Should Germany Revive the Deutschmark? The European Union is in trouble. On the one side you have Germany demanding that its fellow EU members use fiscal austerity to fix their balance sheets. On the other, you have the PIIGS (Portugal, Ireland, Italy, Greece and Spain), demanding Eurobonds and lower interest rates. Nobody is compromising. And the entire union is inching toward a complete collapse. So what’s the fix? Absent financial reforms that lower the running budget deficit, the only other policy they may pursue is a debasement of the currency. Indeed, that’s already started. The ECB’s goal is to create enough inflation to devalue its member countries’ existing debt. That would also make European exports cheaper, which might spark an economic rebound as manufacturing picks up. But the Germans want none of it. And can anyone blame them? Germany already had a bout of hyperinflation in the 1920s, so its leaders are committed to preventing that from ever happening again. So they say “nein” to money printing… and “nein” to Eurobonds. The problem is the solution Germany has proposed — austerity economics — is doing nothing to help the PIIGS. In fact, it’s just forcing them into what seems like a permanent depression. And things are getting worse. Spending cuts and tax hikes are sapping away economic growth. This is pushing budget deficits higher, which leads to even more cuts and tax increases. It’s a never-ending cycle of misery. And it is this dynamic that put Greek citizens in the unenviable position of having two national elections six weeks apart. So what’s the solution? Some people say the PIIGS should abandon the euro. But that wouldn’t help them. You see, when a country abandons one currency for a cheaper one, its financial sector suffers greatly. The banks, which held euro-denominated assets, would have to exchange them for assets in the new currency. They’d get less money because the new currency has a lower value. But it gets worse. In the weeks that follow, the new currency usually loses even more value. This widens the banks’ asset hole. Yet, that’s not the worst part. The banks would still owe their euro debts. This debt would grow as the new currency devalues. And the banks would have less money to pay for it. So then how do you fix a broken banking system? By recapitalizing it. Yet, a country like Greece doesn’t have the money to fix its banking sector. So instead of a resolution, you have zombie banks that refuse to acknowledge how bad their balance sheets are. So leaving the euro would be the most expensive move on Greece’s part. It could cost upward of 50% of its GDP in the first year alone. But what if Germany abandoned the euro instead? I know this is a controversial idea, but hear me out. The PIIGS want currency devaluation. Germany won’t let it happen. But if Germany abandons the euro, nobody would stop the European Central Bank from printing more cash, devaluing the euro and bringing down borrowing costs. What would happen to Germany? This is where things get interesting. If Germany reintroduced the deutschmark, it would be worth more than a euro. That would increase value of all the assets held by German banks and corporations. And Germany’s euro debts would become cheaper. But there are a few sticking points – Germany is an export powerhouse. By introducing a new currency, the value of its exports would become more expensive. This might actually push the country deeper into recession. This isn’t cheap. Every German institution would have to switch its accounting over to one that uses deutschmarks instead of euros. Other EU countries might not like it. The other members of the EU could feel abandoned and boycott or take other actions against Germany. Loans to other countries would be worth less. German banks have made a lot of euro-denominated loans to other countries. Abandoning the euro would lower the value of payment on these loans. So German banks would see losses. These are pretty big negatives. So why would Germany do it? It’s all a matter of cost. If Germany feels that moving to a new currency would cost less than keeping the euro and spending hundreds of billions to bail out the PIIGS then it might opt to revive the deutschmark. Even the vice president of research firm Trim Tabs said: If Germany exits the Eurozone first, it would suffer big losses on its euro-denominated holdings… But if Germany doesn’t exit and keeps playing the bailout game, it’ll be dragged down along with the rest of the euro zone, and the global economy will be much worse off. Germany leaving the euro isn’t as preposterous as it sounds. The country recently passed legislation allowing it to abandon the euro, but stay in the EU, following the U.K. model. It also reinstated a special fund which would 1) guarantee 400 billion euros in bank debt, 2) recapitalize its banks to the tune of 80 billion euros and 3) allow German banks to dump euro zone government bonds if needed. In essence, Germany has put a firewall around its banks. This isn’t the act of a country that is firmly committed to its existing currency. Rather, it is a sign of Germany’s expectation that the euro is in trouble. This isn’t too surprising. After all, the currency was built on a flawed premise. And as James Dale Davidson has discussed time and time again, flawed currencies cannot survive in the long-run. That’s why he expects the euro will cease to exist. And as we know, James’ bold predictions have been right many times before. Take care, Charles Del Valle Editor, Strategic Investment
Posted on: Thu, 20 Nov 2014 05:46:50 +0000
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