Breaking Up Is Hard To Do: TBTF, the Euro and Gold

Perhaps this is one reason why Gold has not reacted in recently "normal" fashion to Greek crisis inspired Euro weakness. Perhaps, the new thinking may go: Monetary Union's loss (in its many forms) is Gold's gain. If the drive to a monolithic world currency has stalled and currency competition comes back into vogue, Gold's track record is tough to beat.

Recent news about Greece's financial travails reminded me of a conversation I had with Helmut Schlesinger as the Asian Crisis was unfolding in 1997. Over a few drinks at the Long Bar in Singapore's Raffles Hotel, Mr. Schlesinger regaled me with his views on inflation, monetary integration and "realignments" (devaluations).  I don't know whether it was the drinks, the ambiance of the historic Long Bar, or the impending realignment of Asian currencies to the US$, but Mr. Schlesinger was in a mood to talk, and I, to listen.

As President of the Bundesbank from 1991-93 Mr. Schlesinger had a wealth of experience on monetary integration (with East Germany), realignment within the ERM (European Exchange Rate Mechanism), and disintegration (as Britain left the ERM). On the side of the "economists" in the debates over EMU, he argued, presciently, as the Greek situation demonstrates, that the "monetarists'" view- monetary integration prior to complete political integration wouldn't be a problem- was not historically grounded. Nor was he sanguine about the German reunification of East with West- 13 years hence East Germany continues to lag the West.

For Mr. Schlesinger, "flexibility" was a key component of economic integration. Adjustments in the terms of trade between economic parts, he told me, would always be necessary. Thus integration which didn't maintain some potential for flexibility-which assumed the combined parts would always thereafter be a unified whole- risked disaster. Perhaps this explains, to some extent, his comments about potentially necessary ERM realignments in 1992 that acted as catalyst to the GBP (British Pound) and ITL (Italian Lira) devaluations, and withdrawal of the GBP from the ERM.

There seems to me a lesson to be learned from both the recent EU and TBTF problems on either side of the Atlantic- breaking up, in the sense of making necessary adjustments in the terms of trade (a phrase that usually refers to the relation between import and export prices between nations, but can more broadly refer to the agreed upon bases of exchanges (prices, credit access, etc.) between and amongst any and all economic units), is hard to do. Flexibility has been lost in the pursuit of economic monolithism (if you will).

Previously, situations like Greece, or the TBTF banks in the US, would have begged a period of disintegration and adjustment in the terms of trade, either via devaluation in the case of Greece, or disintegration (perhaps bankruptcy) of certain units of the TBTF banks, in the case of the US.

To wit, US financial sector reform, in my view, needs to, inter alia, restrict discount window borrowing privileges to commercial banking (i.e. adjust the terms of trade within finance), leaving derivatives and proprietary trading to stand or fall on their own merits.  This is virtually impossible within the current system of financial monolithism.

The cost of the new approach of economic monolithism, is increasing bailouts- dilution of the common currency- which distributes the losses system wide, and slows the necessary adjustments in the terms of trade.

It is not surprising to me that the Germans, where fears of a Weimar style inflation remain strong, are loathe to dilute the Euro to bail-out Greece. After Greece, who else will need a bail-out?

Perhaps what the EU needs is a divorce (perhaps temporary separation, might be more apt) clause- a means to make the necessary terms of trade adjustments. This, in a sense, is that US financial reform seeks- a procedure to disintegrate (temporarily, or permanently) the financial sector to make equally necessary terms of trade adjustments.

The issues noted above, Greece and the TBTF banks, combined with the broader issue of relations between sovereign states and the international whole suggest that the world has, for the time being at least, reached a point of diminishing returns on economic integration. We may need more currencies, and certainly greater economic flexibility between the parts than currently exists.

Perhaps this is one reason why Gold has not reacted in recently "normal" fashion to Greek crisis inspired Euro weakness. Perhaps, the new thinking may go: Monetary Union's loss (in its many forms) is Gold's gain. If the drive to a monolithic world currency has stalled and currency competition comes back into vogue, Gold's track record is tough to beat.