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JakilaTheHun (99.91)

Greece is the First Domino in a Crumbling Eurozone



June 27, 2011 – Comments (8) | RELATED TICKERS: FXE

Jamie Dimon, CEO of J.P. Morgan, recently made some interesting remarks on the Greek debt crisis.   Not only does Dimon believe that Greece won’t default, but that if it does, it will merely be a minor blip. 

"I don't think [a Greek default is] going to freeze the capital markets of the world. We have had defaults around the world before -- Russia, Argentina and Mexico -- and they weren't good events for global economies but they didn't derail global growth.”  - Jamie Dimon

My initial take on this is that either Dimon is somewhat naïve or he’s playing the role of the diplomat; something he has excelled at throughout his entire career.   After all, part of Dimon’s great success is being the most politically savvy CEO of a major bank.   

Let’s take the argument seriously in order to rebut the idea that Greece is merely “another Argentina” because it most certainly is not.   Too many politicians and too many bankers are treating the Eurozone’s issues as an isolated series of sovereign debt problems and not an interconnected set of issues created by the flawed structure of the Euro.   That's why this isn't Argentina or Mexico. Argentina and Mexico were bankrupted by flawed economic and financial models.  Say what you will about Greece, but Spain, Portugal, and Ireland are being sunk by the Euro itself.

A Flawed Design

While I personally consider myself a Monetarist, I do agree with a lot of the economic thought in both the Austrian School of Economics and Keynesian Economic Theory.  I would argue that all three of the major economic schools of thought are sound and hold considerable insight.  There are some differences, but I do not view any of these three models as being majorly flawed in theory.

It’s when I see economic models that violate all three schools of thought that I get particularly worried.  Take the conditions that helped create the US housing boom.  There was something to dislike for any economist. 

If you are an Austrian, you no doubt dislike all the government subsidies and interference in the housing market.  If you are a Monetarist, you can rightfully argue that the Federal Reserve was lowering interest rates in the early ‘00s right when they should have been aggressively raising them.  This loose monetary policy helped fuel the housing bubble.  Finally, if you are a Keynesian, you see a housing bubble, coupled with a Congress and President that pumps more money into the economy with excess government spending during a major boom.  All together, it was a total recipe for disaster.

The Eurozone is no different.  From a Monetarist perspective, it destroys the independent monetary policy of each sovereign nation, giving them no able to change money supply in order to react to observed market conditions.   Milton Friedman would be appalled.   In fact,  Friedman predicted the Eurozone would fail.  It goes against the very core of modern monetary philosophy.

While Keynes was not alive when the Euro was introduced, it’s hardly a stretch to say that he would have predicted its failure, as well.  Keynes was so concerned with trade distortions that when he proposed using the Bancor as an international clearing currency (as opposed to the U.S. Dollar), he also wanted a current account surplus tax, so that currencies and trade could not become distorted.   This is, in effect, precisely what has happened with the Euro, with the wealthier “Northern Block” nations now running perpetual current account surpluses, while the PIIGS run perpetual current account deficits. 

From the Austrian perspective, you can’t help but to note that distortive affect on prices and trade the Eurozone model is having.  Germany and the “Northern Block” of Austria, Netherlands, and Finland all have perpetually undervalued currencies and undervalued assets.    Moreover, they receive the benefit of artificially low interest rates.  This creates artificially high demand for their exports, spurring economic growth.  Meanwhile, the “Troubled Block” of Greece, Portugal, Ireland, Spain, and Italy has to deal with the precise opposite set of circumstances:  perpetually overvalued currency, overvalued assets, and artificially high interest rates.

In short, the Eurozone was stirred up by an economic Frankenstein.   It violates every mainstream economic model.  Sure, there are benefits to having a single currency, including easier trade and travel within the Eurozone, but that minor benefit hardly seems to outweigh permanent market distortions, constant deflationary pressures in the “Troubled Block”, and a lack of independent monetary policy. 

The Dominos

Jamie Dimon might be correct that Europe can withstand a Greek default, in isolation.  But as argued earlier, this isn’t a mere “sovereign debt” issue.  It’s a flawed currency design issue.  And Greece is merely the first domino to drop.

