Euro: Requiem or Renewal?
David R. Kotok
March 30, 2013



In the last several weeks, a sequence of events involving Cyprus has triggered serious questions about the sustainability of the European Monetary Union (EMU). The events surrounding the finance ministers’ decision to levy taxes (i.e., partially confiscate deposits) on depositors in a Euro-system bank led to a sequence of blunders that have been well-recited in the press. There is no need to repeat the details here.

For readers who missed it, I do want to add this link to the personal observation of Edward Scicluna, finance minister of Malta, who was appointed by his country’s prime minister on March 13. His first action was to participate in the notorious Eurogroup meeting on Cyprus. See: . Source: , March 19.

In the Cyprus affair, we observe a defeat of the concept behind the Eurozone and the original European Union. It took half a century to create the European Union after WWII. The driving force was what the French call a “rapprochement” between formerly antagonistic parties. To put it simply, the Germans and French decided to stop killing each other after a thousand years of war. An economic union seemed the right way to go about attaining peace and prosperity. After centuries of destructive inflation outcomes, they realized credible money was absolutely necessary for this peaceful outcome to succeed.

That process led to the Maastricht Treaty (1992), the official adoption of the euro (1995), the final exchange-rate setting of the euro (1998), and the actual launch of the euro on January 1, 1999.

Eleven countries of the original fifteen in the newly formed European Union agreed to adopt the euro. The currency existed only in virtual form for the first three years and then enjoyed a nearly flawless transition to the physical version, which was immediately accepted. The results were stellar. Interest rates converged down to very low levels. Efficiencies resulted, because currency-exchange costs within the Eurozone were completely eliminated. More transparency in pricing and increased trade among the members of the Eurozone added to their economic growth rates. It was a high time for the euro.

In its first years the European Central Bank (ECB) was led by a Dutch central banker, Willem (Wim) Duisenberg, as president, and a French central banker, Christian Noyer, as vice president. The initial governing council of the ECB had a single purpose in mind, and they never violated it. They knew from history that they could not allow the new currency to be destroyed or inflated. They understood that it had to be hard and credible. They set about implementing that policy, regardless of short-term costs. The euro emerged in the early part of the first decade of the millennium as one of the strongest, most widely used, and most dependable currencies in the world.

Subsequently, there was a series of expansions of the Eurozone, which now comprises 17 nations. There also followed a softening of credit-quality restrictions and an easing of collateral rules. There has been apparent succumbing to political pressures. The Eurozone is not the same place it was when Duisenberg and Noyer led the ECB.

Fourteen years after the euro’s launch, we have the perception of currency weakness, coupled with an ongoing banking-system shock. This January, another Dutch central banker, Jeroen Dijsselbloem, became Chairman of the group of eurozone Finance Ministers. In the space of a few months he has undone all the good work started by his predecessor, Wim Duisenberg.

Dijesselbloem has a history. He nationalized a failed bank and insurance group, SNS Reaal, in February. There he wiped out the bondholders and shareholders. We have no arguments with that from our side. But when Dijesselbloem attacked the insured depositors in a Euro-system bank, he went too far.

“Taxing depositors is no different from outright confiscation of individual wealth. This type of action would not surprise anyone under a communist regime, but it is truly troubling in a supposedly free-market capitalist and lawful society.” Well said by Chen Zhao, Managing Editor, BCA Research. Readers please note that “of the 147 banking crises since 1970 tracked by the IMF, none inflicted losses on all depositors, irrespective of the amounts they held and the banks they were with.” The Economist (March 23) concluded that “depositors in weak banks in weak countries have every reason to worry about sudden raids on their savings.”

We agree. We advise clients to take no risk with their bank deposits to the extent they can avoid them.

So, what will the leadership of the Eurozone do now?

Is the euro dying? If that is the case, a requiem may be in order, as we watch it suffer a protracted, agonizing death. We could be seeing the early death throes in Greece and now in Cyprus, and we may soon see them elsewhere (perhaps in Slovenia, Malta, Spain, Italy, or other Eurozone nations). Each in turn may succumb to metastatic euro-failure disease.

Or is there a possibility of euro renewal? Could the Cyprus crisis and bank depositor confiscation policy act as a catalyst for change? The Cyprus events come on the heels of the Greek sovereign-debt default. Clearly that was not enough to trigger a change. Will the finance ministers of the Eurozone finally realize that they cannot continue to do what they have done in the past? Will they be cognizant of Einstein’s guidance that insanity is doing the same thing over and over again and expecting a different outcome?

Is Europe sufficiently shocked to quickly adopt Eurozone-wide banking standards and impose them? Will they include penalties and losses where necessary? Can they achieve a system-wide deposit insurance structure along the lines of the Federal Deposit Insurance Corporation (FDIC)? Is it possible to develop a process by which the ECB’s authority in regulation and supervision can function and a credible zone-wide banking system be implemented? Will the ECB reinstate collateral standards and adhere to them? Emergency Liquidity Assistance (ELA) is a proper vehicle only for the resolution of short-term problems. It led to Greece’s downfall, because it allowed the substitution of unsuitable for suitable collateral. It thereby fed money to deteriorating credits.

