The EMU shambles made simple......

Quote of the week.

"Fitch has concluded that a 'comprehensive solution' to the eurozone crisis is technically and politically beyond reach."

At dinner the other night, my friend Martin (a financial journalist whom I have known for over 50 years) and I launched into a debate as to whether the EMU crisis was a supply-side problem or demand-side. He maintained that it was only the first, with people and governments borrowing too much money to support an unsustainable lifestyle.

My contention is that it is both. It is, of course, beyond peradventure that the Greeks and Irish got in the poo by over-borrowing money that was far too cheap for their own good – the ‘one size fits all’ fallacy.

At the same time Germany suppressed wages and costs by threatening to import cheap labour from Hungary etc. It then stuffed away huge sums into non-productive investments like US sub-primes and Greek bonds.

This suppressed demand because German companies were making huge profits but it was not being shared with the workers to spend on goods and services and thus create consumer demand.

My analogy is that if all in our neighbourhood earned big bucks but stuffed it in the bank the only poor person would be the shopkeeper because we weren’t buying his stuff.

However, the shopkeeper wants our lifestyle, the bank is full of our money that it needs to lend so offers our shopkeeper huge cheap loans which he grabs without any immediate prospect of it being repaid, hoping, like Mr Micawber, that something will turn up.

The day for redemption arrives, shopkeeper can’t pay, and bank can only repay half our deposits. The bank turns to the government to bail it out, so they issue blanket guarantees underpinned with borrowed money. Nemesis arrives when they can’t repay either.

Result: misery!

So what really caused it?

Speculation by Anglosphere speculators, as the French, in one of their many flights of fantasy maintain? Do me a favour!

The Club Med funding a sybaritic lifestyle with other people’s money? Partly.

Irresponsible banks? In the good old days, building societies were owned by their depositors, and lent their money to other members as mortgages on very conservative terms – a 10% deposit at least on one salary only. Then they decided to demutualise and become proper banks. They employed CEOs who often had no experience in financial services but who saw the chance to get up there with the big boys (especially their bonuses).

So they threw caution to the winds. They began funding their lending by borrowing from other banks. They gave 125% mortgages so that they and the borrower were in negative equity from the start.

They assumed that the good times would never end and happily gave remortgages so that their borrowers could also have the good life,  breaking the basic rule they you do not use capital to fund consumer spending (that’s what broke the City of New York all those years ago, built people have short memories).

Then the wheels came off. The sub-prime (i.e. can’t pay won’t pay) mortgage funds went tits-up and the market panicked. The US government came to the rescue but let Lehman Brothers fail, executed by Hank Paulson as Treasury Secretary who came from Golden Sacks, Lehman’s biggest rival.

The banks stopped relending so we had the credit crunch. Northern Rock and others suddenly found that they couldn’t meet their repayment dates.

The ‘one size fits all’ EMUS shambles? You better believe it.

German excess savings sucking the European market dry? You betcha!

But the root cause has so far not been mentioned by our financial gurus.

The second most powerful human emotion.

Greed.