The Triumph of Hope

Europe has no good choices, only a choice among very distressing and expensive options

By John Mauldin

When the Eurozone was created it was the triumph of hope over the reality of political and economic discord. Somehow, countries that had different languages, customs and national characteristics; that had fought each other for centuries; and that all had different views of themselves in relation to the rest of their fellow Europeans, were supposed to come together into a fiscal union, because they now shopped with the same money.

Rather than simply creating a free-trade zone and allowing for a common understanding and economic integration to develop over time, the European leaders wanted to jump-start the process. And they had numerous critics. Many of the best and brightest in the economics world pointed out the problems.

The reality is that the euro has never been a real currency. It is still an experiment. If it is even around in five years, it will be a true currency, as it will have endured its first real crisis. The peripheral countries used the low interest rates of the euro to borrow heavily (both privately and publicly) and got in trouble, and now the true costs of the euro project are being revealed.

A break-up will cost multiple trillions of euros. Keeping the eurozone together will cost multiple trillions of euros. But keeping the eurozone together will also cost countries a substantial loss of sovereign independence. When voters all over Europe signed on for the euro project, they did not think they were giving up their national independence and the right to control their own budgets.

Will Spain or Italy or Germany be willing to allow a European institution to set their budget priorities and limits? To set their retirement policies and health care? To tax them independently? That is what is meant when one talks fiscal integration. Germany is now a minority on the ECB and is beginning to realize it has lost control. Will its voters want to give up political control and become a minority in a "United States of Europe"?

That is the true problem. When real economic difficulties arise, as in Greece or Spain, voters tend to get rather touchy. Tensions rise. And the center does not hold.

George Soros said this week that Europe has three months to resolve its problems. Nobel Laureate Joseph Stiglitz said Soros was being optimistic. A decision is going to have to be made quite soon about Spain, and likely before it becomes clear whether Greece will stay in or leave the euro. And that makes it difficult to give Spain aid that is not offered on equal terms to those Greece got. Monetizing Spanish debt (however you want to do it or whatever you want to call it) when Spain is running an almost 10% deficit, when it had agreed to a little over 5% only a few months ago, will not sit well with Greece.

But it now seems that Europe is unlikely to get the time it needs, absent some rabbit pulled out of its monetary hat to allow Spain to borrow money at rates that it can afford. The Endgame approaches. It will be a long summer.

I get asked all the time if the euro will break up. The honest answer is, we really don't know. I think the economically rational thing to do in the very long term is for some countries to figure out how to leave the euro, but that is more a political question than an economic one. And if you can tell me what politicians and voters will do in a political crisis and deepening recession, then your crystal ball is less foggy than mine.

I think it is 50-50. The drive to hold the euro together will go head to head with national self-interest. Right now, it depends on whom you ask as to what answer you get. But I do not think we will be asking the question much longer. Soon enough, we will know.

To be clear, Europe has no good choices, only a choice among very distressing and expensive options. This will not be good for them or for the world. I think we are already seeing a global slowdown, in great part due to Europe. Let us hope they get the answer right, whatever it is.