Users: robin: The Stock Sage

I didn’t originally intend to split this week’s letter into two parts but due to a special guest writer and the importance of getting to the crux of the eurozone debt crisis I have decided to focus today’s letter on Europe and Friday’s EU Summit announcement while leaving the market analysis for tomorrow.

My father has traveled all over Europe during the last fifty years. He signed one of his biggest business deals in London in 1964 when his French counterpart told him “only in America could someone of your age rise to the top of business”. He owned a house in Spain on the Costa Del Sol during the 70s and bought Picasso plates in the south of France from the man himself. Ever since the late 90s my parents have spent the majority of their time in Malta and have witnessed the tiny island transition from an independent nation on the lower fringe of Europe to the smallest member of the European Union and the eurozone.

Without further ado here is my father:

The Fate of a Currency Without a Country

The problems that have caused the EZ to fall into crisis are exactly as stated above—the EZ is not a country.  Let us examine for a moment the qualities that a country has, which the EZ does not have:

1. A uniform tax code for both corporations and individuals with criminal penalties and armed enforcement (police powers).

2. National fiscal policy

3. National bank deposit insurance, coupled with strict bank surveillance

4.  A Central Bank that:

Can properly implement monetary policy without fear of promoting high inflation in one member country (Germany) while attempting to avoid deflation in other member countries (periphery) – lack of necessary structural reforms and labor immobility have handcuffed the ECB’s ability to effectively conduct monetary policy (time and time again the ECB has been woefully behind the curve, raising interest rates weeks before deflationary flare ups in the debt crisis) Has a stronger mandate to act as the lender of last resort during times of crisis Has strict oversight of systemically important financial institutions  Controls a national clearing system for both wire transfers and checks – (In the EZ one cannot write a check from one country to another, you have to use a wire transfer or credit card instead)

5. National pride and cohesion

Unless and until the EZ has implemented the above they are just kicking the can and filling the air with high sounding nonsense.  From the very beginning until now politics and fudging have ruled the day in the EZ.  I live in the EZ and can say from both personal experience and observation that the EU was and is a paper tiger where politics trumps enforcement.

European leaders formalized agreement on a currency union with the Maastricht Treaty, signed on February 7, 1992.  This treaty agreed to create a single currency by January 1999 without the participation of the United Kingdom.

Member states had to meet strict criteria such as a budget deficit of less than 3% of their GDP, a debt ratio of less than 60% of GDP, low inflation, and interest rates close to the EU average.  Greece failed to meet these criteria and was initially excluded from participating.

The German government published documents in the summer of 2011 which prove that Italy should never have been accepted into the common currency.  The decision to invite Italy to join was based exclusively on political considerations.  This exception also created a precedent for Greece’s acceptance into the euro zone two years later.

There is also strong evidence that François Mitterrand, President of the French Republic 1981 – 1995 forced the chancellor of Germany, Helmut Kohl into a deal: French approval for the reunification of East and West Germany would be given in return for Germany abandoning the beloved Deutsche Mark with the introduction of the euro.

The Maastricht Treaty limited the budget deficits to 3% and the EU Commission had the Stability and Growth Pact to enforce it.  In 2003, France and Germany had both exceeded the 3% of GDP limit to which they were legally bound.  The Commission – then led by the former Italian Prime Minister Romano Prodi – had the power to fine them.   But the finance ministers of what was then the 15 EZ member countries met in Brussels and voted against the Commission.  Romano Prodi was prevented from fining France and Germany for breaking the Maastricht Treaty.  They voted to give France and Germany a pass.   They voted to not enforce the rules they had all signed-up to and which were designed to protect the stability of the single currency. 

Since the EZ crisis initiated in 2010 there have been 20 emergency meetings of the top EZ officials and it has been a joy to watch the subterfuges and legal dodges that have been used to kick the can over and over again.

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I found a couple of articles to be especially noteworthy this morning – first there is a piece in the WSJ on former ECB Chief Economist Jurgen Stark in which Mr. Stark states:

“we need a new institution informally or formally with the power to interfere in national procedures…..somebody on the spot to monitor, day-by-day, minute-by-minute, what’s going on in the budget.” 

This is the crux of the issue which has been pointed out repeatedly over the last two years despite being purposefully obfuscated by EU leaders. To understand the challenge facing EU leaders in creating a single fiscal overseer with strict enforcement powers throughout the eurozone look no further than the following quotes from the Prime Minister of Malta:

“We agree on the broad conclusions of the EU’s vision to have more coordination in certain economic areas but we have our reservations on a fiscal union, particularly with regard to taxation. This is a no-go area for us and we will not agree to lose control over this important aspect of our economy,”

And when asked what Malta would do if Malta were to be outvoted regarding retirement ages and cost of living adjustments at the next Ecofin meeting Prime Minister Gonzi responded:

“Malta will not implement them. Our position is clear. The EU cannot force us on this because these recommendations are not legally binding.”

It doesn’t get much clearer than that – Malta may be a small inconsequential member of Europe, however, the attitude displayed in the above quotes is symptomatic of the much larger problem facing France, Italy, Germany, Spain and the rest of the eurozone. While the issue of national sovereignty and the enforcement limitations of any single eurozone supervisory authority are likely to be a major stumbling block over the coming months – the most difficult challenges facing the common currency are a complete lack of a common labor policy, labor immobility, large labor productivity gaps between countries, wage repression and deflation throughout the periphery, and continued pushback against the much needed economic and fiscal structural reforms.