Wednesday, December 14, 2011


Markets are not always smart. The initial reaction to the EU26 “fiskalunion” agreement last week was positive for no intelligent reason. That agreement is a great mistake. The Merkel-Sarkozy Accord (known as the Markozy Settlement in some circles) will make economies worse in Southern Europe as austerity and punishments are imposed, which will slow or impair growth. The accord, which is to be administered by unelected officials, limits the democratic rights of citizens, does not stimulate growth or deal directly with trade imbalances and is a recipe for conflict, tension and dissent. Britain is smart. It is not part of this, though to listen to the British politicians criticizing David Cameron, you would think that not joining in on the march to Eurogeddon was something to be regretted.

The accord does not deal with the vulnerability of banks in Europe, the need to stimulate spending by citizens and governments nor does it address the decline of manufacturing and the lack of growth in some key sectors of regional economies. Indeed, by requiring larger payments into the stabilization fund and the IMF from certain countries, it will actually increase public sector borrowing requirements and likely spur downgrading of the bonds which will be used to raise the funds. Overall, it’s a very bad deal for Europe and a bad deal for the worlds financial system.

So why did everyone except Britain agree?

The conventional wisdom of crowds did not occur here. Instead, we have the behaviour of the herd, made worse by the fact that decisions were being made in the middle of the night. Groupthink led the agreement, with most led to believe that this was the only choice – the last option on the table.

They had previously suggested raising the stabilization fund to $2 trillion, but no one could find the money. They even asked China to help, who politely but firmly said no.

They had asked the US for help, which came in the form of support for the liquidity of the banking system by the injection of funds into the exchange system used by banks to fund debts.

They had suggested a Tobin tax on bank profits – still likely to occur, despite Britain’s veto. This will boost the stabilization fund, but will simply provide more bailout funds for more failing economies.

They had suggested other measures throughout the period since the beginning of the year when the crisis began in earnest.

All to no avail. What they will now do is shrink the Eurozone, with some countries likely to default and began the slow Argentinean like march to recovery. They will start to address Germany’s trade balances and they will start to form serious audit processes for national economies and find ways of stimulating growth.

One suggestion being seriously floated by economists is for “helicopter money” – grants of funds to households to stimulate purchase behaviour. Cash for clunkers was an example. Cash for green home renovation is another. They make the point that the only real option is stimulus.

So lets now watch as Britain begins its journey to growth and Europe does what it does best. Screw up.

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