Investment Contrarians

New Cracks Appear in the Eurozone From One Small Source

By for Investment Contrarians |

New Cracks Appear in the EurozoneFor the past few months, the eurozone financial crisis has significantly subsided, at least on the surface. However, because of the fragility within the eurozone, it won’t take much for a new financial crisis to be sparked.

There are new questions arising about the future of the eurozone, and these begin not with the giant nations of that union, but with tiny Cyprus.

Finance ministers from the eurozone countries are hotly debating much-needed bailout funds for the tiny island of Cyprus. One organization missing from these talks in Brussels is the International Monetary Fund (IMF).

As it stands, funds from the 700-billion-euro European Stability Mechanism (ESM) can only be dispersed if the IMF agrees to the cash payments. However, the IMF is disagreeing with some European nations as to the viability of Cyprus being able to pay back its debt under the current restructuring agreements. (Source: Pauly, C., et al., “Troika Travails: Split Emerges Over Cyprus Bailout Package,” Der Spiegel, January 21, 2013.)

Clearly, the financial crisis within the eurozone is not over if a nation like Cyprus is expected to have its debt load at 140% of its gross domestic product (GDP) by 2014—a clearly unsustainable level. This is the conclusion that the IMF has determined, and it is demanding that creditors of the banks within Cyprus incur a haircut in their principal or a decrease in their total claims.

Another serious worry for eurozone members is that Cyprus has a reputation of money laundering. With the financial crisis still a worry for many, especially the super-rich, having funds in accounts across the eurozone is clearly a problem. All citizens need to pay their fair share, and if one island nation is holding billions in assets hidden from the other eurozone members, this needs to be addressed.

While Cyprus is a tiny nation, this disagreement on how best to deal with the nation’s financial crisis is a great example of the inability of eurozone member nations and organizations to work together to come up with solid long-term solutions.

If the eurozone members in the IMF can’t agree on the bailout to avert a financial crisis in a small country like Cyprus, there’s not much hope or optimism for the much greater problems of their larger members.

While many investors have begun piling into eurozone investments, believing the worst of the financial crisis is over, this small split in views on how to handle Cyprus is indicative of possibly much larger problems to come.

The problem with so many eurozone members having interconnected ties across different countries is that it raises the issue of conflicts of interest. To avert a financial crisis, is it better to increase austerity at the price of local citizens while bailing out international investors? Or should creditors take some of the losses for their poor investments?

Similar questions continue to arise, and no end is in sight. The problem with the eurozone is that actions tend to only come because of a financial crisis. Very little progress is made when times are tranquil. But a financial crisis forces all eurozone members to focus on trying to solve some of the bigger problems.

The eurozone’s recent quiet environment is not due to the implementation of a long-term solution that will prevent any financial crisis down the road; it is simply buying time for member countries to enact the type of structural reforms necessary.

If the eurozone members do not take advantage of this lull in activity and simply waste time, the next financial crisis will be even worse.

Unfortunately, the only predictable outcome I can see for the future is that eurozone members will continue bickering.

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  • woja53

    This is a particularly excellent piece of reporting and 100% accurate in it's content and in it's predictions to my mind, watching this eurozone slowly breaking apart from the comfort of my home in Australia.
    The eurozone must find a way to break away from the euro single currency so that countries other than Germany can grow at their correct rate and not be forced into financial strangulation by currency valuations that are sky- high for individual countries generally and non manipulatable. (A new word for you).
    The Europeans surprisingly cannot or will not yet see that the writing is on the wall for a euro currency failure and the later this happens the harder countries will fall when it does , (as it must), fail.

  • Kenneth Childers

    Your word is fine but there exists already the word "manipulable,' admittedly mostly used in education for toys that can be manipulated …

  • Teresa

    I think you forget that the "Euro" has roots dating back to the sixties: it was a long time coming, and didn't take anyone by surprise, I think. Perhaps the timing was a bit rushed, but it's said and done. The countries of Europe established, after the horrors of the second World War to establish "ever closer union", and a cohesive economic area was simply one facet of this. There are advatages to a single currency area (see Mundell and others' writings on the subject; Mundell happened to win the Nobel Prize for his efforts), and the notion of some utopia where currency devaluation alone can save a troubled economy are equally as flawed as the policies you criticize. I could list a number of examples, but one, I think would do: look at the United States: surely, the economy of Alabama moves at a different rate, consists largely of different ventures than does the economy of California, and so on. But, there are nevertheless decided benefits for both Alabama and Calfifornia, and Utah and Nebraska and Maine and Illinois and Hawai'i and Missouri to remain in a single currency area, despite the differences. The European leaders of yesteryear determined with soem certitude that the countries of Europe would similarly benefit from such a monetary union, and the necessary steps had been implemented since the recession of 1968/9. The problem of today is principally political and finds its extension in a fiscal divergence and a monetary prudishness, both of which have to be transcended, if Europe can hope to weather the storm, so to speak. Europe is finding itself in a situation in which the institutions that will emerge, will emerge of necessity, but that can sometimes be a good thing. Of course, the pains and sufferings along the way are not a good thing, but one can only hope for a decent and positive resolution, whether that is realistic is entirely a different thing.…

  • woja53

    Many thanks Kenneth, manipulable sounds and looks much better. It only goes to prove that King Solomon was right when he said there was nothing new under the sun.

  • woja53

    I do understand what you wrote Teresa and you are obviously an intelligent person. I guess the issue that I have with the euro is that of Europe itself. Europe is stunningly charming and interesting in the absolute and even acute diversity of even almost neighbouring states where the values and way of life of their peoples are not necessarily very similar. In the USA the states are certainly different to each other but overall the value and way of life issues are more cohesive. In Australia we have 8 separate states and territories each with a government that come under the umbrella of a federal Government similar in many ways to the EU also in an area somewhat bigger than most of Europe but one could be forgiven for thinking that they were all one state.

