The difference between hard and soft

Upon reading the title I thought – that might be interpreted a bit weird… I don’t weigh in that often on the future of the Eurozone, other than to say that I think it will continue although large changes will be required.

And that is where I get the ‘hard and soft’ idea from, the marriage of states that formed the Eurozone was between fundamentally different philosophies and the pre-nuptial agreement was weak.

There are broadly three groups, the hard money, financially disciplined (and free market oriented) and competitive nations are the first group. This group is Germany, Finland, Austria, and the Netherlands. Then there is group two who prefer soft money, socialism, statism and weak financial discipline.

Group three is France, they have a whole group all to themselves, because they are in both camps at once but will one day choose between them.

Eurozone breakup is still not something I can fathom, but it has become more probable from what was an outlier two years ago. As the crisis enters it’s 6th year we still don’t seem to have an end in sight, debts are unsustainable, reforms are not as forthcoming as desired and group one nations won’t take on joint liability for group two nations.

We have seen 20 EU summits in three years and they tend to be predictable, first is they all come out saying something postive happened, we get a few days reprieve on the markets then upon examination we observe that nothing really happened. There are decades of reform to get done but we don’t have decades to do it – but this reality doesn’t seem to be pervasive. Back home we call that ‘two quarts of crazy in a one quart jug’.

In the past, problems like this were solved by a central bank, and if you don’t have one now, the problem can only likely be solved by creating one, which is why two outcomes are likely in my opinion.

1. Some countries leave the Euro (Greece is in pole position)
2. There is a surprise ‘bank holiday’ and some kind of secondary (soft) Euro is developed, whether this is a ‘PIIGS’ catch-all or one that is made up of the secondary Euro of lots of countries (the Greeks would have their own, as would Spain, and Portugal – I think we might be willing to do whatever it takes to join the first group).

Those who have assets in group one will win, in particular if debts are with group two, those who have the inverse will get wiped.

There are few options for creditor repression left, low rates and some inflation will do that, but group one nations see that as taking a punch for group two and we can moan all day about Angela Merkel, but she is not bending under pressure for a fix that will see her nation pay for the mess; even though it is contradictory to the reality that her nation benefited supremely from it in numerous ways (from strong exports to avoiding losses where bank debts should have defaulted and affected Germans).

To put a time-line on it, I would imagine that there is not another year in this before something has to give, German bond yields are negative out to 2016, that is basically a ‘call option’ on the main group one nation. People in the markets obviously know more than I do so one can only assume that the information flow is at work and those yields exist for a reason. What I do know is that if something can’t work it won’t, and in the present form the Eurozone is not fit for purpose, every large nation goes through these teething problems, it’s quite normal, we just need to realize this and address the structural imbalances sooner rather than later.

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