What More Debt and More Financialization Will Mean for the Euro

Financialization is the process of turning tangible, intangible, future or present promises into financial instruments. And it can be scary for the global economy. But we appear more afraid of its potential absence. For example, the financial crisis in 2008 called into question many things.

Among them:

•  The understanding of derivatives

•  The merit of easy credit

•  The sustainability of massive trade imbalances

•  The value of government spending

And now, many investors and homebuyers who were piling on debt like crazy back then wish they would have paid attention to this quote from the Milwaukee Daily Sentinel And Gazette, October 1839:

“And we ask one question that they dare not firmly answer, whether they are not now making a tolerable attempt to pull the wool over the eyes of the people.”

I can easily argue that the last several years of monetary and fiscal tweaking have amounted to little more than pulling the wool over the people’s eyes. The problem: It has happened pretty much voluntarily.

The people have more or less willingly accepted numerous gestures aimed at “making things better,” which have actually served to make things worse! The only success has been …

Postponing the Day of Reckoning

In 2010 Carmen Reinhart and Kenneth Rogoff published a paper called Growth in a Time of Debt, which goes into the dire consequences of the growing and unsustainable debt. You can read the piece here. But let me summarize it this way: A 90 percent debt-to-GDP level seems to be the threshold at which developed economy growth begins to falter (the threshold is considerably lower for emerging markets).

In other words: Taking on more and more debt to finance growth eventually takes its toll on growth.

Enter Austerity …
Exit Austerity

In the U.S., back in 2010, the Tea Party movement took shape and began pressing the issue of austerity, i.e. rein in government spending so we could avoid a fiscal cliff. That push seems to have faded as the austerity conversation in Europe reaches a fever pitch.

Using Greece as an example, the harsh push towards fiscal prudence hit Greece’s economy hard. It may have been the wrong medicine or the wrong dosage or simply an unavoidable conclusion. But austerity is now undergoing a rethink across Europe.

Many Europeans have come to expect the state to make things right. They’ve built an aversion to the recent austerity efforts, which may open the door to renewed government accommodation.

And, of course …

Government Accommodation
in Europe Is Nothing New

Maybe you’ve heard that Greece should have never made it into the euro zone to begin with. Indeed, based on debt-to-GDP and other previously determined criteria for getting into the club, Greece did not measure up.

Rules were bent to let Greece and Italy join the club.

But maybe you didn’t hear that Italy didn’t measure up either …

When the whole euro-zone concept was being invented, criteria outlined in the treaty were side-stepped, in several cases, to make way for political maneuvering. The creators had Germany in, and they wanted France. But they couldn’t get France to join unless they got Italy.

But based on the predetermined criteria, Italy had no business being included in the conversation. So new temporary criteria were applied, which allowed founding members of Europe (e.g. Greece and Italy) in to bolster the spirit of the new euro zone.

You could spend hours reading about all the back-door, political dealings that went on to get the euro zone off the ground. But my point is this: One need not worry about the risks of indebtedness if it is believed the further financialization of economies will save the day.

More of the Same …
but for How Much Longer?

The consistent reversion to the status quo of growth via financialization and debt confuses me. Perhaps its acceptance is simply a sign of desperation from all parties. So chances are the trend continues for a while longer before the day of reckoning finally arrives.

In the meantime, the status quo will be tested. And I hate to say it, but we must look to Europe now.

The face-off between anti-austerity voices and Germany is growing tenser. The potential resolutions to zone-wide economic contraction seem to be shrinking in number. Germany doesn’t want to perpetuate the spending spree of euro-zone governments for fear the underlying debt issues will never be resolved. Meanwhile, Germany’s opponents don’t want to suffocate their economies in the name of austerity.

Inevitably, the common currency will be called into question. It’s clear to me the euro has prevented much needed economic rebalancing within the euro zone. Only now are analysts seriously considering the potential for a Greek departure from the euro. But whether or not Greece, or another country, departs is not the issue just yet …

As the euro is increasingly seen as a considerable headwind for the euro zone, its value should reflect that view and move lower to alleviate growth pressures.

Best wishes,

JR

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