Wednesday, December 1, 2010

The Europe's Woes and the solution

It's stiking how much trouble they are in and how no one says what the obvious solution is and, instead, keeps wringing hands about how this is so very complicated.

There are three possible ways the mess gets resolved:

1. They keep doing what they're doing and Ireland, Greece, Portugal and quite possible Spain and Italy default on their debt, causing a worldwide banking crisis all over again that will be too big to salvage even for the Fed.

2. PIIGS exit the EMU and reinstate their national currencies, which massively devalue, while the reinstated Deutche mark massively appreciates causing no end of trouble for Germany (see here).
3. There is a temporary spike in inflation in the Eurozone - let's say 10% for three years or so, which wipes off the real value of everyone's debt burden and causes some amount of economic distress for the savers and bondholders, but not any kind of massive Depression-scale disaster. German inflation would be especially high given that they are closest to full employment, and the result would be that Germany would be less export competetive vs other EU countries (same result as would happen under deflation in those other countries).

You can see that option 3 is clearly preferrable, from the point of view of economic turmoil and the amount of human suffering. And there are of course ways to achieve it, such as the helicopter drops of Euros that Bernanke wrote about but never got around to actually doing. And you can see why it's the solution that will never be chosen: in it, Germany suffers worse than anyone else, while in Option 1 everyone else suffers more than Germany.