This is getting absurd...
LAST WEEK revealed the absurdity of Europe's situation, says Dan Denning, editor of the Daily Reckoning Australia.
The October 26 plan that led to a huge rally in markets had three components: the resolution of the Greek problem, the recapitalization of Europe's banks, and a mechanism to fund the European Financial Stability Facility (EFSF). Since the 26th, all three components have fallen into general disarray.
Take the EFSF. It's an unfunded bailout fund. The institutions that CAN fund it – China and the IMF – don't want to. And the institutions that can't fund it – the bankrupt governments of Europe – don't want to either. Any bailout fund that must borrow money in order to lend money is bound to fail when no one has any money to lend to begin with.
Then there's Greece. Under the October 26 plan, Greece's creditors would accept a 50% write-down in their bonds. The Greek people – who were denied the right to consent to their own servitude – would endure painful years of austerity, lower pensions, a higher retirement age, and less government spending (all of which are probably a good idea anyway). In exchange, Greece would stay in the Euro.
But why should Greece stay in the Euro if the cost is years of lower living standards? There are 27 nations in the European Union yet only 17 of them are in the currency union that uses the Euro. Can't Greece remain in Europe but ditch the Euro?
Of course it can! It can withdraw from the currency union, revert to the Drachma, default on its debt in an orderly way, and pay back creditors after devaluation. A devaluation of its currency is exactly what Greece needs to pay down its debts and become more competitive.
But Greece cannot devalue the Euro as a member of the currency union. This is the drawback of currency union finally exposed – lack of flexibility when managing a national economy, not to mention loss of sovereignty. The answer is simple: Greece should leave the Euro, devalue and then default.
Would the world end? Probably not. It would free Europe to focus on the banking systems and countries that really are too big to fail: Spain and Italy. And just think...if Greece leaves the Euro and defaults...it would provide the financial markets with enough certainty to rally by ten or twenty percentage points by the end of the year. And we could postpone Italy's reckoning until next year.
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