One reason it’s been easy to waive this off as an isolated problem is the dysfunction of Greece’s economic model.  Certainly, no one would ever point to Greece as the model of economic order, efficiency, and success.  But that’s beside the point.   Greece’s dysfunction and waste only explains why it’s the FIRST domino to fall; not why the Eurozone itself is in danger of collapse.

No economic system is perfect, but Spain, Portugal, and Ireland have hardly been models of economic dysfunction over the past few decades.  In many ways, they’ve been models of success, increasing their attractiveness for business and running sound fiscal policies.   Yes, that’s the difficult part to explain away for those treating this as merely as “sovereign debt issue.” 

Spain, Portugal, and Ireland have all been financially responsible in the near past and none had racked up considerable government debt through reckless spending.  Their sovereign debt issues came as a result of economic collapse, which depressed government revenues severely.  And those collapses were the result of the market distortions created by the Euro.  Now, due to a lack of independent monetary policy, none of these nations can recover.

America vs. Europe

People are very down on America right now and the housing bubble and subsequent bust certainly did a lot to erode faith in our system.   But there’s a striking difference between how the United States and the Eurozone have chosen to handle their problems that might reveal why the US model has prospered much more in the near past than the European model.

America has some very big problems, but let’s be frank:  nearly all nations have huge problems right now.  While American politicians will continue to frustrate for the rest of our lives, there’s one major difference:  American pols at least acknowledge the problems facing the US.  You can fault them for dimwitted solutions, but our system no longer seems to be in complete denial.

That’s critical because issues cannot be addressed if people pretend they don’t exist.  We certainly have issues with entitlement spending, a bloated defense budget, and underfunded pensions.  But we acknowledge that they are problems, so there’s a mentality that we all have to work through them, even if the struggle to do so is very rarely anything other than ugly and painful.

Eurozone policymakers and bankers have not shown the same degree of awareness about their issues.  And in truth, they might not be nearly as accountable as American policymakers.   While the Euro continues to cause economic destruction in Europe, the Eurozone policymakers keep acting as if the issue is reckless spending in the troubled nations. 

If you’re a German politician, it’s easier to blame those lazy Spaniards or drunken Irish, rather than face that fact that you are all entangled in a dysfunctional nightmare of an economic order.  And the only way to remedy the situation is either to take the radical step of breaking everything up or give up your own nation’s sovereignty for a system that can actually function:  call it a “United States of Europe”, if you will.  But the latter seems to be a non-starter for the Eurozone nations.  And the former isn’t particularly desirable.  So the alternative course is to pretend the problem doesn’t exist, throw a little bit of money at the “Troubled Nations” occasionally, make them agree to “cuts” in exchange for “your aid”, and hope it all goes away.

Except it won’t.   The problem is the Euro.  The Euro distorts prices.  The Euro distorts interest rates.  The Euro creates economic carnage.  And the problem won’t be fixed until the Euro is fixed or dismantled.

A Greek default would not be the isolated incident that an Argentine, Mexican, or Russian default was in the past.   A Greek default is only the beginning of the crumbling of an unsustainable economic order.

8 Comments – Post Your Own

#1) On June 27, 2011 at 4:59 PM, Schmacko (88.00) wrote:

"Meanwhile, the “Troubled Block” of Greece, Portugal, Ireland, Spain, and Italy has to deal with the precise opposite set of circumstances:  perpetually overvalued currency, overvalued assets, and artificially high interest rates"

The euro does distort things but the artificially high interest rates bit isn't exactly accurate.  After Greece petitioned to join the monetary union it was able to borrow money at lower interst rates than it had while using the drachma.

This article had a pretty good summary of the current crisis and gets into some of the things you're hitting on in terms of soverign debt vs. currency related issues:

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#2) On June 27, 2011 at 5:04 PM, JakilaTheHun (99.91) wrote:

After Greece petitioned to join the monetary union it was able to borrow money at lower interst rates than it had while using the drachma.

That was one of the original selling points, but those lower interest rates weren't sustainable. Greece would have lower rates right now if it had independent monetary policy; as would Spain, Ireland, and Portugal. 

Also, you have to keep in mind that the situation was somewhat reversed about a decade ago.  It was the PIIGS with undervalued currencies and artificially low interest rates at that time.  Now, it's reversed.  

