Things Just Got a Lot More Complicated in Europe

United they stand, divided they ____?

It's tough to say whether the eurozone as a whole is headed into recession, but I can't figure that the mixed results in the elections this weekend helped that cause. I've postulated before that prolonged recessions seem inevitable in Greece and Spain, and austerity measures designed to curb rapidly rising debt levels in France and Germany are likely to curb any economic strength. In short, the possibility of a Euro-recession is a real possibility.

The secret to survival over the next few months, until we get a better understanding of how these new governments will cooperate with one another, is to focus on strong cash flow businesses that tend to perform well even in stagnant times. This means telecom and health-care companies just might be your best shot at betting on a European recovery.

http://www.fool.com/investing/general/2012/05/07/things-just-got-a-lot-more-complicated-in-europe.aspx 

What does this mean for your money?

With many investors trading more on emotion than actual earnings results, it's likely we can expect more pressure on European-based businesses. The fallout in some companies can be, at least to some extent, justified as with large Spanish banks, Banco Santander (NYSE:STD  ) and Banco Bilbao Vizcaya Argentaria (NYSE: BBVA  ) . Both of these institutions are dealing with ridiculously high unemployment rates and commercial real estate portfolios littered with potential problem loans.

But we're also likely to see pressure on companies that won't be directly affected by austerity. Two such companies that may get lumped into the "guilty by association crowd" are France Telecom (NYSE: FTE  ) and U.K.-based oil services company BP (NYSE: BP  ) .

France Telecom has been on a steady downtrend over concerns that its mobile business may suffer as Europeans cut back on discretionary spending. What investors are failing to take notice of is France Telecom's strong international growth in Sub-Saharan Africa and even in troubled Spain.

As for BP, weakness in the stock makes little sense because so many of its oil assets are diversified throughout the world. There may be some give and take as emotional oil traders react to the unpleasant news out of Europe, but that's hardly a game-changer for a company that's putting its Gulf of Mexico PR nightmare in the rearview mirror.

Banco Bilbao Vizcaya Argentaria (NYSE: BBVA  ) .

 France Telecom (NYSE: FTE  )

 BP (NYSE: BP  ) .

It is interesting to review this old article 

December 10, 2010:    What Happened to Banco Santander?

The European debt crisis explained: The debt levels around the globe are unprecedented in peacetime.

The European debt crisis explained: The debt levels around the globe are unprecedented in peacetime.

The odds of restructurings and/or defaults are higher than most believe. When does debt become unsustainable? The video shows the debt levels of numerous countries have reached "problem" levels. Since the bill coming due in the form of maturing bonds is so large, policymakers in Europe have no easy way out.

"Solutions" may include printing money to create inflation or debt restructurings/defaults; or a combination of the two. 

Chris Ciovacco of Ciovacco Capital Management compares healthy markets to the current state of affairs.
Which investments tend to perform well during deflation/defaults/restructurings?
Which investments tend to perform well during periods of inflation/money printing by central banks?
What is a back-door bazooka?

 A breakdown of the European debt situation, starting with Greece and consuming the entire continent.

Global Financial Crisis and World Collapse Explained

Global Financial Crisis explained in 96 seconds.



World Collapse Explained in 3 Minutes

Should investors stick with the winners of 2011?

Should investors stick with the winners of 2011?


The eurozone crisis has plunged many investors into a state of gloom. But some shares and funds have still made money this year. Are these the assets to hold on to, or should we look elsewhere in the new year?

Novak Djokovic won his first Wimbledon title this year - but does past success mean future returns for investors? Photo: EDDIE MULHOLLAND

By Rosie Murray-West

6:00AM GMT 12 Dec 2011

Comment

With the euro crisis posing as many questions as Jeremy Paxman in an episode of University Challenge, it is difficult to know what lessons can be drawn from the past year's performance of funds and shares.

Almost all the world's major stock markets are in negative territory this year. Despite this, some funds and individual shares have done exceptionally well over the past 12 months. Is their performance likely to continue, and how are the experts rebalancing their portfolios?

Figures from Morningstar show that almost all the best-performing funds of the year are corporate or government bond funds. These have benefited from investor panic, with prices rising as people sought safe havens.

Baillie Gifford's long-dated gilt fund rose by nearly 22pc in the period – beaten only by Legg Mason's Japan Equity Fund, which has been boosted by a faster-than-expected recovery following the Japanese earthquake. Index-linked gilt funds also did well out of rising inflation.

