Fragile Things Have A Tendency To Break

Will German guilt overcome German fiscal responsibility?

By Jeff Harding

Europe is a fine example of the dangers of governments that become too involved with their economies. On the one hand their politicians try to “run the economy” and on the other hand they are fiscally irresponsible, the results of which harm economic growth. It is like watching a slow motion car crash in the making as these governments try to solve the problems they created.

 Last week that in the Rome mini-summit with Merkel, Monti, Hollande, and Rajoy, they agreed to promote a new round of funding for measures to stimulate economic growth to offset the “ravages” of so-called austerity. This €130 billion funding will be another waste of money, much of which will be German money. There is another summit this week. They are worried.

Recently Nassim Taleb has been talking about “fragility” in economies. From the Second Edition of The Black Swan,

Upon the completion of The Black Swan, I spent some time meditating on the items I raised in Chapter 14 on the fragility of some systems with large concentration and illusions of stability—which had left me convinced that the banking system was the mother of all accidents waiting to happen.

[Taleb is about to release a new book on this topic: Antifragile: Things That Gain from Disorder.]

I would put government as an economic actor one rung higher than banks in terms of creating economic fragility. After all, it was government fiscal recklesness, government regulations, and government central bank monetary policies that brought about the eurozone debt crisis. The more they are involved, it is their mistakes that cause the greatest harm to the economy, albeit, thanks to central banks and bank regulations, banks are high up there. 

The current eurozone crisis is an exemplary of this concept. In a naive desire to create more political unity in Europe these tinkerers ignored the laws of economics and created the euro truly built on a foundation of sand (actually, paper since sand has some value). By trying to centralize a monetary system that gives member states de facto rights to spend money they don’t have can only but fail when the money runs out.

The eurozone is at a critical point. I do not believe there is enough money to bail out all of the necessary banks, or support Eurobonds for the same purpose. Spain is asking its fellow eurozone members for an unknown amount bail out their banks. There is a €100 pledge from its fellow eurozone members to accomplish such bailouts. France’s Hollande is calling Italy’s “austerity” plans “virtuous” because they are giving austerity a go. Yet Hollande has no idea of how deep is that hole. France wants a kind of pool-and-split backing of fellow eurozone member debt plus the issuance of more common Eurobonds. Germany is set against these plans since it knows that it will be the ones paying most of the bills. For all of her shilly-shallying, Ms. Merkel knows where German voters stand on bailing out their weaker EU cousins. The markets are worried about Germany’s future and as a result Bund yields are rising.

There are two lines of thought to save the eurozone. One is headed by France which wants to pool bailout assets and apply as much as is necessary to achieve stability. This could be paid directly to banks or for the purchase of troubled sovereign bonds. Germany resists turning over their money without strings. And those strings are that strict fiscal measures be applied to all eurozone countries. Yet France says it won’t give up its sovereignty to do that.

 No one can predict what the outcome will be. But, they have an impossible situation. Will German guilt overcome German fiscal responsibility? Will they turn over their euros to in essence a third party with no real strings attached? Will France give up control over its own budget to accept Germany’s demands? 

Remember, fragile things have a tendency to break.