Looking at 2011 through the rear-view mirror, we need to acknowledge that it has been quite a formidable year. It started with the “Arab Spring” and ended – there is still another week to go – with the passing of Kim Jong Il, the North Korean leader.
In between, there were many extreme events of both the “Black Swan” type, such as the Fukushima disaster, and the politically self-inflicted type, such as the US debt ceiling debate and the five last chance summits to resolve the euro crisis.
All this made 2011 a challenging year for the markets. Many equity indices, especially in Europe, are significantly down from 2010, and volatility is almost back at levels last seen during the financial crisis of 2008. There doesn’t seem to be any end in sight.
It can be quite revealing to take a glimpse at what we wrote a year ago, so I pulled up the text, I wrote in 2010, “Unfinished business,” and was rather surprised that its first paragraph is still a perfect fit a year later, adjusting the outlook horizon accordingly: “With a week to go until New Year’s Eve, 2010 ends with many unresolved problems that will continue to affect the first part of 2011… The most obvious is the European sovereign debt crisis, or, as we prefer to call it, the crisis of the euro.
So far, European leaders have failed to address the underlying problem of the crisis: To really function as a currency area, the Eurozone simply needs much more economic, fiscal and social integration.
Instead, they have focused on reshuffling and guaranteeing governments’ debts with ever more complex schemes. Despite these band-aids, the debts refuse to disappear… Hence, we expect the crisis of the euro to continue making headlines in the first months of 2011.”
I continued by acknowledging the US debt problems, which are also still unsolved and are likely to remain unsolved in 2012, a presidential election year. I concluded with China’s struggle with its inflation issues. At least this last point has been dealt with in 2011, to the extent that now it is the Chinese growth outlook that worries many market participants.
Despite all the challenges that prevailed in late 2010, I thought 2011 would be a transition year, with at least a decent performance in the equity markets, since stocks had been fairly valued and in some cases even cheap.
I was proven wrong. Indeed, even technical analysts indicated that 2011 should be an outstanding year for equity markets, being the third year of a US presidential term. Since World War II, this period has delivered a 16% performance on average on the S&P 500, compared with 5% in the first year, 4% in the second, and 7% in the fourth. So much for inferring patterns without enough data points.
This is why we enter 2012 in a very cautious and conservative mood. Although equities are now even more attractively valued than in late 2010, we learned from 2011 that a state of unfinished business is not a healthy environment for aggressive investing.
Wednesday, December 21, 2011
Friday, December 16, 2011
16/12/2011: France’s latent power over the future of a common currency
The concept of any euro only makes sense if France participates. Thus, even in the unlikely scenario of a euro split and adapted to the economic strength of user countries, France plays a crucial role.
Every new European summit failing its chance to save the euro and finally resolve the European sovereign debt crisis raises the prospects of a possible breakup of the common currency. Don’t get me wrong: This is not our base case. We still assign only negligible probability to such a scenario. Nevertheless, we do consider that the consequences of such an event would be disastrous, so the risk, defined as likelihood times expected loss, is quite significant.
Numerous scenarios are currently discussed in the press about how such a breakup could proceed. They range from one or several countries exiting the euro to a full disentanglement of the common currency into seventeen new national ones. Often discussed is the split of the euro in two parts: a northern euro or “neuro,” and a southern euro or “seuro.” The neuro would take in all the strong countries of the Eurozone, and the seuro all the weak ones.
We see this among the least likely of scenarios. Why? Because the concept of any euro only makes sense with the participation of France. A neuro without France, including only Germany, the Netherlands, Austria and maybe Finland, would not differ at all from the good old Deutschmark. Before 1999, both the Netherlands and Austria were de facto pegged to the Deutschmark. Implicitly Switzerland also had such a peg, and Yugoslavia quite explicitly before it dissolved in the early 1990s. Therefore, the participation of France is crucial to make it something truly different.