Are these funds the place to be for the next 12 months? John Chatfeild-Roberts, who runs the Merlin funds of funds for Jupiter, said not. His advice came with a caveat: "If you had asked me a year ago I would have said gilts were too expensive, and I would have been wrong. They are even more expensive now."

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He said that if you valued gilts and US Treasury bonds like shares they would look overpriced. "There's no long-term growth, and a price to earnings ratio of about 44."

Instead he urged investors to think carefully about the nature of risk when picking funds and stocks, given the situation in Europe. His Merlin funds hold a number of good performers from the past year, including star fund manager Neil Woodford's Invesco funds. Mr Woodford has seen his High Income fund gain around 11pc in a year. He holds cash-generating stocks including large pharmaceutical companies.

Mr Woodford said he was confident that by picking strong companies with sustainable earnings growth his portfolio would continue to thrive in 2012. "The increasingly tough economic outlook is not a surprise to me – I maintain my view that the developed world faces a prolonged period of low economic growth," he said.

"However, I also continue to believe that there are certain types of company that can thrive, delivering sustainable dividend and earnings growth in this environment."

Nick Raynor, an investment analyst at the Share Centre, is also banging the drum for defensive sectors. His research shows that the top performers this year come from sectors such as food, drinks and pharmaceuticals. "The majority of defensive sectors have held up well and are among the highest performers for the period," he said. "In 2012 we expect this to continue and the markets to remain unpredictable until the uncertainty with the eurozone is resolved."

The top-performing share for the year so far is Arm Holdings, which has risen by 46pc. The chip maker is doing well out of the fact that there is greater demand for mobile phones, and more advanced chips as phones get "smarter". Other top performers include Shire Pharmaceuticals, up by 43pc, which has made advances in market share and has been buoyed by takeover rumours.

Not everyone is confident that even defensive stocks are the answer. Douglas Chadwick of Saltydog Investor, a newsletter for those who control their own Isas and Sipps (self-invested personal pensions), said: "Wait for the market to confirm your opinions before trading. You've plenty of time to capitalise on a recovery."

His portfolio has risen by 7.2pc since its launch on November 23 2010. However, since last week, Saltydog has advised people to put 100pc of their money into cash.

But advisers agree that trying to time the market is an impossible task. Ted Scott, director of global strategy at F & C Investments, believes that those in cash may miss out on recovery.

"With each emergency summit proving to be more disappointing than the last, investors have lost faith in eurozone policymakers to provide a solution that will work," Mr Scott wrote in a research note under the heading "A great opportunity to buy equities will emerge".

"This has contributed to a collapse in investor sentiment with fear the overriding emotion in today's markets." But he added: "If a satisfactory solution for the debt crisis were to be found, the reversal in investor sentiment could contribute to a very strong and sustained rally." Equity fans can only hope that Mr Scott is right.

http://www.telegraph.co.uk/finance/personalfinance/investing/8946743/Should-investors-stick-with-the-winners-of-2011.html

S&P has no choice: Euroland risks bankruptcy on current policies

By Ambrose Evans-Pritchard Economics Last updated: December 6th, 2011

Standard & Poor's dropped a bombshell at the right moment (Photo: AFP)

Very quickly, Standard & Poor’s is of course right.

The immediate eurozone crisis cannot be solved by punishment measures alone. There needs to be some form of joint debt issuance and a lender of last resort to halt "systemic stress".

It was well-timed to drop this bombshell on Monday night after the Merkozy fudge (though S&P made the decision earlier), since the duumvirate yet again failed to offer any meaningful way out of the impasse.

"Policymakers appear to have acted only in response to mounting market pressures, rather than pro-actively leading market expectations in a way that might have better supported and strengthened investor confidence. We take the view that the defensive and piecemeal nature of this response has helped expand the crisis of confidence in the eurozone."

Spot on.

IMF chief Christine Lagarde was equally dismissive of the Merkozy plan. "It’s not in itself sufficient and a lot more will be needed for the overall situation to be properly addressed and for confidence to return."

As S&P states, a credit crunch is taking hold, partly because of the EU’s pro-cyclical demands for higher capital ratios. Euroland’s incoherent mix of policies are pushing the eurozone into recession and therefore into deeper debt stress.

"As the European economy slows, we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, eroding the revenue side of national budgets."

 There has of course been consternation in Germany, usually based on a misunderstanding of how rating agencies operate. They measure default risk, therefore members of a fixed currency union are inherently more risky.

