Tuesday, May 11, 2010

A Big-Bang, Trillion-Dollar Euro Burial?

“Friends, Romans, countrymen, I come to bury Caesar, not to praise him.”

Oops. What the European leaders really meant to do with their big-bang, trillion-dollar sovereign-debt rescue was to save the euro currency, not to bury it. But with the cave in by European Central Bank head Jean-Claude Trichet (formerly a hard-money man and closet gold watcher) to use the “nuclear option” to buy up dubious sovereign debt, the euro is likely to keep depreciating.

When central banks buy bonds they pay for it with new cash. That’s almost always negative for currency values. Ben Bernanke bought a ton of new mortgage and Treasury bonds last year, and until the Greek crisis came along, the dollar sunk like a stone. Get ready for more euro declines.

And then you wonder if the European leaders came to save welfare socialism rather than bury it. The mere fact that this rescue package will provide loan guarantees to the very countries that boast the largest welfare states and can’t afford to pay for them probably suggests that the loan guarantees will guarantee more welfarism.

There’s a lot of talk about belt-tightening and spending cuts. But where’s the enforcement mechanism? No one knows. This is the Achilles’ heel of the whole European Union experiment. The monetary discipline has now been broken while the sought-after fiscal discipline is still broken.

If the trillion-dollar European package succeeds in calming lending markets and stopping an outright credit freeze-up, that’s good, at least in the short run. Perhaps it will allow a cyclical-growth recovery, with JPMorgan indexes of Euroland purchasing managers or manufacturing and services showing the possibility of a 3 percent continental growth rate. Yet while a cheap euro will stimulate exports in the short run, in the longer term it will stimulate inflation.

And in addition to Western Europe’s failure to enforce real welfare-state reductions, there really is no flat-tax reform — such as adopted in Eastern Europe — to promote growth. Ironically, the countries of Western Europe, including the southern tier of Greece, Spain, Portugal, and Italy, have a lower corporate tax rate than the United States. That is good. But they could build on that with real flat-tax reform, rather than jacking up value-added taxes.

So there are no enforced spending cuts, there is no flat tax, and there is plenty of political upheaval. (Angela Merkel just lost an important regional election.) So right now, on the day after a big relief rally in stock and bond markets, a sober assessment of the so-called rescue package doesn’t look so great. Actually, the real winner looks to be gold, which is up $20 this morning and is almost at its all-time high of $1,226. That’s a sign of no confidence in the European story.

The euro currency has been compromised and the European welfare state continues. Not good.