A sound currency is the fundamental basis for a productive economy.
DURING the past two months, global share markets have synchronised in lockstep, speculating on day-to-day developments of the European sovereign debt crisis.
Libor-Overnight Indexed Swap spreads, which measures the fear factor in the banking sector, are back at levels not seen since the collapse of Lehman Brothers.
While Australian banks have no exposure to Greece, they have been withdrawing billions in funds from Spain and reducing lending to France.
It is noteworthy that German engineering conglomerate Siemens has withdrawn more than €500 million from two major French banks, and moved those funds to the European Central Bank (ECB).
On September 6, the Swiss National Bank introduced a cap of 1.20 francs to the euro to combat deflationary threats and assist Switzerland’s exporters, while investors sought a refuge.
The world’s second-largest cement maker, Holcim, said the currency’s strength shaved 916 million francs off second quarter sales, reducing operating profit by 203 million francs.
Many analysts have already deemed Greece to be in ‘selective default’ after the EU’s second bailout in July, which involves private investors sharing part of the rescue cost through a debt swap.
After its lenders threatened to withhold further funds, Greece announced that it can sustain repayments until October.
German and French monetary authorities have begun devising a strategy to build a ‘firebreak’ around Greece, Portugal, and Ireland to help prevent the contagion spreading to Italy and Spain, countries considered too big to bail.
The blueprint is to be unveiled at the G20 summit in Cannes, France, on November 4.
The plan is set to involve recapitalising European banks and bolster the eurozone’s €440bn bailout scheme, the European Financial Stability Facility (EFSF).
This package would allow governments to substantially increase resources available to the EFSF without having to seek approval from national parliaments.
But breaking the Greek deadlock is seen as only postponing the problem until December, when another fiscal review is due.
While local investors continue to place faith in China, Australian markets are not far removed from the front-line, which includes the Greek crisis.
Funds are flowing back into US greenbacks, in the process making gold temporarily less attractive.
With copper trading at its lowest level for 2011, pressure is now on Australian mining shares and the Aussie dollar.
Bank funding costs for Australian home lending will come under renewed pressure, with about 40 per cent of funds sourced from global wholesale markets.
Margaret Thatcher’s 1993 autobiography The Downing Street Years carries some prophetic observations about the European single currency.
Her overriding objection was not political, but economic.
As early as 1990, Thatcher warned her euro-friendly chancellor of the exchequer, John Major, that a proposed single currency could not accommodate both industrial powerhouses like Germany and smaller nations such as Greece.
Two decades later it seems she was right.
While on the surface unified Europe appeared to be travelling well, the union’s poorer countries have wilfully and persistently failed to meet conditions they had agreed to under the so-called Convergence Agreements that define the single market.
In 1997, then British foreign secretary William Hague was criticised for claiming that adopting the euro would be like “being trapped in a burning building with no exits”.
Today the acrid smoke from that fire is billowing across world markets.
In other words the crisis Mrs Thatcher predicted has eventuated.
A fresh warning to watch for opportunists coming out of the woodwork has been issued by a senior diplomat based in Brussels.
“If they get their way, you would have a single government in Europe setting fiscal policy, macro-economic policy for all of the eurozone, with individual countries reduced to the status of regions,” the diplomat is reported as saying.
The outgoing head of the European Central Bank, Socialist Party member Jean-Claude Trichet of France, is calling for the creation of a position of a European finance minister.
Renowned hedge fund manager George Soros has warned of the possibility of the default and defection by Greece, Portugal, and perhaps Ireland from the eurozone.
Mr Soros believes the euro crisis reveals the need for a new treaty, transforming the EFSF into a fully-fledged common treasury.
And this embryonic European government is already taking shape.
Earlier this year, German Chancellor Angela Merkel and French President Nicolas Sarkozy agreed to hold twice-yearly summits between the 17 member euro countries.
Herman Van Rompuy, the current president of the European Council, would oversee these.
However, rather than permitting Greece to leave the European monetary union, other options are being considered.
Onetime financial markets adviser to president George W Bush, Philippa Malmgren, who now heads Principalis Asset Management, has warned that strong economies like Germany may opt to leave the euro.
Germany is seen to be in the best position to take advantage of a euro break-up with a new German Deutschemark being appealing.
Mr Trichet was unwilling to answer questions posed to him regarding the possibility of Germany returning to the Deutschemark, instead defending Germany’s membership of the ECB by claiming it had experienced more favourable price stability since joining than it had under its Bundesbank.
However, the problem that continues to confront the European monetary authorities is that all these bridging rescue packages remain sinkhole loans.
If the proposed package collapses, all possibilities could be back on the table.
Sometimes a return to the past offers a solution to current problems.
In 1948, the German minister of economics, the legendary Ludwig Erhard, replaced the failed Reichsmark with a new Deutschmark.
Erhard fully realised that a sound currency was the fundamental basis for a productive economy.
He clearly understood that accommodating monetary policy doesn’t create wealth, but prolongs instability.
But he did not stop there.
His goal was to replace a bureaucratic culture with an entrepreneurial one, thereby giving people an incentive to work by scrapping all income tax on work undertaken after the first 40 hours.
Exporters paid lower taxes on profits and the German top tax rate fell from 80 per cent in 1948 to 55 per cent in just two years.
Productive industries received tax deductions for capital investment and high depreciation allowances were introduced.
The lesson of those immediate post-war years is clear. Failure to return to sound monetary policy could have a profound, long-term effect across the world.
• Steve Blizard is a senior securities advisor at Roxburgh Securities
