During the spring of 1724 in the small city of Königsberg, a boy by the name of Immanuel Kant was born. Kant, an academic prodigy, endured a ‘strict, punitive and disciplinary’ (Wikipedia) education that would form the basis for his Critique of Pure Reason. Kant’s most famous work focussed upon the idea of the Categorical Imperative; the duty that a human must fulfil a certain number of obligatory actions or mannerisms that should become universal laws of society. Or as Kant put it, “Act only according to the maxim whereby you can, at the same time, will that it should become universal law”.
This ideology is clearly identified in a scenario dubbed “The Inquiring Murderer”. In summary, the scenario is the following:
If one is hiding an innocent person in his or her house, and a known murderer knocks on the door asking if the innocent person is hiding inside, would it be morally correct to tell the truth at the risk of the innocent person's death, or to lie to the murderer in an attempt to save the innocent person's life?
Kant would argue that telling the truth is a Categorical Imperative and as a result should trump all other moral or ideological reasoning. Stay with me here, there is a key point to come.
Kant’s work, although academically disputed, has had a profound impact on the way that Government’s construct ongoing legislation to encourage the “correct” civil virtues in their populations. There is no greater proponent of these beliefs than Germany whose relentless pursuit of human dignity has resulted in enacted constitutional legislation to drive its inhabitants towards a higher regard for human dignity. So much so, that in the wake of the 9/11 it was ruled that a strategic destruction of a hijacked aircraft would be unconstitutional with regards to the human dignity of both the captives and the hijackers in there own right. Economically, this entrenched belief of human dignity has developed into somewhat of a Categorical Imperative towards rescuing the financially bankrupt countries or soon to be bankrupt countries of the Eurozone.
Fast-forward to 2011 and lets evaluate economic fundamentals that exist today within Europe. Of the 17 member states that adopted the Euro, we know that roughly 6 of them are broke (Portugal, Ireland, Italy, Spain, Greece and Cyprus); a list that seems to grow by the day as the Euro politicians shake off last nights hang over and finally get a grip with reality. Now some of you may be wondering, hasn’t Germany single handedly rescued these countries and made Angela Merkel somewhat of a god like figure in these states…Not exactly. Germany’s resilience to letting it’s Euro brothers and sisters fall by the wayside seems to have formed somewhat of a Categorical Imperative in itself.
If we are to look at the 2008 crisis in detail, the fundamental issues lie between issues of policy, greed and pursuit of profit by individuals and firms alike. This "private sector" contraction, although difficult to swallow, resulted in economic calamity that was in many ways a far better situation than we are in now. For now, it is the governments that are broke and have fallen victim to the endless pursuit of political success and the idea of a relative improvement in quality of life. This rose tinted ideology is the overarching umbrella that sits above the private sector in both an authoritarian and protectionist manner. The reality is that this umbrella has shrunk to such an extent that the private sector sitting beneath it is going to get wet. In some cases, for instance Greece, their umbrella is now so small that countries with a larger protection from the impending storm are lending a place of refuge. The justification for such practices to prevent contagion will eventually lead to the polar opposite outcome.
Without Germany, the Eurozone would already be a failed experiment and now it seems determined to drag itself down with the pack. In an interview on Bloomberg (9th August), one European politician was quoted in saying "we must chose between more Europe or less Europe. We will choose more Europe". Now this opinion is somewhat sensible for the likes of Greece who seem to have found themselves with an endless piggy bank called Germany but for the rest of the states one must question what exactly are these people smoking. The austerity measures entered into by a vast quantity of these nations are dependant on fixed price imports, improved exports and tourism. If you were to break down what would happen in an economic contraction, one must only conclude that the situation is going to be made an exponential amount worse with the inverse predictions happening.
Last week’s plan by the ECB to purchase members states bonds on both the primary and secondary markets should send alarm bells ringing. The reality is that Germany is using it’s own economy and low lending rates to fund the whole Eurozone area whilst increasing it’s exposure to 133% of GDP (Zerohedge). This is only going to end badly.
If we take a step back for a minute and consider a similar situation that occurs with aid in African nations we know this is the wrong thing to do. The effectiveness of financial relief is solely dependant on the social response of the people that are affected. Don’t get me wrong; aid in Africa is the right thing to do, however far more progress has been made through teaching the society better agricultural techniques and encouraging the practice of safe sex than has ever been made financially. Germany is making exactly the same mistake, the relaxed liberal European way of life needs a fundamental slap in the face to awake these societies that believe tax evasion is a birthright and that retirement at 50 is just how it is.
No no no Mr Berlusconi, life isn’t quite so much of a party as you make it seem.
