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.

So if both paying more and building inflation potential are out of the equation, the whole concept of the euro needs to be questioned. Neither of the two trilemmas has been seriously answered and tackled by the seventh definitive plan. Hence I foresee more definitive plans and meetings of last chance down the road, unless a solution imposes itself. Such a solution would not necessarily be the best outcome. Hence, without serious thinking, the euro will be sinking.