Travelling through Switzerland I can’t help but think that politicians both here and in the UK have a lot to thank their predecessors/electorates for. The relative safe-haven status enjoyed by both economies reflects, at least in part, the arm’s length relationship with the euro. (Swiss readers may not take kindly to being compared with us Brits, but you take my point.)
The eurozone policy makers who are currently trying to thrash out some sort of ‘deal’ have an almost impossible task on their hands. Despite a belated recognition that some leadership is much required, the reality is that a comprehensive solution won’t be reached. We’ve talked before (see here) about the inherent dangers in any monetary union absent fiscal union. Are the French, Italians, the Spanish, even the Greeks ready to be governed by Berlin? Or indeed, if Greece et al are willing to give up all sovereignty, are the Germans willing to take responsibility for the deficit countries of Southern Europe? Fiscal union requires both the debtors and creditors to be compliant. The foundations of the building are unsafe; replacing the roof may help keep the rain out but it won’t ultimately stop the house collapsing.
Absent fiscal union and two outcomes spring to my mind; euro breakup (of some form) or the monetisation of deficits. The former would likely see a return to 1930s depression economics, the latter some would argue risks a rerun of the 1920s Weimar experience. While we’re certainly not predicting a rerun of 1920s hyperinflation, it will be the temptation to inflate that will win out. The structural adjustments required of many European economies will likely prove too big a pill to swallow. German led protests will fall on deaf ears, and German resignations from the ECB will make little difference. Inflating away liabilities will prove an easier sell for economies that have binged on debt and leverage for decades.
Time to visit some inflation protection? Given there is so little inflation priced into bond markets right now, I think so!