Last week I was fairly optimistic about the Euro plan. I reasoned that while many complained that there was a sparseness of detail, nevertheless the details we did have were more than enough to go on-50 percent haircut on Greek debt and quadrupling the EFSF bailout fund.
However many economists who I respect and rely on for info like Krugman, DeLong, and Yglesias and even some of the Market Monetarists seemed to be much less high on the deal. But I didn't necessarily understand their objections and figured at the minimum it was a step in the right direction.
Then too, I figured that add this to the apparently improving U.S. growth story and maybe there is some light at the end of the tunnel. What has happened now though which makes me temper my optimism about Europe considerably is this piece here http://bilbo.economicoutlook.net/blog/?p=16685
It questions the deal on many levels that I am finally getting. Then too there's the fact that the equity markets have tanked the last few days. Still the fact is that if you want to assess a deal like this the proof is in the pudding, and that pudding is the market response, but the market in question is not the equities market-what do they know about it anyway?-but the bond markets. The day of the announcement last week the bond markets were not impressed but rather saw various spreads continue to widen.
Not only Greece, but Italy and France as well. The trouble largely seems to be that Europe has no effective central bank. This deal is supposed to restore confidence to the markets and the hope is that the Chinese are going to invest in Euro bonds. The question is why would the Chinese do this? U.S. Treasury debt is the number one safe haven in the world because it has the backing of "the full faith and credit of the U.S. Government." What do these Euro bonds have? The EFSF? What they need is to be able to say something like the "full faith and credit of the European Government." The reason why they can't say this is obvious-to try anything like this is a political minefield on so many levels let's not even get started.
While it seems good that the Greek debt is cut in half it doesn't exactly infuse confidence for future investors. Even besides that, the more austerity that is demanded the less attractive these economies become to invest in. A major part of the reason why the original July haircut number of 21 percent is now up 150 percent is the austerity keeps further depressing Greek growth. Europe however can't seem to shake the fear of inflation and high interest rates. There's this illusion that with Greek deficits, Weimar Republic style inflation is just around the corner. This after Japan had deficits for 20 years and the inflation genie never came out.
What we may be dealing with is the fact that maybe the Eurozone was structured poorly from the start, like a building that was mis-designed but which only becomes clear during a natural disaster. What we have is a bunch of countries that have deprived themselves the power to print their own money. The EFSF is supposed to make up for this. It may be that this is little more than a water pistol. A real solution for the Eurozone may be what is impossible politically-a higher degree of political intergration. But in the form it is in now we have a halfway house which is the worst of all worlds.