A seuro with Spain, Italy, maybe Portugal and Greece, but without France, doesn’t make any sense either. Why would Spain and Italy want to share a common currency? The exports of Italy to Spain represent 6% of all Italian exports; Italy exports twice as much to both Germany and France. In comparison, Spain’s exports to Italy represent 9% of all Spanish exports, while those to Germany are 11% and to France a whopping 19%. Hence, again, only a participation of France in a seuro would grant lasting credibility to this new common currency.France is on the verge of losing its AAA rating. Top French politicians including President Nicolas Sarkozy, alluded to this recently. Once this has occurred, as we’ve discussed here previously, Mr. Sarkozy’s strategy to follow Germany on its gloomy austerity path may seriously jeopardize his chances for reelection next year. He will need to exert pressure on his German partners to ease their rigid stance, either by allowing Eurobonds or a greater involvement of the European Central Bank to mitigate the current contagion. In this respect, France has far more negotiation leverage than it realizes or has recently exercised. Because wherever France shall go, the euro will also follow.
Every new European summit failing its chance to save the euro and finally resolve the European sovereign debt crisis raises the prospects of a possible breakup of the common currency. Don’t get me wrong: This is not our base case. We still assign only negligible probability to such a scenario. Nevertheless, we do consider that the consequences of such an event would be disastrous, so the risk, defined as likelihood times expected loss, is quite significant.
Numerous scenarios are currently discussed in the press about how such a breakup could proceed. They range from one or several countries exiting the euro to a full disentanglement of the common currency into seventeen new national ones. Often discussed is the split of the euro in two parts: a northern euro or “neuro,” and a southern euro or “seuro.” The neuro would take in all the strong countries of the Eurozone, and the seuro all the weak ones.
We see this among the least likely of scenarios. Why? Because the concept of any euro only makes sense with the participation of France. A neuro without France, including only Germany, the Netherlands, Austria and maybe Finland, would not differ at all from the good old Deutschmark. Before 1999, both the Netherlands and Austria were de facto pegged to the Deutschmark. Implicitly Switzerland also had such a peg, and Yugoslavia quite explicitly before it dissolved in the early 1990s. Therefore, the participation of France is crucial to make it something truly different.
A seuro with Spain, Italy, maybe Portugal and Greece, but without France, doesn’t make any sense either. Why would Spain and Italy want to share a common currency? The exports of Italy to Spain represent 6% of all Italian exports; Italy exports twice as much to both Germany and France. In comparison, Spain’s exports to Italy represent 9% of all Spanish exports, while those to Germany are 11% and to France a whopping 19%. Hence, again, only a participation of France in a seuro would grant lasting credibility to this new common currency.France is on the verge of losing its AAA rating. Top French politicians including President Nicolas Sarkozy, alluded to this recently. Once this has occurred, as we’ve discussed here previously, Mr. Sarkozy’s strategy to follow Germany on its gloomy austerity path may seriously jeopardize his chances for reelection next year. He will need to exert pressure on his German partners to ease their rigid stance, either by allowing Eurobonds or a greater involvement of the European Central Bank to mitigate the current contagion. In this respect, France has far more negotiation leverage than it realizes or has recently exercised. Because wherever France shall go, the euro will also follow.
Friday, December 9, 2011
09/12/2011: On European diets and Euro defibrillators
The difficult task for someone, who writes editorials for a weekly publication edited on Fridays, is that politicians have the unfortunate habit to come up with big decisions on weekends. Hence many outcomes speculated upon at the end of one week might be completely out of question at the beginning of the next one. We are currently once again at such a juncture. I am writing my editorial on this Friday 9 December, while European politicians are meeting for a summit, which might be again labeled summit of last chance.
Since Greece ignited the fuse of the European crisis eighteen months ago we had already numerous summits of last chances and plans to once and for all solve the crisis. Carole Sirou, the head of France research at Standard & Poor’s, mentioned on Monday in the aftermath of the rating agency’s announcement to put under review 15 of the 17 Eurozone countries, the eighteen European summits over the last two years, each of them disappointing investors, as one major reason for this decisions.
