The Unavoidable Shrinking of the Eurozone

eurozoneWhile perusing weekend financial press, I could barely smother a chuckle. Again the economists and various experts are puzzled over how something relatively small, and thus presumed insignificant, can threaten to bring down an entire institution. The first time this question arose three years ago, it was the U.S. subprime mortgage mess that had almost choked the global economy to death. This time it is tiny Ireland with a population of less than five million that is threatening the survival of the entire Eurozone.

Things are rarely simple just because their size causes the assumption of insignificance, but poor Ireland is merely the latest catalyst to a much larger issue that has been the root cause of most of the economic misery of the past two years: bankers’ greed. Unlike Greece, Ireland’s government did not bring its citizens to ruin. It was the lenders who had overextended themselves, lending irresponsibly to everyone and anyone asking for a loan, completely ignoring even the most blatantly obvious risk flags.

This has been debated long and hard: the reckless abandon of risk management on the global level, as well as how wild lending is even possible after the fall of Lehman Brothers. Most have thought the issue of risk management, or lack thereof, resolved. Only, the problem with reactive measures is that they cannot erase what has happened before or the fact that there are no easy and fast fixes of systemic problems.

The systemic problem that has obviously been systematically ignored is that Eurozone lenders, just like the U.S. subprime lenders, have enjoyed lax supervision for so long that losing perspective was easy. The problem was further exacerbated by the fact that the Eurozone has attempted one economy and one interest rate without accounting for the impact of separate tax regimes and the vastly different spending habits of citizens of individual European Union (EU) members.

A comparison between Ireland and Germany provides for a quick litmus test. Germans are well aware that their industry has matured and that, as a behemoth, it cannot move fast. That is why Germans would rather save than spend. The Irish, in contrast, love to go on fancy shopping sprees, courtesy of the cheap euro, regardless of whether they can actually afford them or not. In the end, Ireland’s government, although not directly guilty, other than perhaps by being willfully blind, had to ask for the EU’s help to rescue its irresponsible banks. Making things exponentially worse is the fact that Ireland’s bailout and relying on short-term loans could export its crisis to other vulnerable states in the Eurozone. The trouble not just with the Eurozone but the entire global economy is that everything is so interconnected, so a single stone thrown into the pond can have powerful ripple effects.

Perhaps the German chancellor Angela Merkel is onto something more than a “share the pain” lesson with her propositions to inflict some of the pain on future sovereign debt-holders, and not only taxpayers, and certainly not only the German ones. This seems to be a case of simple mathematics. It does not seem likely that either Greece or Ireland can continue financing themselves without robust economic recovery and without increasing their revenues through taxation, neither of which is forthcoming or easy. So how will they pay off the bailouts and continue to attend to their long-term debt?

Not without miracles. Germany wants future holders of the Eurozone’s sovereign debt to take haircuts in case of defaults when buying the risky treasury bonds of countries such as Greece, Ireland or Portugal. Who would buy such bonds, considering the excess of risks that accompanies them? Perhaps only speculators could show some interest, but at exorbitantly high costs of borrowing. Eventually, when houses of cards start collapsing, stronger players in the Eurozone might finally “see” what Germany has been harping about for months and expel those who cannot afford their EU membership, leading to the Eurozone’s potentially unavoidable shrinking. Perhaps this is Merkel’s ultimate goal, perhaps it is not, but it should certainly give the Eurozone and the rest of the world pause.