FX MONETARY POLICies
option. But in Northern Europe the circumstances are reversed. Northern European economies are creditors and very high- value-added, sporting massive industrial bases, highly educated work forces and excellent educational systems. Northern Europe is not high in debt; it is high in credits and high in assets. And those assets are the key to Northern European income streams and Northern European political power within the EU. Monetization would directly endanger all of it. The Germans are particularly ner vous about this aspect of monetization. Monetizing Southern European debt would also have no clear chance
for improving the
European financial crisis. Monetization eliminates pressure upon states to reform. Case in point: the European Central Bank started buying Italian debt back in August. Italy abandoned their austerity plans in August. Unless watertight restrictions on state spending are in place before monetization begins, there is no reason for fiscal conser vatism. And if those constraints are already in place, there’s no reason for monetization.
A clash between political and monetary authorities has already happened in the past, right on German ground. In
1990 monetar y union
in Germany as part of the reunification process required
40 FX TRADER MAGAZINE January - March 2012
a conversion rate between the Deutschmark and the Mark, the currencies of West and East Germany respectively. During
the monetar y union,
preparation i.e.
for from
February to May 1990, a serious conflict arose between the West German government and the Bundesbank, mainly on the appropriate conversion rate. Whilst the West German government was in favor of a conversion rate based on social and political considerations, the Bundesbank drew attention to the potential for inflationar y consequences of such a solution and advocated a conversion rate based on economic criteria. In that occasion the government prevailed. Even the resignation of Bundesbank governor Pöhl in early 1991 may be seen to have been a consequence of this (if you want to go deeper in
the stor y : http://eprints.
lse.ac.uk/22355/1/wp74.pdf ). This time, by the way, German politics and core-ECB thinking seem much more on the same page. Anyway, despite al l disadvantages, may well be
emerging
monetization as
the
only tool that can preser ve the euro, albeit in an increasingly distorted form. If Europe’s other tools fail, Northern Europe is going to be faced with a stark and painful choice: monetize and suffer the consequences, or let the euro fail and suffer the consequences.
A TAIL RISK SCENARIO: PARTIAL OR TOTAL EURO BREAK-UP. Based on a Nomura study
Developments over the past few weeks have highlighted that some form of eurozone break up is, if not a central case, a possibility investors should plan for. Specifically two different events have highlighted the two main categories of potential structural change, which may occur to the Euro in its current form.
• The proposed Greek referendum on the bailout package and eurozone membership, despite being abandoned in less than three days, has shown the increasing risk of some limited form of eurozone break-up, where one specific or a few smaller eurozone countries exit, and the remaining eurozone countries stay put and continue to use the Euro.
• The severe instability in the Italian bond market over the recent period is a different development pointing to an increasing risk of a more dramatic break-up scenario, involving an Italian default and a potential break-down of the entire monetary union. In this more dramatic scenario, the Euro would eventually cease to exist and the ECB would be dissolved.
Nomura is the first bank to have seriously delved into such possibilities, in two directions: the legal aspects
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