Churchill once said about Americans that they will always do the right thing, but only after exhausting all other options. Under pressure from rating agencies, with interest rates increasing, social tension mounting, impatient markets ready to sell all European sovereign debt, including the German one, we hope this time Europeans act like Churchill’s Americans and come with a credible solution. But what would a credible solution be?
I like to compare the Eurozone with a very heavy man, who is in the middle of a heart attack, surrounded by doctors, who are telling him that he should go on a diet and lose some weight. While this is a very sound advice in the longer run, which everyone would agree with, it is not tackling the fact that just in this moment the patient has a heart attack and that a shock from a defibrillator would be an appropriate mean to make sure he’s not dying.
It is clear that a long term solution of the Euro crisis is needed in the form of more fiscal discipline, which implies both more austerity and loss of sovereignty from the Eurozone countries. But such a plan, which President Sarkozy and Chancellor Merkel alluded to last Monday is incomplete without tackling the short term issue of stopping the Eurozone contagion; more concretely of ensuring that interest rates on the sovereign debt of Eurozone members, which haven’t bee rescued so far are not reaching unsustainable levels. Here only one institution could do the trick, the European Central Bank, either directly or indirectly through the International Monetary Fund, the European Financial Stability Facility or a yet to be created new institution.
If we get those two elements in the plan than it could give a relief, which would last longer than the ones the last plans achieved but we would just be at the beginning of solving the whole crisis. If we don’t get those elements or something close to it in one form or another, than we should brace for markets, which might again run havoc.A diet without defibrillator will be not credible to stop the crisis in the short run. A defibrillator without a diet will be not credible to solve the crisis in the long run.
Since Greece ignited the fuse of the European crisis eighteen months ago we had already numerous summits of last chances and plans to once and for all solve the crisis. Carole Sirou, the head of France research at Standard & Poor’s, mentioned on Monday in the aftermath of the rating agency’s announcement to put under review 15 of the 17 Eurozone countries, the eighteen European summits over the last two years, each of them disappointing investors, as one major reason for this decisions.
Churchill once said about Americans that they will always do the right thing, but only after exhausting all other options. Under pressure from rating agencies, with interest rates increasing, social tension mounting, impatient markets ready to sell all European sovereign debt, including the German one, we hope this time Europeans act like Churchill’s Americans and come with a credible solution. But what would a credible solution be?
I like to compare the Eurozone with a very heavy man, who is in the middle of a heart attack, surrounded by doctors, who are telling him that he should go on a diet and lose some weight. While this is a very sound advice in the longer run, which everyone would agree with, it is not tackling the fact that just in this moment the patient has a heart attack and that a shock from a defibrillator would be an appropriate mean to make sure he’s not dying.
It is clear that a long term solution of the Euro crisis is needed in the form of more fiscal discipline, which implies both more austerity and loss of sovereignty from the Eurozone countries. But such a plan, which President Sarkozy and Chancellor Merkel alluded to last Monday is incomplete without tackling the short term issue of stopping the Eurozone contagion; more concretely of ensuring that interest rates on the sovereign debt of Eurozone members, which haven’t bee rescued so far are not reaching unsustainable levels. Here only one institution could do the trick, the European Central Bank, either directly or indirectly through the International Monetary Fund, the European Financial Stability Facility or a yet to be created new institution.
If we get those two elements in the plan than it could give a relief, which would last longer than the ones the last plans achieved but we would just be at the beginning of solving the whole crisis. If we don’t get those elements or something close to it in one form or another, than we should brace for markets, which might again run havoc.A diet without defibrillator will be not credible to stop the crisis in the short run. A defibrillator without a diet will be not credible to solve the crisis in the long run.
