Saturday, January 17, 2009

The Debts of the Spenders: The Euro - An Inherently Flawed Currency

Commentators calling for the demise of the dollar as an "inherently flawed currency" should be looking at another currency across the Atlantic instead.

The Euro is a fundamentally flawed currency. The Eurozone is in even worse shape than the US due to a combination of inherent structural and banking flaws.

Structurally, the EU is a union of disjointed states that lack common fiscal and monetary policy. Indeed, the Euro's biggest flaw is the requirement that individual member states surrender their sovereignty over key economic policy decisions to a distant council in Brussels.

The weakest links in the chain are in the periphery - Greece, Spain, Italy, Ireland, and Portugal. These are spendthrift happy states perpetually in big deficit that are dragging the rest of the Eurozone down w/them. All states have common taxes and public services throughout their territories. BUT on average, poorer areas and regions pay lower taxes and receive more public services than their richer ones. This is a thinly disguised wealth transfer scheme that has caused animosity among the EU members even during the best of times. Brussels was not even able to get the EU Constitution ratified DURING the credit bubble in 2004! The prospects for economic integration and common ground have diminished dramatically since then.

As for the banking system, European banks are even MORE leveraged than their American counterparts. Fractional reserve ratios of 30-40% LOWER than American banks are common among European banks. The most egregious culprits are the British banks but since this is a piece on the Eurozone, we should focus on the German, Belgian, and French banks instead.

The Europeans are trying their hand at native quantitative easing experiments. But these measures will inevitably fail. There is simply not enough demand in the world to soak up all the supply being issued by G7 govts (emerging market govts are a different story as they will continue to attract yield chasers and other risky money).

Conclusion: There can be only one quantitative easing beast in the world and that is the United States.