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#3) On June 27, 2011 at 5:22 PM, JakilaTheHun (99.91) wrote:

I also think Eagle Global's analysis looks at this as if it's a "sovereign debt crisis" rather than a currency crisis.  The analysis of Spain focuses on Spain's past history of debt payment, rather than the structural flaws that have created Spain's current predicament.

Actually, if Greece and Ireland leave the Eurozone, it will only get worse for Spain, because the distortions will become more severe. 

Even if all the PIIGS leave the Euro, that won't fix the currency.  It will merely cause a delay between this crisis and the next crisis that inevitably occurs. 


All in all, I think a few nations will end up exiting the Eurozone.  I think Greece and the German banks are so thoroughly joined together right now, that it might actually be more likely that Ireland or Spain will be the first to leave.  Of course, Greece is in much worser shape, but Germany and France can continue to bail out Greece, whereas, they'll have more difficulties funding Spain.  And Ireland is more hostile to German control over their economic policies. 

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#4) On June 27, 2011 at 6:00 PM, constructive (99.97) wrote:

While the Euro continues to cause economic destruction in Europe, the Eurozone policymakers keep acting as if the issue is reckless spending in the troubled nations. 

If you’re a German politician, it’s easier to blame those lazy Spaniards or drunken Irish, rather than face that fact that you are all entangled in a dysfunctional nightmare of an economic order.

Substitute a couple of ethnic slurs and you have described the US perfectly.

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#5) On June 27, 2011 at 7:22 PM, Frankydontfailme (29.38) wrote:

Very nice write up ( I find myself usually disliking what you say because you don't like gold - I shouldn't be so biased).

I think you give too much credit to American politicians. Yes, many of them recognize that their is a problem. Virtually none of them, however, recognize what the problem is.

Deficit alone doesn't explain it. U.S must default and then cut deficits. Also, even if what I wish for happened, there is very little reason to believe that the new system would amend its ways. Revisionist history and what not.

I respect what you say about moneterism but don't believe that it is the nature of man to increase interest rates when the going is good (like the great fed chairmen Martin). So I only subscribe to the Austrian but, to each his own. 

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#6) On June 27, 2011 at 10:06 PM, ChrisGraley (28.71) wrote:

The dollar has the same problem because it's a forced reserve currency. We are exporting our problems on to other countries.

I'll raise you one on the bet that Spain would be the first to default and tell you that economically the UK should be the first to default. They aren't that far off from the lunacy of Greece and should be more scrutinized, given their size.

Don't get me wrong, Greece has done plenty to create their own pain, but the UK has destroyed their economy before and is large enough to know better in the second go around. France will fail the day after the UK does because they are France and do everything backwards anyway and nobody really likes them that much other than their new buddies the Russians. Maybe Spain comes in 3rd.

Portugal and Greece are cheap enough for the bigger countries to carry until they get into trouble on their own. They may fold before Spain, they may not. I have a hard time seeing Germany folding in any scenario. It's not that they are doing everything right, but they are doing more right than most other countries in the European union.

I refuse to look at Greece as a victim though. Hair stylists retire at the age of 45 over there. I'm not to far from that age. I would have moved long ago to Greece to become a hair stylist if I thought they had a sustainable economic plan.

Looking at Greece now, they still don't get it. Almost every industry is on a rolling 48 hour strike. It's the same mindset that our auto unions had and I don't think that they have enough retirees to rob to survive like our auto unions did.

I just don't see Germany as the evil influence that you do. I see them as the most sane country in an insane continent. They at least have a parachute. I don't see the Greeks as evil either. They just let unions get powerfull enough to dictate terms to politicians. Now they are in the sweet spot where the debt is cheap enough to let other countries pay it for them. Paying the debt is better for those countries than letting Greece default. 


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#7) On June 28, 2011 at 12:06 PM, Frankydontfailme (29.38) wrote:

Nice Chris, I never thought about it like that (the bigger dominoes falling first).

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#8) On July 06, 2011 at 11:40 PM, Option1307 (30.44) wrote:

Finally had time to read this. Great thoughts per usual. Your blogs have been awesome lately, keep the good thoughts coming Jakila.

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