Friday, December 2, 2011
02/12/2011: Europe’s French swan
The race against time to save the euro has now seriously started. The dismal bund auction last week, the Italian interest rates now stuck above 7% and the Spanish ones close to those levels, despite new elected and non-elected “technocratic” governments, the spread between German and French bonds widening to levels last seen in the early 1990s and Moody’s announcing that even Germany is not safe from downgrade: all this point to the endgame.
Famous British editorialists are becoming almost hysterical. Wolfgang Münchau writes in the Financial Times of Monday 28 November: “The Eurozone has 10 days at most.” Ambrose Evans-Pritchard tops it the same day in the Daily Telegraph: “What we know for certain is that Europe’s current policy settings must lead ineluctably to ruin and perhaps to fascism. Nothing can be worse.” The German newsmagazine Spiegel runs its cover with a broken one euro coin in front of a gloomy dark sky asking: “What now?”
New solutions leaked during last week-end and likely on the table at the next European summit on 9 December, like the introduction of Eurobonds for a “core Eurozone” or the involvement of the International Monetary Fund to channel European Central Bank funding are too complex and too cumbersome in an environment, where market participants are asking for quick fixes involving the ECB.
… and then there is the huge Damocles sword over the Eurozone: the possibility of a rating downgrade of France, losing its AAA. This event would precipitate the euro crisis in a completely new dimension.
Not that this downgrade is unexpected. It is not a black swan. Currently we are forecasting that France will lose its top rating within the next two years. With French interest rates rising quickly, it could happen sooner rather than later. However, if it would happen before May 2012, i.e. before the Presidential elections in France, then France’s reaction is likely to become a 180 turnaround from the policy followed so far. This is for me the French swan.
Nicolas Sarkozy the incumbent President will run again and despite current rather weak poll numbers he has a fair chance to get reelected given that he is an excellent campaigner. His campaign will run on two axes: 1) law and order and 2) economic and fiscal responsibility. France losing the AAA rating would seriously tarnish the fiscal responsibility narrative and would certainly be used by Mr. Sarkozy’s rivals. They are already now pointing to the fact that under his Presidency France’s debt increased by 500 billion euros.
In my view after a first outraged reaction bashing markets and rating agencies in the same vein US President Obama reacted after the US lost its AAA, the French government might well take the stance of becoming the defender of the Mediterranean countries instead of shadowing Germany, as it does now.
A rift between Germany and France is very likely to become the beginning of the end of the euro crisis. Either with France’s weight the supposedly “weak” countries get then at least some relief from the European Central Bank or under French leadership they might consider other options leaving Germany alone with his strong euro, its psycho rigid European Central Bank and a deep recession. The French swan could well be the one singing the demise of the euro.
Famous British editorialists are becoming almost hysterical. Wolfgang Münchau writes in the Financial Times of Monday 28 November: “The Eurozone has 10 days at most.” Ambrose Evans-Pritchard tops it the same day in the Daily Telegraph: “What we know for certain is that Europe’s current policy settings must lead ineluctably to ruin and perhaps to fascism. Nothing can be worse.” The German newsmagazine Spiegel runs its cover with a broken one euro coin in front of a gloomy dark sky asking: “What now?”
New solutions leaked during last week-end and likely on the table at the next European summit on 9 December, like the introduction of Eurobonds for a “core Eurozone” or the involvement of the International Monetary Fund to channel European Central Bank funding are too complex and too cumbersome in an environment, where market participants are asking for quick fixes involving the ECB.
… and then there is the huge Damocles sword over the Eurozone: the possibility of a rating downgrade of France, losing its AAA. This event would precipitate the euro crisis in a completely new dimension.
Not that this downgrade is unexpected. It is not a black swan. Currently we are forecasting that France will lose its top rating within the next two years. With French interest rates rising quickly, it could happen sooner rather than later. However, if it would happen before May 2012, i.e. before the Presidential elections in France, then France’s reaction is likely to become a 180 turnaround from the policy followed so far. This is for me the French swan.