What the Euro MP’s seem to have missed is that these societal and policy values that will prevent any credulous rescue package from success. A point that George Soros has been clear to advocate in his recent article entitled Three Steps to Resolving the Eurozone Crisis
“Sadly, Germany has unsound ideas about macroeconomic policy, and it wants Europe to follow its example. But what works for Germany cannot work for the rest of Europe: no country can run a chronic trade surplus without others running deficits. Germany must agree to rules by which others can also abide.”
Instead, Mrs Merkel and Mr Sarkozy seem intent on wasting both time and valuable resources drafting new measures in an attempt to save the Euro from certain collapse. The one area of Soros’ article that this writer agrees to surrounds formulating a comprehensive exit mechanism from the Euro.
“In the absence of an orderly exit, the regime would have to carry sanctions from which there is no escape – something like a European finance ministry that has political as well as financial legitimacy. That could emerge only from a profound rethinking of the euro that is so badly needed (particularly in Germany).”
Although a departure from the Euro may cause economic redress for other Euro denominated countries, the long-term effect would be to reduce the toxicity of the Euro and facilitate the payment of outstanding debts (at a significantly depreciated level). Although difficult to swallow, this is singularly the best option for the likes of Greece who needs to regain control of their monetary policy in order to get their house in order. The process wouldn’t be pretty or please the financial community but in many ways this self-sacrifice would provide the all-important Human Dignity to the Greek population that they deserve.
Instead, the latest meeting between Merkel and Sarkozy pledged to harmonise corporate tax and potentially introduce further taxes to aid deficit reduction. However, stupid the idea of taxing a faltering economy may sound (especially penalizing your own banks) some common sense did prevail out of Tuesdays meeting. Firstly, Germany seems to have finally checked its bank statements and realized that it is losing money faster than a junkie in Tijuana; this realization led Mrs Merkel to announce that the ECB piggy bank would not be increased to the magnitude previously expected.
Secondly, they dismissed the idea of Eurobonds; in this writer’s opinion, the best decision ever made by Europe’s Punch and Judy. Eurobonds would have effectively bred contagion despite what Mr Soros may believe. A Eurobond is effectively a Collateralised Debt Obligation where Germany is the A game and Greece is the Z, but unlike 2008, the investor friendly A game will risk life a limb to protect Z….You can see where this is going.
At this point, one must ask why Germany would even be interested in a Eurobond?
Lets suppose, I am Warren Buffett and I go into the market to raise $1bn. The market says, Warren you’re a smart guy, we trust you so we will lend to you at 3%.
Now lets suppose, I am Warren Buffett’s family and I go into the market to raise $1bn. The market says, Warren is a smart guy but the rest of you…not so much; especially Uncle Charles who seems to be very overdrawn and the workers from his business are always striking. The best I can offer we can offer is 5%
With or without the intended puns, were we seriously expecting Germany to agree to this? They may have made some pretty stupid decisions but this really would have rocked the boat. So why did we expect it?
This deep-rooted answer comes back to the original point of the Categorical Imperative that Germany seems to have developed towards the rest of the Eurozone. The market is pricing in the idea that Germany will be there to stabalise the Eurozone area at least in the short term. But from what we have discussed, there are underlying concerns about the viability of this continuing. One must consider that Germany has already committed tens of billions of Euro’s towards helping it’s sick brothers with only a handful of overpriced to market rate bonds to show for it. So what happens next?
In the coming months, Germany is going to be forced into the situation where they must chose between the blue pill and the red pill knowing that whichever one they take, it is going to cost them an astonishing amount of money. Before we conclude, let’s talk through the two competing options.
Option 1 – Germany Continues to Bank Roll the Eurozone – Probability 70%
§ The market reacts positively in the short term but corrects once the fundamentals are evaluated
§ Germany increases it’s long term debt obligations during a contracting economy and finds itself with the mother of all overdrafts
§ Dream scenario (probability 1%) – Austerity measures prove effective within the PIIGS and Germany becomes the overwhelming power regarding all European matters
Option 2 – Germany Separates Itself from the Eurozone Debt Burden – Probability 30%
§ Markets contract but are reassured by long term viability of Germany’s economy.
§ Eurozone exit mechanism allows the contagious nations to leave the Euro in order to balance their books over the long term and reduce the toxicity of the Euro
§ Germany retains free trade environment but looses the long term viability of a singular monetary union
It is clear that whichever choice is made, Germany will experience a significant opportunity cost. Should Germany promote an Exit Mechanism, the fundamental framework surrounding the EU in it’s entirety would be on the line. Conversely, should Germany support the Euro, its deficits would slowly constrict its economy and eventually cause a Eurozone Meltdown. This option is further complicated by the lean and organized nature of the German economy that would significantly weaken the effects of austerity and restructuring when compared to the likes of Greece.
The conclusion is clear, whichever route Germany takes in this shaebacle there are going to be a lot of losers. However, the magnitude of loss will be in many ways dependent on Germany’s ability to act whilst time and the economy are on its side.