Spain and Italy Would Not Necessarily Follow Greek Exit of Euro


The problems of the Bundesbank


The problem is that prices in Northern Europe are to low and in Southern Europe to high.

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–          Before the Euro the Southern EU-members could devaluate their currency, but that is not possible today.

–          The method within the Euro would be to make social reforms in the South. The drawback is here, that these countries won’t – at least not adequately. If for no other reason than because a drop in wages and salaries will hardly be followed by the same drop in prices – principally housing.

–          This means the corrective measure is a higher inflation in Germany than in the rest of Europe. We have seen that the German Finance Minister Schäuble is ready to do just that with his support to wage increases in Germany.

The European Central Bank cannot raise interest, as that would make it impossible for the Southern European countries to finance their deficit. And as the Southern countries have 70% of the votes in the ECB, that will not happen.

The alternative is for the ECB to buy sovereign bonds of the Southern countries – which at the moment is about 1000 bio. EUR – where Germany is the main creditor with about 2/3 of that trillion EUR.

Up to now that has not been too big a problem, as there were property values in Southern Europe to match their debt. As reported here – that is no longer the case as the ability of the banks to keep the bad debt – primarily real estate – on the books is giving in due to illiquidity that will reveal their insolvency.


Repression is when the interest rate is below the rate of inflation. This results in debt being “serviced” through negative real interest rate. (In Denmark the real interest rate has been minus 2% for the last couple of years).

The reaction to repression from the investors is that they run away from cash into real estate property thus giving new wind to a real estate bubble. That is possibly the reason for rising housing prices in Germany. On the other hand the last two years of repression has not dented housing price in Denmark – in fact investors still break out in hysterical mirth when presented with “price-ideas” on real estate.

The real problem is here to keep inflation under control. That happened in the 1970’ies in the US under the influence of the oil price chock (and leaving the gold standard?). The cure was the very unpleasant period in the 1980’ies when Paul Volker controlled the FED. He succeeded bringing inflation under control, but at the cost of a deep recession.

In a more global perspective inflation in Europe will make it even harder for China (that not only finances the US debt, but also a considerable portion of the European). China has to revalue their currency as their export dies off and their import needs remain high.

As to the Euro the threat is not that Spain, Italy and sundry leave the EUR, but that Germany cuts its losses and opts out. But we are not there yet.

First of all developments in oil prices and other raw materials have yet to register an appreciable slowing down of the Chinese and Indian economies. That may bring inflation to a screeching halt – the major part of the inflation in Europe is due to raw materials directly and especially indirectly. That could very quickly make the repression scenario uninteresting – as there would be a full blown deflation.

Furthermore it is not clear what will happen if Spain (and Italy) passes through a similar default scenario as the Greeks are passing through at the moment. Presumably the recalcitrance of Greece will have such scary effects – on the Greeks – that the “kick start” populists will have to reconsider.

From there on – any kind of sooth saying relies on tealeaves of an extraordinary poor quality.

So for several reasons: Let’s not get ahead of ourselves.

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