Nicolas Sarkozy the incumbent President will run again and despite current rather weak poll numbers he has a fair chance to get reelected given that he is an excellent campaigner. His campaign will run on two axes: 1) law and order and 2) economic and fiscal responsibility. France losing the AAA rating would seriously tarnish the fiscal responsibility narrative and would certainly be used by Mr. Sarkozy’s rivals. They are already now pointing to the fact that under his Presidency France’s debt increased by 500 billion euros.
In my view after a first outraged reaction bashing markets and rating agencies in the same vein US President Obama reacted after the US lost its AAA, the French government might well take the stance of becoming the defender of the Mediterranean countries instead of shadowing Germany, as it does now.
A rift between Germany and France is very likely to become the beginning of the end of the euro crisis. Either with France’s weight the supposedly “weak” countries get then at least some relief from the European Central Bank or under French leadership they might consider other options leaving Germany alone with his strong euro, its psycho rigid European Central Bank and a deep recession. The French swan could well be the one singing the demise of the euro.
Friday, November 25, 2011
25/11/2011: Dear China, give me your money! Signed: the euro
In trying circumstances, European leaders can lose their aplomb, and naively expect counterparties to behave outside of economic etiquette. We can learn a lesson from China.
A couple of weeks ago in Brussels, to save the euro once and for all, leaders agreed to create an off-balance-sheet, special-purpose investment vehicle to the European Financial Stability Facility. This SPIV to the EFSF would be fed with capital from China, Japan, Brazil, Norway and anyone else with a vested interest in the euro's survival. That was the idea.
Hence, after negotiating through the night of 26-27 October, tired European leaders told bleary-eyed journalists that French President Sarkozy, still perky, was on the phone with Chinese Prime Minister Hu Jintao, begging him to back the plan with funds. So far, none of the potential donors has agreed to fund the EFSF, even after detailed explanation by European leaders at the G20 in Cannes. Distrust not only of the EFSF but also the ability of Europe to resolve its own crisis is profound.
Shameful, in my view, is that such a rich continent as Europe now needs external help from emerging markets to save its own currency. This walk to Canossa answers the question of whether the euro could ever rival the US dollar once and for all with a resounding “no!” There are more fundamental flaws imbedded in the plea for foreign aid, however. They come from international bookkeeping.
If China gave 500 billion euros to the EFSF, this would be an import of capital to the Eurozone from China. So what would stand opposite this import of capital in the ledger? Very likely it would be found in the current account balance as a deficit, implying an increase of the Eurozone trade deficit with China.
The US is getting much more money from China than Europe and the Eurozone ever will. In fact, the vast US current account and trade deficits mirror the massive growth of China's dollar reserves through buying of US treasury and agency bonds. The US never explicitly asked for this money, but did not refuse it, either. Current grandstanding by US politicians about Chinese currency manipulation aims to reduce those deficits and ultimately – by extension – at not accepting Chinese money as capital anymore.
By asking China to contribute to the EFSF SPIV, Eurozone leaders are taking a path opposite to that the US pretends to cancel. But I am not sure that European politicians really grasp the full implications of the EFSF SPIV. Begging China for money invites the fox into the henhouse, even if China does not seize the chance to leverage its own agenda.
In international macroeconomic quid pro quo, a benefit (funding) requires eventual payment. Here the Chinese are more thoughtful economists (and bookkeepers) than Europeans. Europe's petition to China will be answered: “Dear Europe, open your markets to our exports wider first, then we might consider investing into your funny currency.” China is right in this.
Friday, November 18, 2011
18/11/2011: Navigating drunken sailor markets
The gales of politics and economics have markets sailing in circles, pitching and rolling on nervous seas. Anchors and safe havens seem wishful, steering a long-term course is harrowing. The volatility of it all might actually deliver some return. Just don’t try to predict what tomorrow may bring.
