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Krugman's mistake, and the point that you don't address in your projection, is failing to realise that a Euro exit cannot be ringfenced. Once Germany kicks Greece out, France is sure to follow within a few years.


Will it work? Three reasons it won't

... The idea that exiting the eurozone is a simple matter of devaluing is dead wrong. It confuses the correct view that Greece and Portugal and Ireland would have been better off outside the euro with the quite different, and catastrophically erroneous, view that exiting is the optimal strategy. ...

... Germany's new Plan A is doomed. Here are three reasons:

The first reason is that, in the short, run, just like in the case of Lehman's, the Frankfurt optimists are assuming that they know the unknowable (just like, prior to 2008, they assumed they had created riskless risk). The interconnections between the Portuguese banks with those of Spain, and of the Greek banks with those of France and Germany, are of the sort that will only see the light of day when disaster strikes. And when they do appear in full Technicolor their sight will be terrifying.

The second reason is that the massive liquidity injection into the Italian and Spanish banks, not to mention the French and German ones, will operate like large cortisone doses injected into a cancer patient. They will cause temporary relief but, at the same time, they will give the underlying malignancies time to grow nastier, bigger and deadlier. In short, the remaining eurozone's banking sector will turn into a monster version of Japan's zombie banks of the 1990s, brewing en masse the next banking crisis and embedding the virus of recession everywhere, from Spain to Germany, from France to Italy.

The third reason is structural. The eurozone's troubles stem from the lack of a pan-European system of supervising the banks, of managing public debt and of planning for aggregate investment. None of these three constituents of the Crisis will be dealt with if Greece, Portugal and possibly Ireland are amputated - even if the stumps are effectively cauterised. This means that on the Morning After, Italy will be the next Greece and Spain will be the new Portugal. The internal imbalances of the eurozone, after a brief lull, will start rearing their hideous heads again, and, in conjunction with the zombie banks and the recessionary environment, it will not be long before another round of amputations will become `inevitable'.

There is, in other words, no way to ringfence the crisis unless all deficit countries all the way to France are ejected and all that remains is a Neuro consisting of Germany, Netherlands, Finland, Luxembourg and maybe a couple of others, which could only remain a surplus country by engaging in massively mercantilistic currency policy in competition with China.

In other words, finally the Bundesbank would accept responsibility for countering upwards pressures on its currency's exchange rate, or else there would be massive internal deflation and/or one of the Virtuous Four Euro countries would find itself a net importer once the Neuro(tic)zone achieves balanced external trade at a stable exchange rate.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Sat Mar 17th, 2012 at 09:54:49 AM EST
In a sick system there will always be at least one sick man. The system requires it.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sat Mar 17th, 2012 at 11:52:22 AM EST
[ Parent ]
Migeru, maybe I wasn't clear enough, but that's exactly what I meant when I wrote this:

Outside, most other Eurozone members have had to impose some sort of capital controls too; even if succeeded, they wont prevent every trade deficit and surplus in the Eurozone to close.

You just need one euro state to leave the EU and a regression process takes place that can all other states in hours.

by Luis de Sousa (luis[dot]de[dot]sousa[at]protonmail[dot]ch) on Sat Mar 17th, 2012 at 02:29:51 PM EST
[ Parent ]
So the euro will bury us all.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Sat Mar 17th, 2012 at 02:36:16 PM EST
[ Parent ]
Kicking out every single country but Germany one at a time, will take a long time, years and years. Meanwhile, the internal imbalances might go away.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Sat Mar 17th, 2012 at 04:44:37 PM EST
[ Parent ]
Hmm, the rumours are that Greece will be out this year, followed shortly after by Portugal (give it 6 months?). Then Ireland will fail to pass the Fiscal Compact in referendum. And Spain is going to follow on Greece's heels with 2 year lag. So, give it 3 years until either France is out or the Bundesbank folds (like they did in 1992/3 - apparently even they were not willing to see the Franc ejected from the ERM, unlike the Pound and the Lira).

That's, of course, in the gradualist view. If Varoufakis is right, the whole thing unravels within 6 months of Greece being shown the door. So, next year?

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Sat Mar 17th, 2012 at 06:11:11 PM EST
[ Parent ]
Depends on how observant the Portuguese, Spanish and Italian governments are (I have given up hope that France will realise that it has a greater commonality of circumstance with the rest of the deficit countries than with Germany). It is possible that they will see the handwriting on the wall if Greece is sufficiently rudely ejected, and skip the 6-24 months of unnecessary pain.

But this is EPP-PES governments we're talking about. I would not bet money that they have the clarity of vision to find a lit fire on a moonless night.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sun Mar 18th, 2012 at 08:05:41 AM EST
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