One Way Out for the Eurozone?

The capital markets have Eurozone fatigue.  Day after day, hour after hour, we await the same news: an answer is forthcoming from the next meeting of EU finance ministers.  There's a Monty Python sketch in which the characters play around with an innocent question, "How big is it?"  Well pundits at the IMF conference have suggested a rescue/bailout/fiscal equalization fund of 1.4-4.0 TRILLON euros would solve the problem.  There is no answer to "How big?"

A facility of that size is out of the realm of possibility, for a union in which the strongest member has a GDP of 2.5 trillion euros.  Eventually, Germany will have to deal with the reality that its interests diverge not only from the weaker members of the union, but from those of France as well.  Then, Merkel and Sarkozy will no longer be able to pose as figurative, "Brothers in Arms." 

Greece has announced that its austerity measures will not enable it to meet its budget targets in today's WSJ. So, really we are moving, like a slow motion train wreck, towards a default of some kind, semantically within or outside the euro.  We wrote way back in June about the likely fate of the euro and about the attractiveness of Treasuries despite all of our fiscal management issues. 

A country's exchange rate is the most effective market price for adjusting imbalances in merchandise trade and external capital  accounts.  With the euro, Greece or Italy don't  have an exchange rate for the market to devalue until their economises  adjust to a new equilibrium.  Playing with tax and fiscal policies are not primary tools for these adjustments, as Greece is finding out.  Italy is waiting in the wings, and I don't believe that the Berlusconi government would have any inclination to drive itself down a path as Greeece has done. 

Thinking back to the Lehman crisis, one of the justifications for the absurd bailout concocted by Treasury was the fact that nobody could really map out the complete counter party network for Lehman/AIG/Bear Stearns and the other SIFI's, along with the amounts at risk.  Nobody knew how bad it would get and whose hands would get blown off. So we implemented a really bad deal.

Likewise, the structure of the EU and the obligations of its members were built without contemplating the alternatives we're now facing, namely an exit from the euro.  However, if one member exits, the utility of the entire common currency mechanism is mortally wounded as an economic construct. I'm not sure anyone really knows how the default//exit scenario would play out in practice.  Markets need to adjust and move one, but that means a paralyzed Europe has to come to terms with the failure of the notion of their common currency union. 

It doesn't matter how many times the finance ministers meet and where they meet, there may only be "One Way Out."

"Ain't but one way out, baby,
  Lord, I just can't go out that door.
  Ain't but one way out baby,
  Lord, I just can't go out that door.
  'Cause there's a man down there,
  Might be your man, I just don't know."
 
  (Holland/Dozier/Holland) EMI