I arrived in the office just past seven in the morning on Monday, 14 November. Silvio Berlusconi had resigned as Italian Prime Minister, replaced by Mario Monti, a move seen by many as the one needed to calm markets.
To prepare for an interview about the Italian political change and its implications for the euro, I head to the coffee machine and punch it twice for a double espresso, then switch on the TV for the latest news from Asian markets to start the week. On CNBC, the news anchor asks a clever trader from an Australian investment boutique, “Well John, what is your feeling for today? Will the market be in a risk-on or risk-off mood?” The double espresso is to no avail; this line of inquiry depresses me.
Is this what things boil down to now? Worldwide, thousands of dedicated analysts, economists, strategists and theorists, technicians and rocket scientists, scrutinize every asset class, dissect economic statistics, examine historical patterns, weigh every word and central banker antic, plumb the Byzantium of Greek politics and the Florentine of present-day Italy. For what? Is all we need to know now “risk-on or risk-off?” Even a dart-throwing chimpanzee seems a worthier benchmark.
What to do in such a market? Wait until European politicians finally make up their minds? For sure, if “risk-on, risk-off” sounds like coin flipping, then trying to time the market is no better strategy. Neither is thinking that a magic, unshakable asset exists somewhere. In my view, capital protection, over a longer time horizon, can already be achieved with a well-diversified portfolio. While equities might induce tachycardia on occasion, at least those paying high dividends consistently grant some income for the doctor bills. Many “safe” government bonds don’t even do this anymore.
Bolder investors seeking opportunities in this challenging environment should focus on market volatility. It is currently very high and hence expensive to buy. History has shown that it tends to revert to its mean. Looking ahead six months from now, we think the euro crisis will have been resolved, either through forceful ECB intervention to end speculation against sovereign European debt (best case scenario), or by a break-up of the Eurozone (worst case scenario). In both cases, the uncertainty will be gone and market participants should again return to fundamentals. This means that market volatility and its price will have dropped. So why not sell some volatility today?
Friday, November 11, 2011
11/11/2011: The politics of scapegoating
The Greek prime minister has resigned, the Italian one will. These are the desired results of the “friendly” pressure from France and Germany and the less amiable sort from financial markets. But now what? Beyond these symbolic outcomes, everything is more or less the same, or even worse.
Greece is still bankrupt and Italy has entered an explosive debt spiral with interest rates shooting above 7%. Even a “technocratic government of experts” in both Athens and Rome wouldn’t change these facts. Next year, Greece will clock negative growth for the fifth year in a row. Its GDP, as I see it, will be somewhere between 20% and 25% lower than it was in 2007. This evolution recalls the US experience during the Great Depression from 1929 to 1934. Even had the Greek debt stayed constant in the last five years, Greece’s debt-to-GDP ratio would still have increased by more than 25 percentage points. This means the drastic austerity measures adopted so far have only succeeded in pushing Greece further into poverty.
We can continue to joke about the number of untaxed swimming pools in Athens and the supposed 400 blind people living on an Aegean island with 800 inhabitants. But at some point, we need to question whether the brutal and collective punishment of the Greek population for the misdeeds of their government – falsifying statistics to gain acceptance into the euro – is justified. After all, it was the foreign creditors who eagerly lent money to a country they had perceived as being as solid as Germany. And by the way, did we ever hear the Germans voicing doubts and concerns about Greece before 2010?
Italy is even more of a sad story. I remember the first time I was confronted with economic statistics. It must have been in the early 1980s, when I was still a youngster. My father and I were watching news on TV announcing that Belgium would be the first developed country since World War II to post a government debt higher than its GDP. The journalist went on to say that Italy was just behind. And what did it mean? Nothing.
