The austerity debate lingers on across Europe. As the pain increases the debates become louder. The austerian position that most of Europe has implemented sounds like a reasonable idea in theory, but is extremely tough or impossible to implement successfully within the currency union in which they are operating (which we discussed here). Germany’s economy has continued to be OK and thus they continue to see this as someone else’s problem and argue for the deficit countries on the periphery of Europe to adjust.
One of the ways the austerity theory is supposed to work is by causing lower wages in the weaker countries. But that only occurs with corresponding increases in unemployment and it makes it harder to pay down debt. Not surprisingly, this is now causing elections across many countries in Europe and the leadership in favor of austerity measures is being voted out. These leadership changes are a rejection of the austerity deals struck with the stronger countries who are saying that failure to follow the deal is not acceptable. This could potentially lead to some countries leaving the Euro currency union.
In a Euro breakup scenario, the countries that are left in the Euro union would see the Euro spike against the exiting countries’ new currencies making the remaining Euro countries’ exports more expensive and their economies less competitive around the world. Not to mention, the additional negatives of more massive defaults, more wage cuts, and the possibility of a “Lehman” like panic. This doesn’t seem like an outcome Germany should want.
Germany is in the driver’s seat and one of the central questions is whether they will allow inflation to rise in their own country, so that the weaker countries can become more competitive with less wage reductions thus easing the pain and making their debt burdens easier to support. Germany’s history of hyperinflation during the Weimer republic, still haunts them today and has prevented them from allowing more inflation up to this point. Ironically, the current situation is very similar to the problem that the gold standard created for Germany following World War 1 – they could not acquire enough gold back then, and today the weak Euro countries can’t acquire enough Euros as austerity measures feed a vicious cycle of falling incomes and rising unemployment.
But the winds are slowly changing and the wage increases for German workers that would come with a little inflation might be just enough to be politically acceptable and would result in more disposable income to spend on products imported from the weaker countries. If this is the course, there could be a successful stabilization over the long-term, and avoidance of a Euro breakup.
The ultimate outcome could take years or even decades to unwind. We do know that with much of Europe already in recession, investments there have become cheaper compared to the rest of the world and thus more likely to provide good returns over the long term. We are continuing to monitor the changes and how it will affect our investment strategies. We are maintaining our international allocations and if prices continue to fall we will use some of the funds from sales we made earlier in the year to rebalance our US/international positions accordingly.
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