"Kee" Points with Jim Kee, Ph.D.

It is important that Spain asked for and received a $100 billion bailout from the European Union for its banks (not government), and that sum is well in excess of the $40 billion the IMF estimated it needed. The sequence of the Spanish government going from "We don't need EU funds for our banks" to "We need funds" follows exactly the prior pattern set by, in order, Greece, Ireland, and Portugal. If I were to summarize the consensus on Europe, whether it be from financial press "economists" or from book authors like Johan van Overtveldt ("The End of the Euro"), it would be that the euro and the European Union project is destined to fail, and that officials are kicking the can down the road in what will ultimately result in the demise of the common currency and the European Union.

Does any intelligent person see a different outcome? Yes! I think the most interesting thing from last week was a Financial Post interview on the subject by Robert Mundell, the Nobel Laureate who championed the euro and spent sixty years making the case for common currencies and fixed exchange rates. Mundell is the true intellectual giant in this space. He advises governments in Europe and Asia (owns a castle in Italy) and has been the most prescient economist on major global events for 50 years. Since one of my goals with Kee Points is to report on things that I think clients should hear but usually don't from the mainstream press, I wanted to share Mundell's assertions with Kee Points readers:

On the euro: The euro has passed its youth with flying colors, is a world currency par excellence and has a great future as an international reserve asset. It is second only to the dollar. Indeed, it is challenging the dollar as a stable global unit of account. The euro is not the problem. The problem within the European Monetary Union is government deficits and the debts of a few countries mostly in Southern Europe. If California is on the verge of insolvency would that be a U.S. dollar problem or a debt-default problem for California? Many prominent American economists hated the idea of the euro (e.g. Paul Krugman) and predicted its collapse if it came into being. They now seem to be trying to validate their past predictions. But bygones are bygones and the euro - barring a political revolution in Europe - is here to stay. If the euro has been a problem for Europe, it is because the euro has been too strong, not too weak.

On what's to be done: The process of deficit adjustment has to continue, with austerity, structural reform and new investment strategies. Fire engines have to be ready to put out the financial fires that are engulfing Greece, Portugal, Spain, Cyprus, and Italy. Money has to come from the ECB, the European Financial Stability Facility, and the IMF, and they have to be linked to some transfer of fiscal authority from countries that have been insolvent to the European Commission acting under the auspices, for constitutional correctness, of the European Council.

On a greek exit: A currency union is an alliance - shedding a small member with more liabilities than assets can make the union stronger. Yes, Greece can’t devalue without its own currency. But Greece’s problem is not an overvalued currency. The problem is an excess of debt and budget deficits. Greek debts are now denominated in euros. If Greece created a new currency in order to devalue, its debts would still be in euros and devaluation would not change that fact. Of course, Greece could repudiate its debts in euros but if it were going to take that Draconian step it could do it without creating a new currency. Should Greece follow the path of Argentina? That would result in a horrendous drop in the standard of living and social benefits and, if that were politically possible, why not do it inside the euro?

On the future of the global monetary system: A great risk to recovery in the U.S. is a strong dollar and a great risk to fiscal insolvency in Europe is a strong euro. Actions to stabilize the dollar-euro rate (with the Fed supporting the euro when it went, say, below $1.25 and the ECB supporting the dollar when the euro went to $1.35), combined with monetary cooperation on targets between the Fed and the ECB would remove the instability of the dollar-euro exchange rate as a threat to global prosperity and would benefit the entire world economy.