Vice President of Analysis Peter Zeihan examines the equally unpleasant choice of monetizing the euro or letting the euro fail.
Editor’s Note:Transcripts are generated using speech-recognition technology. Therefore, STRATFOR cannot guarantee their complete accuracy.
The Europeans are running out of tools to combat their deepening financial crisis. The bailout fund is at best compromised, European banks are degrading by the day and borrowing costs are rising week by week. One of the very few tools that remaining is something called monetization. In essence, the European Central Bank expanding the money supply to purchase distressed government debt, most notably for Italy. Monetization proponents argue that such activity would melt European debt away. The reality is not so clear-cut, and the Northern Europeans are at best leery of this option. In the Northern European mind, monetization will not solve the core European problem — competition. Southern Europe is already non-competitive with Northern Europe. The average Southern European worker is 1/4 to 1/3 less productive than the average Northern European worker. Throwing free money at them will only make them less competitive. And for those who can remember back a few years, it's obvious that throwing free money at Southern Europe is in a large part what caused the current debt crisis. Instead what would be achieved is inflation. Monetization encourages consumption, which largely explains why the United States, United Kingdom and Japan have used the tool in recent years. But in the European case, it would be encouraging consumption in only part of the currency zone — in an area that is already a substantial importer. Southern Europe needs to get their consumption production in balance. Monetization does the opposite — deepening the existing imbalances while boosting inflation. Now inflation does eat away at the relative value of debt. But it also eats away at the relative value of assets. Since Southern Europe is more debt-driven than asset-driven economy, it is easy to see why countries in the South see monetization as desirable option. But in Northern Europe the circumstances are reversed. Northern European economies are creditors and very high-value-added, sporting massive industrial bases, highly educated work forces and excellent educational systems. Northern Europe is not high in debt — it is high credits and high in assets. And those assets are the key to Northern European income streams and Northern European political power within the EU. Monetization would directly endanger all of it. The Germans are particularly nervous about this aspect of monetization. Monetizing Southern European debt would also have no clear chance for improving the European financial crisis. Monetization eliminates pressure upon states to reform. Case in point: the European Central Bank started buying Italian debt back in August. Italy abandoned their austerity plans in August. Unless watertight restrictions on state spending are in place before monetization begins, there is no reason for fiscal conservatism. And if those constraints are already in place, there’s no reason for monetization. Finally, there’s demography. There is a big bulge in late-40-somethings in the German demographic with a very sharp drop off in younger population cohorts. These late-40-somethings know all the tricks of their trade — they are massively productive. They also have few bills and are at the height of their earning potential, so they are also massive creditors. The skills and personal wealth of this group are the foundation of the current German geopolitical strategy — trade financial and economic strength to force the rest of Europe to agree to a rewiring of the EU to German preferences. And to achieve this before the demographic advantage dissolves in about 10 or 15 years, when the population bulge retires en masse. Monetization would upend this strategy. First it would decrease competitiveness vis-a-vis Southern Europe, weakening the German leverage in reformulating Europe. Second, it would debase the assets and savings of Germany’s most economically and politically powerful demographic in favor of Southern Europeans. It is the monetary equivalent of the American government using Social Security funds to pay for services to Mexican immigrants, and expecting retirees to be ok with it. But despite myriad disadvantages, monetization may well be emerging as the only tool that can preserve the euro, albeit in an increasingly damaging and distorted form. As Europe’s other tools fail, Northern Europe is going to be faced with a stark and painful choice — monetize and suffer the consequences, or let the euro fail and suffer the consequences.