    Actually Teresa, they all work just as you wish Europe to exist and it does work brilliantly here but put in place the very same governments and financial systems into Europe and it would never EVER work because of the absolute diversity and differences in priorities and values between the separate countries of Europe. I guess you can also throw in the language problems too but that's not the main issue to be fair.

    In Europe we see on the other hand, open antagonism between states long and simmering and unable to be healed for a myriad of reasons that lead back to lack of trust that dates back centuries that no one wants to acknowledge and even the goals of individual states(countries) are different as are the aforesaid languages.

    As a visitor /employer in Europe I see these things because I personally am not so closely entwined in the European web.

    Seriously Teresa, I wish that I could share your optimism about the Eurozone's future, but as an outsider looking in with a vested interest in Europe, I see only that the euro is a very negative influence and will keep many countries poorer than needs be. On the other hand The EU is a brilliant idea. I guess that its the same age old story; when friends introduce either money, politics or religion into any relationship there are often serious unfixable problems. The euro is one such case as I and many other commentators looking in from the outside of Europe see it.

    So in a nutshell I would Keep the EU but ditch the euro as soon as possible because sadly, I see the euro as the catalyst that is surely and subversively opening up divisions between the European and EU peoples.

  • Teresa

    Let me see if I can type all this without making serious syntactical blunders or otherwise writing something unintelligible:

    The fact that it doesn't have to be this way already reveals, though, that the problems you're alluding to (the economic situation of "north" versus "south", and other various divisions, perhaps those of the Monetarists and the Derigentists, etc., ad infinitum) are inherently political in nature. And, I honestly believe you're looking in the wrong place. I cite an anecdote from Keynes I heard Krugman use in an interview some weeks ago on the BBC: Keynes described, per Krugman, something to the effect of a "Magneto problem" (what one would call today battery problems) in one's vehicle; supposedly, the example continues, an individual responds to the problem not by proceeding to pay $100 and buy a new battery, but instead takes the bus and/or the train more, and abandons the car, because, according to Keynes' anecdote, it's too expensive to fix!", in a nutshell; Krugman makes the point, drawing on inference from Keynes, that the Euro problem is like the "Magneto troubles", and the solutions that the central bankers offer (the bankers, essentially, of the "north", but you can't really even say that, because some of the present policies of the ECB would certainly never occur if the Bundesbank were in control, so there is the loss of sovereignty there, a good thing, actually) are to ditch the car and take the train or plane or what have you, because they're, quo Krugman, not willing to make the necessary investments at present to ensure the car (the total Eurozone economy) is running well. I think it's a great example, which, for instance, Greece is a great embodiment of, and which reveals some of the real internal crises wracking the Eurozone (certainly the least of which are the language problem, and the cultural antagonisms you point out really have no economic basis: there's nothing which "culturally" speaks against a shared currency, which is just that). What are these crises? Well, for one, the inability to come to a concrete solution to get out of the crisis, and this can be problematic in the long run. Probably the biggest threat to the integrity, ironically enough, of the Eurozone are not immigrants or deficits, but the political leaders of the troica, who seem hell-bent on inflicting harmful, painful and pointless austerity on innocent bystanders. And, as recent events show, "helping the south" may ultimately be a fiscally sound policy:

    And, I certainly wouldn't suggest that further political and economic integration would never, ever happen in Europe: quite the contrary, in fact, has been the norm if we look at the historical picture: just look at the level of integration we've seen just in the last ten, twenty years. Take Germany, for instance: literally 60% of Germany's trade is with Western Europe, and the great bulk of that (more than 50%) with Eurozone countries. One can assume, all economic variables considered, Germany would match the criterion of any OCA modellers' stipulations, and so would most Eurozone members. And what are these criteria? If you don't know them, look them up: it's all information that's freely available on the internet. I'll mention just two here that are typically mentioned: open economies and shared preferences. And what you have in Europe, in general, is a group of small, relatively open economies, which tend to benefit from the stability membership to a larger currency areas offers.What are these benefits? Well, for starters, stability in aggregate demand, but also the added benefit of scale economies and stable interest rates, to name but a few areas in which small countries tend to suffer, and which optimum currency areas tend to provide their members (can you talk about a Connecticut, or a Scottish or Queensland interest rate?). For one extreme example of these effects, look at Montenegro, not a Euro member. However, the Euro was used to stabilize the economy during the civil war, and, in fact, continues to be used in the state to this day. This stabilizing effect can be attested to those same factors that cause countries like Belgium, Luxembourg and the Netherlands to benefit from Euro membership, as well, and there's plenty of literature on the subject, and plenty of examples to this effect, as well. Much of the sustained growth these same countries will more than likely see in the future will probably derive from the increased economic activity as a result of Euro membership. That's, if the leaders of the Eurozone can find a way to synthesize the second criterion I mentioned: shared preferences. There's an old joke, that, in heaven, the cooks are French and the Germans are bankers. So, if you get a French dirigentist and a German Monetarist spirit operating (and these are just steretypes, in my mind, but they represent certain views shared across various political strata within Europe as a whole, as in any democratic society where diversity is an underlying element), and you can't get these to work, co-operate in tandem, then there's going to be trouble on the horizon. If you can patch up those differences, and put pragmatism ahead of politics (something I think you see happening, especially recently at the ECB: ( ), then the future looks alot brighter. This isn't "optimism" speaking, it's evidenced in practice.

  • Deltav123

    I must apologize, you lost all credibility when you referenced Krugman. This is the same man who called for a housing bubble in the U.S. Please reference the link below for a review of the economic carnage his previous suggestions have caused.