Is Europe’s “Nixon Shock” Next?

Notation_financière_des_Etats_européens_par_Standard_&_Poor's.svgGeorge Soros is at it again, lecturing poor Europe with his economic musings.

In an op-ed  on monetary policy in Britain’s lefty Guardian, Soros claims that European countries are in trouble because they accepted a currency they cannot control. Soros misses that Europe’s “crisis” is no more than politicians kicking and screaming for more vote-buying loot. It is, in other words, the “Nixon Shock” with an accent. 

Just as Nixon’s challenge was how to run endless deficits without breaking the gold peg, Europe’s “crisis” is simply how to run endless deficits in Greece, France, Italy, without breaking the German banker peg.

Today the only thing holding the Euro up is that those ex-Bundesbank guys don’t allow massive printing of new money. As long as it stays hard the Euro operates like a gold standard, since individual governments can’t run around just printing it up in the basement, any more than they could print up gold in the basement.

Germany, in effect, *is* Europe’s gold standard.

This is very bad for a vote-buying government, who would dearly love to print money in the basement so they can buy those votes. No money no votes. No votes no power. No power no money.

It’s the oldest game in government, and those prude Germans are standing in the way. Hence all the anger, principally from the left, that a hard Euro, like the gold standard, ties up their vote-buying crony little paws.

And so those Eurozone vote-buyers gaze longingly at the US and Japan, who gaily run deficits and pass the check along to the central bank. Nevermind that this game of funding deficits out of the central bank toilet paper instead of taxes is how Weimar Germany made its hyperinflation. Once a governments discovers that it’s easier to print than to tax, it enters a dangerous phase.

So as the German’s refuse to give the kids a blank check, where does this leave Greece, Italy, France? With two choices: they can act responsibly, living within their means and reining in their deficits.

Or, much more fun, they can shift the vote-buying deficits onto commercial banks instead. Make the banks buy up all those deficit bonds since the central bank won’t.

Of course, you can’t put a gun to the bankers’ heads (yet), so you’ve got to sweeten the pot. And this European spendthrifts are doing with bail-out guarantees. This renders the deficit financing into a no-lose proposition for the banks, and lets the politicians merrily on their vote-buying ways.

Of course there’s a downside — national governments are taking on massive and unsustainable loan guarantees. In theory, taxpayers will pay those off.

The fly in the ointment for this scam is that the people can always say no. And the bankers can’t do anything about it. Meaning that, at some point, those guarantees get too big to be believed. When that day comes — and it might be years, it might be months — then banks will refuse to buy more sovereign bonds.

We got a trial run of this comeuppance in 2012. Commercial banks stopped buying new government debt, pushing the prices down and the yields up. In some cases very high — Greek and Spanish bonds topped 30%, effectively closing off financial markets to those governments.

Rather than blaming the PIIGS champing at the bit to print money for cash-for-votes, Soros blames — wait for it — Germany. Why Germany? Because hard-money German bankers are the only thing standing in the way of re-starting that great central bank money-machine. The one that drains savers for voter hand-outs. The Germans won’t turn the ECB into a vote-buying machine, because they know who’s buying the votes — non-German politicians — and they know who’s paying for it — German households.

So where Europe stands today is that the neighbors have maxed out their credit card, now they want to borrow yours. And you’re the bad guy for saying no. I assume Soros doesn’t lend his credit card to bankrupt drunks, so I’m not sure why he tells Germany to force that on hard-working and prudent households. Germany is right to stand firm, and critics like Soros might pause to ask why vote-buying is such a sacred act that it justifies impoverishing the innocent.

For investors, the main thing to watch here is the velvet boxing match between the hard-money crowd and the reckless spendthrifts. You can sort who’s who by simply looking up their credit ratings — the green ones are prudent, the rest are not. So it’s basically Germany plus the Nordics versus the rest of the EU.

The biggest risk is the left gaining power in Germany. Mindful of the voters, the German left has been so far non-committal. But it’s hard to imagine they’ll have the backbone to stand up to the vote-buyers, when the left’s entire project is vote-buying to begin with.

In theory the opposite could occur — a right-wing shift in the southern countries that pushes France or Italy into the German hard-money position. I wouldn’t put too much faith in this, since the European right is generally to the left of Barack Obama. Still, it could happen if, say, anti-immigration sentiment brings in a more muscular right and brings hard-money in for the ride. Still, I’d put small odds on this kind of move, since even conservatives in Europe don’t have much backbone for shutting off the money spigot.

My best guess going forward is the Germans get worn down, as the hordes of vote-buyers cut deals and pick off the hard-money Germans. The trend in Europe is towards looser money, and Germany is fighting a rear-guard action. This suggests a weaker Euro medium-term, and of course lower economic performance with occasional “tissue fires” of boom-bust from cheap money.