Italy has had a high debt-to-GDP ratio for the last thirty years, yet no one seemed to care until a couple of weeks ago. The ratio occults the fact that Italy has been among the most virtuous European nations in the last decade. It entered the Eurozone with a debt-to-GDP ratio above 115% and reduced it to about 104% by 2007 despite having almost no growth at all. For comparison, take the supposedly more serious countries of France and Germany. From 1999 to 2007, their debt-to-GDP ratios went from roughly 60% to almost 70%. The soon-to-be-former Prime Minister Berlusconi might be considered a buffoon by many, but fiscal profligacy was not one of his flaws.
You might object that Italy has a growth problem, and you would be right. Since entering the Eurozone, its competitiveness as measured by unit labor cost has declined relative to Germany’s by more than 30%. But austerity will not solve the lack of growth. It will only exacerbate it.
After Greece, Ireland, Portugal, Spain and now Italy, who will be the next in line? Belgium, or even France? The politics of scapegoating the weak European countries has so far worked for the Grande Nation. It kept a government that has increased its debt by half a trillion euros in the last five years from becoming the center of the market’s attention. This could change rapidly. Moody’s has put France’s AAA credit rating under review. In case of a downgrade, President Sarkozy, who faces elections in May, could be the next casualty of the euro crisis. If such a scenario came true, the weak politicians would obviously blame the markets.
But remember: The euro was conceived as a political project, not an economic one. Thus, if the euro fails, it will be a failure of politics, not economics. Finding scapegoats and blame-gaming wouldn’t help then.
Friday, November 4, 2011
04/11/2011: Wishful sinking
In a funny commercial run by Berlitz Languages a few years ago, a young German coast guard is left alone in a control room to monitor the radars. Suddenly, a voice comes out of the radio: “Mayday, mayday! Can you hear us? We are sinking, we are sinking!” In a rather thick German accent, the novice officer nervously answers the distress call: “Hello? Zis is ze Cherman Coast Guard. What are you sinking about?”
In my view, there is no better metaphor to illustrate the latest compromise to solve – once again and once for all – the crisis of the euro. Yet again, it is too little, too late, and continues to rely on a fundamental disagreement between Germany alongside other northern Eurozone members, and the European periphery alongside France, despite the fact that President Sarkozy would deny any rift between France and Germany.
Two trilemmas, one concerning Europe as a whole and the other specific to Germany, are leading to the current crisis. A trilemma—unlike the either/or situation of a dilemma—demands a choice of two out of three options since, logically, only two are possible at any given time. The one that pertains to Europe is the Rodrik trilemma of globalization, named after the Harvard economist Dani Rodrik who was among the first to identify it.
In the current context, it states: you cannot have at the same time a supranational entity (the EU) using a common currency (the euro) with sovereign nation-states that practice democracy. Between the Eurozone, the sovereign nation-states and democracy, at least one will have to give.
You can have a Eurozone and nation-states at the expense of democracy. This is what the populations of Greece, Portugal and all other peripheral European nations are currently experiencing: not having any say in the austerity measures imposed upon them. In this respect, the recent decision of Greek Prime Minister Papandreou to submit the Brussels accord to a referendum can only be applauded, despite having caused markets to scream bloody murder. You can have a democratic Eurozone, but this would imply a hefty loss of sovereignty among the nation-states, and this is what the ultimate goal of a fiscal union is. And you can have democratic nation-states without the Eurozone. This would be the euro-breakup scenario.
But the Rodrik trilemma unfortunately does not encompass the full complexity of the crisis. On top of it, you have a Germany-specific trilemma: We want to keep the euro, but we want neither to pay more nor any solution that would increase inflation. Here again one of the three wishes is incompatible with the other two. If you want to keep the euro, then the path to fiscal union will imply much more in terms of transfers from the European core to the periphery.
An alternative to keeping the euro without having to pay for it would be to monetize the toxic debt of the European periphery. This is a strategy practiced on their own sovereign debt by such “serious” central banks as the Federal Reserve and the Bank of England under their quantitative easing programs. But for historical reasons, this is a no-go for Germany.
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