 The US and the UK have used QE to inflate away some of the debt, and they have weakened currencies to act as a shock absorber. This is undoubtedly a form of stealth default, but that is not what S&P measures. It deals only with "credit events", and such an event is less likely for countries with a sovereign currency and central bank that can inflate (provided their debts are in their own currency).

Furthermore, shrieking Europols commit the fallacy of comparing levels of public debt and deficit levels with the US. That evades the core problem, that the eurozone’s banking nexus is €23 trillion, or three times sovereign debt. This has become a contingent liability of the governments themselves, especially the AAA core.

"For countries in net external liability positions, including the eurozone’s peripheral economies, we see growing risks to the funding of their external requirements. In our view, financial institutions located in countries in net external asset positions (such as Germany) also face pressure where the quality of those assets is deteriorating. Deleveraging by European banks is intensifying, as they reduce their balance sheets amid worsening funding conditions, look to bolster their capital ratios, and address concerns about deteriorating asset quality among their borrowers. By our estimates, a sample of 53 large eurozone banks from 12 countries will face bond market maturities of an historic record of over 205 billion euro in the first quarter of 2012."

I might add that EMU banks have a loan-to-deposit ratio of almost 1.2 (like Japan before the Nikkei bubble burst), compared to 0.7 in the US. They are much larger in aggregate, much more leveraged, and mostly underwater already on EMU bonds if forced to mark to market. In essence, the whole eurozone is already insolvent. Face up to it.

(Yes, yes, before you all scream over there, Britain is insolvent too by the same yardstick. That is why it is useful to have the magical instrument of a sovereign central bank in such circumstances – and one willing to act – to conjure away the awful truth.)

Euroland’s crisis is not about Greek pensions or Italian labour laws, but about a vast and catastrophically ill-designed edifice of interlocking bank debt and sovereign debt.

You cannot separate the two. The sovereigns are destroying banks, and the banks in turn are destroying sovereigns. The two disasters are feeding on each other. This will continue until there is a circuit-breaker, both to act as lender of last resort and to end the slump.

S&P does not pull its punches on this:

"We will analyze the policy settings of the ECB to address the economic and financial stresses now being experienced by eurozone sovereigns. In particular, we will examine the potential impact these policy settings will have in both staunching the eurozone’s increasing output gap and ameliorating its currently dislocated debt markets."

 In other words, Europe has been told that the ECB’s contractionary policies – if continued – will lead to downgrades. The agency is targeting the output gap.

The Europeans are entitled to ignore this as – in their view – the worst sort of New Keynesian and Anglo-Saxon muddled thinking. Fine, but you can hardly complain if you lose your AAAs from an Anglo-Saxon New Keynesian agency.

Take it on the chin, defy the world, and pursue your 1930s policies if you wish.

http://blogs.telegraph.co.uk/finance/ambroseevans-pritchard/100013647/sp-has-no-choice-euroland-risks-bankruptcy-on-currrent-policies/

ECB cuts rates but downplays crisis help

December 9, 2011 - 6:04AM

The European Central Bank acted to soften a looming recession and avert a credit crunch by cutting interest rates and offering banks long-term funds on Thursday but spooked markets by dousing hopes of dramatic crisis-fighting action in the euro area.

ECB President Mario Draghi discouraged expectations that the bank would massively step up buying of government bonds if European Union leaders, gathering in Brussels for a crucial summit, agree on moves towards closer fiscal union.

He said the euro zone's rescue fund should remain the main tool to fight bond market contagion, despite its clear limits, and said it was illegal for the ECB or national central banks to lend money to the IMF to buy euro zone bonds, appearing to veto one firefighting option under active consideration.

To counter that, Draghi announced unprecedented action to support Europe's cash-starved banks with three-year liquidity and cut interest rates back to a record low 1.0 percent.

The euro and European shares dived as markets, increasingly convinced that only the ECB has the power to protect the euro zone, focused on what Draghi was cool about rather than the measures he announced.

"One step forward, two steps back," said Alan Clarke, UK and euro zone economist at Scotia Capital. "The euro zone leaders might as well not bother. Pack their bags, go home, enjoy the weekend and do their Christmas shopping."

The ECB cut its main rate by a quarter-point and flagged a strong chance of recession next year. Draghi admitted the central bankers had been divided even on that decision.

"The intensified financial market tensions are continuing to dampen economic activity in the euro area and the outlook remains subject to high uncertainty and substantial downside risks," he told a news conference.

French President Nicolas Sarkozy dramatised the danger facing the 17-nation single currency area hours before their eighth crisis summit of the year in a speech to European conservative leaders in the French port city of Marseille.