These and a hundred other issues have become urgent. Therefore, they require actions that will produce results acceptable to markets, investors, bankers, observers, academics, and journalists, all of whom are monitoring these events intensely.

And the actions must be believed and accepted by the general populace and the active business person. This sentiment issue has become critical. My sense from recent travel in Europe and the Emirates is that the general European population has given up on its leaders. Europeans feel powerless.

My sense also sees a Europe looking for believable answers. If positive action happens quickly, the euro can experience renewal. But it must happen quickly.

A bungled effort by the Eurozone finance ministers has resulted in a catastrophe of larger, uninsured deposit failure, threatened breach of smaller deposit insurance, and, now, capital controls. Capital controls are a desperate act and represent failed governance. They are the last twitch of a dying animal. Cyprus now has them.

Cyprus will suffer through an economic depression as it joins Greece and others in a downward spiral. Nothing good can come out of the recent events if the finance ministers remain in “business as usual” mode. Political statements in the Eurozone are falling on disbelieving ears. When an official says that everything is safe, he prompts additional runs on his banks. When someone says his government can honor its obligations, no one believes him. At this point, political silence is more credible than affirmative statements.

We have traveled the last two weeks in Europe and the Persian Gulf. Our discussions occurred in the midst of the Cyprus and Euro-system crises. We have held those conversations with professionals from as far north as Finland and as far south as Abu Dhabi. We have witnessed and discussed transfers in the billions. We viewed the manner in which they are occurring. We watched the surreptitious bleeding of balances from troubled banks, and we read the reports of individuals, businesses, and other agents performing an end run around the Eurozone finance ministers.

Euro sickness is coming to a head. Capital controls are the death of a country, currency, and economy. They create depressions. They are not temporary in the true meaning of a short-term action. Iceland still has capital controls five years after its banking shock. Nearly all countries in Europe are suffering a spiraling down of their financial structures. The 17-member Eurozone’s overall growth rate in 2013 will be near zero. The 27-member European Union will not be much better.

Europe’s leaders face a fundamental question regarding the euro. Do they want a requiem, in which case all they have to do is keep doing what they are doing, or do they want a renewal, in which case behavior must change credibly, immediately and decisively?

We are going to find out soon enough. Markets will force the requiem if political forces do not deliver the renewal.

For investors, this has become an easy decision. You can either bet on the renewal, which we are not ready to do, or you can bet on the requiem, which means capital moves out of the Eurozone.

We are underweight in Europe for very good reason. We are emphasizing investment strategies that seek some safety and resilience in a very dangerous, event-driven world.

We’re back in Sarasota. It is supposed to be 75 today, sunny and clear skies. It is Easter weekend and Passover. It is a time for celebration of freedom and resurrection. Both are needed for renewal.


Have a good weekend.


David R. Kotok, Chairman and Chief Investment Officer, Cumberland Advisors

Category: Currency, Think Tank

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

5 Responses to “Euro: Requiem or Renewal?”

  1. Herman Frank says:

    Yes and No. A nice historic overview, but it should have been put against the background of (at the time-) worldwide economic growth.

    In the mean time we see the US digging itself out from its economic hole, whether it’s enough to really come out of the hole we’ll see in another 10 years. Economic inequality has never been greater, the political parties never been more divided, the President going into the last 3-years stretch, the debt position is under control as long as interest rates are kept (artificially-) low and the alternative currency is not yet declared. Did I mention a race to the bottom to cheapen currency exchange rates to promote exports (Japan, USA, China)?

    So, next up is “a tax-paradise where the time of reckoning has come for its bloated banking system”. Plenty of warning, plenty of pre-advise, plenty of concern. Neither BoCyprus nor Laiki B made it through the ECB stress test. Money should have been shifted already. However, tax payers on the hook in Ireland, Spain, Italy, Greece … so why not Cyprus? Well, in the mean time that same tax payer is having enough of it! The politicians laid their ear to the wind, and it said “not again!”. Are they used to playing “the stern man-with-spine”? Hell no, “they’re politicians!” So they came out with a wobbly yes, no, yes, but! Agree, a PR nightmare!

    That said, the message is loud and clear. “Tax-payers are going to be the last to suffer for the sins of the bankers!”. (Straight from a populist re-election campaign!) The same politicians could hardly say “Listen up! Those guarantees we talked about?! We don’t have the money to back them up! Sorry!”

