, EUR 1,288.67, and GBP 1,126.24 per ounce.
Yesterday’s AM fix was USD 1,806.00, EUR 1,310.03, and GBP 1,143.18 per ounce.
For the latest news and commentary please follow us on Twitter.
Silver is trading at $40.03/oz, €28.99/oz and £25.31/oz.
PLATINUM GROUP METALS
Platinum is trading at $1,803.50/oz, palladium at $734/oz and rhodium at $1,750/oz.
Gold heads for biggest weekly drop since early 2009
Gold Slumps on Signs European Cash Infusion May Ease Debt Crisis
Gold may reach $2,000 this year as investors flee stock markets
(Nation of Change)
Thinking the Unthinkable in Europe