Forget Cyprus: Low Competitivness and High Unemployment Are the Real Drag

Lots of media space is given to the crisis in Cyprus. The real problem however, is the low competitiveness of Southern Europe. The chart below taken from the FT, displays the low unit labor costs of Germany against the rest of Europe.

Meditereanan countries used to devalue their currency once a while in order to regain competitiveness. After the joining the European Currency Union they no longer have this economic policy option. The result is rising labour costs, lower competitiveness and higher unemployment rates (see chart below):

Looking at the chart above, I do not see any solution of the Euro crisis any time soon!

The two factors weighing on markets

Financial markets have been determined by the "risk on or off" argument for 4 years. Fundamental market analysis does not count in this environment. Last year the meltdown in stock prices was caused by a deterioration of the Euro crisis and was saved in autumn by massive liquidity injection of the ECB (twice € 500bn). This summer we have even two potential areas of infection:

1. The situation in Greece might trigger contagion. Equity markets already have discounted a deterioration in Greece.
2. Some people think that Israel might attack Iran soon. Reuters published an article today. The article states, that Bibi is determined and the window of opportunity is closing fast. Furthermore, experts have problems to read the Israeli signals properly.

Since March, we have been in a situation of great uncertainty. And markets hate uncertainty. However,
should it be clear that those scenarios are false, markets will rally. Should one of the two worst case scenario come true, markets will dive. In the meantime they are volatile and under pressure.

UBS on Euro Break Up

Below I have included a research report by UBS about a Euro break up. Key points:

1. Under the current structure and with the current membership, the Euro does not
   work. Either the current structure will have to change, or the current membership
   will have to change.
2. Our base case with an overwhelming probability is that the Euro moves slowly
   (and painfully) towards some kind of fiscal integration. The risk case, of break-up,
   is considerably more costly and close to zero probability. Countries can not be
   expelled, but sovereign states could choose to secede. However, popular discussion
   of the break-up option considerably underestimates the consequences of such a
   move.
3. The cost of a country leaving the Euro is significant sovereign default, corporate default, collapse of the banking system and collapse of international trade.
4. The only way to hedge against a Euro break-up scenario is to own no Euro
   assets at all.

xrm45126

20 Sceptic Quotes of Leaders about the Euro

Usually you only hear leaders repeating the mantra that the Euro is safe. A ultra bearish blogger/website theeconomiccollapseblog.com has made the effort to collect quotes from leaders stating the opposite:

#1 Polish finance minister Jacek Rostowski: "European elites, including German elites, must decide if they want the euro to survive - even at a high price - or not. If not, we should prepare for a controlled dismantling of the currency zone."
#2 Stephane Deo, Paul Donovan, and Larry Hatheway of Swiss banking giant UBS: "Under the current structure and with the current membership, the euro does not work. Either the current structure will have to change, or the current membership will have to change."
#3 EU President Herman Van Rompuy: "The euro has never had the infrastructure that it requires."
#4 German President Christian Wulff: "I regard the huge buy-up of bonds of individual states by the ECB as legally and politically questionable. Article 123 of the Treaty on the EU’s workings prohibits the ECB from directly purchasing debt instruments, in order to safeguard the central bank’s independence"
#5 Deutsche Bank CEO Josef Ackerman: "It is an open secret that numerous European banks would not survive having to revalue sovereign debt held on the banking book at market levels."
#6 ECB President Jean-Claude Trichet: "We are experiencing very demanding times"
#7 International Monetary Fund Managing Director Christine Lagarde: "Developments this summer have indicated we are in a dangerous new phase"
#8 Prince Hermann Otto zu Solms-Hohensolms-Lich, the Bundestag's Deputy President: "We must consider whether it would not be better for the currency union and for Greece itself to go for debt restructuring and an exit from the euro"
#9 Alastair Newton, a strategist for Nomura Securities in London: "We believe that we are just about to enter a critical period for the eurozone and that the threat of some sort of break-up between now and year-end is greater than it has been at any time since the start of the crisis"
#10 Former German Chancellor Gerhard Schroeder: "The current crisis makes it relentlessly clear that we cannot have a common currency zone without a common fiscal, economic and social policy"
#11 Bank of England Governor Mervyn King: "Dealing with a banking crisis was difficult enough, but at least there were public-sector balance sheets on to which the problems could be moved. Once you move into sovereign debt, there is no answer; there's no backstop."
#12 George Soros: "We are on the verge of an economic collapse which starts, let's say, in Greece. The financial system remains extremely vulnerable."
#13 German Chancellor Angela Merkel: "The current crisis facing the euro is the biggest test Europe has faced for decades, even since the Treaty of Rome was signed in 1957."
#14 Stephane Deo, Paul Donovan, and Larry Hatheway of Swiss banking giant UBS: "Member states would be economically better off if they had never joined. European monetary union was generally mis-sold to the population of the Europe."
#15 Professor Giacomo Vaciago of Milan's Catholic University: "It's clear that the euro has virtually failed over the last ten years, even if you are not supposed to say that."
#16 EU President Herman Van Rompuy: "We’re in a survival crisis. We all have to work together in order to survive with the euro zone, because if we don’t survive with the euro zone we will not survive with the European Union."
#17 German Chancellor Angela Merkel: "If the euro fails, then Europe fails."
#18 Deutsche Bank CEO Josef Ackerman: "All this reminds one of the autumn of 2008"
#19 International Monetary Fund Managing Director Christine Lagarde: "There has been a clear crisis of confidence that has seriously aggravated the situation. Measures need to be taken to ensure that this vicious circle is broken"
#20 German Chancellor Angela Merkel: "The Euro is in danger ... If we don't deal with this danger, then the consequences for us in Europe are incalculable."
Most of the individuals quoted above desperately want to save the Euro.  They are not going to go down without a fight.  The overwhelming consensus among the political and financial elite in Europe is that increased European integration in Europe is the answer.
For example, EU President Herman Van Rompuy is very clear about what he believes the final result of this crisis will be....