    More threatening than some hot money running across continents is a worrisome trend towards nationalism and isolationism. That is the major threat facing the EU! The electorate does not want the innocent to pay for the guilty anymore (read this blog and you come away with the same US feeling!) Through September all EU countries are on heightened alert for the “no more Mr. Nice-Guy” approach. Gov’r Draghi will be able to keep interest rates low, however, will not allow (or himself BE allowed) to support countries who come back to the till for a free meal. That way the politicians will have a message of strength to the frustrated masses. Mrs. Merkel (the pay-master) needs a balanced message of strength to be re-elected. (This is all uncharted economic water, so why the loathsome comparisons to WW-2 events – when it is THEM paying – is only despicable.)

    Coming back on the “yes-no”. Very bad PR events, 17 nations still having to come to grips with being on the same team, memories of grandeur, realities of hardship, a continent which has played “forgive and forget” a couple of times too often. True!
    The major challenge will be to present to the electorate the “good” of the union. A tool for this will be the reminder to “the paying electorate” that societies will need to grow up fast, responsibilities will need to be taken. The pay-masters will force discipline, Brussels will continue to have plenty of money to support economic development, countries will learn to stand on their own legs and walk again. (Latest news “Cyprus wants to set up a casino-industry!”).

    So, “no”, this is not the year of the demise, but the year of awakening for the EU. They are still production and (inter-EU) export oriented. The fact that the Euro went down was a blessing in disguise! After Mrs. Merkel’s re-election the EU-wide savings-deposit guarantee will be brought down to the former level of Euro 40-50K, which will be more sustainable. The forced discipline and market reforms in the deficit countries will bring about (painful-) changes, but the system will become sustainable. Even the surplus countries will need to change, because they’re on the hook for all their guarantees. A sobering development, but at the same time an exercise necessary to come to a more cohesive total. It’ll happen, the alternative is a multitude of isolated nationalistic poor houses. And every screaming, yelling, protesting member of the electorate knows this.

    (PS. all the development in China will only get them from -0- to -1-, then you still have a centrally guided economy without inherent sustainability! The demise of the infrastructure in the US will wreck havoc on the potential for development, the political & economic house divided cannot get its act together – not even when all the rest of the world deposits its money there to play with! Russia is looking at the clamp-down under Putin, a negative spiral continues. Africa remains the promise it has always been, “a promise”.)

  2. stonedwino says:

    Sobering analysis from David. “Last throes” for the Euro?

    My lifelong dream-come-true would be to go fly-fishing (my biggest passion, alongside my wine business) with David & crew Maine. I’ve heard the fly-fishing is amazing and cannot imagine how incredibly enlightening the conversation is with such a group…one can dream…

  3. Angryman1 says:

    Wrong Frank. Interest rates have little to do with debt. Pure mumble.

    • Herman Frank says:

      Dear Angryman1,

      Thank you for your interest in my thoughts and observations! In the subject paragraph you refer to I sketched the background to the present fragile growth scenario of the USA (we must have faith that it holds and continues!).

      At the same time, I thought to make the specific risk point because it is my (rather accounting-) view that the present low interest rates which the Fed has orchestrated (to stimulate jobs growth and keep the economy falling into a deep recession) has helped make the present debt position of the USA a manageable quantity. The present combination of GDP and debt servicing capacity of the USA are no problem.

      However, when the Fed gets out of the market this becomes an entirely different market game, as present federal tax receipts are not enough to permit even a 2% increase in debt-servicing costs (do 16 trillion x 2%/yr). Here I take the +2% as an example as that coincides with the accepted level of inflation – any further increase would make the budget negotiations on the Sandy disaster relief look like child’s play.

      As such, I respectfully disagree with you on your observation that interest rates and debt have little to do with each other. In a fluid market without intervention they are very much aligned.

      That said, we are indeed very fortunate to have present debt levels with the present artificially lowered interest rates! The phenomenon of the managed interest rate curve has spawned a new economic term, “financial repression”. I can recommend the article GMO wrote about it: “Capital preservation during financial repression”. The article provides examples of some countries managing the curve for as long as 30 years! As Mr. Bill Gross said “Low returns are the new normal”. The curve will have to be managed for the USA to climb out of the recession hole.

  4. CitizenWhy says:

    Muddle through. No revolution. No reform. lay by play, no grand game strategy, just pressures to do this, do that, avoid this, avoid that. Like many of u who are financially pressed. Artful dodging. And Europe will mange to go on this way.

    Europe currently has midget politicians as far as vision is concerned. The Germans have a good folk vision – keep costs (including labor costs and health costs) down, product quality up – export, export, export. Their self-image is primarily that of producers, not consumers. The south does not share this vision. The south’s only vision, combined with honesty, comes from the worker owned cooperatives. Perhaps they will spread. But finance capitalism will not tolerate such a development.

    Will Europe at some point produce a “big man or “big woman”? A visionary? Probably not. But the southern countries might produce a Juan Peron. Their socialist parties are corrupt enough to produce such a figure.

    Certainly a huge economy without economic growth is bizarre. Isn’t that what brought don the USSR?