"Never has the risk of Europe exploding been so big," he told leaders including German Chancellor Angela Merkel and the heads of the EU institutions.

"The diagnosis is that the euro, which should inspire confidence, is not inspiring this confidence," the French leader said. "If there is no deal on Friday, there will be no second chance."

France and Germany used the Marseille meeting to lobby for their plan to amend the European Union treaty to toughen budget discipline, which they want to have ready by March. But several countries are sceptical of full-blown treaty change.

German Chancellor Angela Merkel said she was convinced leaders would find a solution to the euro crisis at the summit.

The new ECB chief said his remark last week that "other measures" might follow if euro zone leaders agreed to seal tougher new budget rules had been overinterpreted as hinting the bank could step up bond purchases.

"I was surprised by the implicit meaning that was given," Draghi said, without offering an alternative interpretation.

The plight of Europe's banks was thrown into sharp relief. Two financial sources told Reuters that watchdog the European Banking Authority had told them to increase their capital by a total of 114.7 billion euros, significantly more than predicted two months ago.

A Reuters poll of economists found that while 33 out of 57 believe the euro zone will probably survive in its current form, 38 of those questioned expect this week's summit will fail to deliver a decisive solution to the debt crisis.

DIVISIONS

Euro zone officials said the summit was likely to decide to bring forward the launch date of a permanent bailout fund to 2012 from mid-2013. Before Draghi spoke, one euro zone source said negotiators were close to agreement for their central banks to lend 150 billion euros to the IMF for firefighting.

However, a proposal to give the permanent European Stability Mechanism a banking licence with access to ECB funding was "off the table" due to German opposition.

The EU remains divided over the need for treaty change. Summit chairman Herman Van Rompuy is urging leaders to avoid a laborious full overhaul that could take up to two years and face uncertain ratification. He wants them instead to slip stricter budget enforcement through in a protocol to existing treaties.

This infuriated Merkel and was one reason behind a gloomy briefing by a senior German official on Wednesday, who dampened hopes for a breakthrough and said some leaders and institutions still didn't understand the severity of the crisis.

If all 27 EU states do not support more fiscal union by adapting the existing Lisbon treaty, which took eight years to negotiate, then Sarkozy and Merkel want the 17 euro zone countries to go ahead alone with more integration.

"Should it turn out that not all 27 are able to go down this path, then we have to make a treaty change for the 17 euro states," said Luxembourg premier Jean-Claude Juncker, who chairs the grouping of euro zone finance ministers. "I don't want this but I don't exclude it."

Swedish Prime Minister Fredrik Reinfeldt, speaking for a non-euro state, said: "We want to stick with the 27 concept of course because all of us are members of the European Union and we want to have our influence. We want to keep the European project together."

The Franco-German plan would slap automatic penalties on countries that overshoot deficit targets and make countries anchor a balanced budget rule in their constitutions. The sanctions could be stopped only if three quarters of euro zone countries are against them.

Not all euro zone countries are comfortable with all the French and German proposals, with Finland opposed to their call for majority votes on major policy decisions.

U.S. Treasury Secretary Timothy Geithner, ending a visit to Europe to urge decisive action with talks with new Italian Prime Minister Mario Monti, said it was essential for European leaders to strengthen their financial firewall to give economic reforms a chance to work.

Monti is pushing through economic reforms after the euro zone's third biggest economy found itself sucked to the centre of the debt crisis.

In one glimmer of positive news for stressed euro zone countries, two big financial clearing houses cut the cost of using Italian bonds to raise funds following some easing in the country's bond yields.

Reuters



Read more: http://www.smh.com.au/business/world-business/ecb-cuts-rates-but-downplays-crisis-help-20111209-1olyh.html#ixzz1fzJNGtpk

US stocks fall on Europe woes

December 9, 2011 - 9:01AM
UPDATE

Wall Street fell after the European Central Bank dashed hopes that policy-makers were preparing a financial "bazooka" to contain the debt crisis, and Germany rejected some proposals to add power to the euro zone's bailout fund.

US markets have been on edge all week in anticipation of a summit deal that would come to grips with the euro zone's growing debt crisis, and pave the way for greater action by the ECB to hold down bond yields.

But actions from Europe - both early and late in the day - were a stark disappointment.

Before the market's open, ECB President Mario Draghi discouraged expectations that the central bank would massively increase its purchases of government bonds after a crucial Brussels summit on Friday.

Shortly before the closing bell, Germany rejected some measures in draft conclusions from the summit, including giving the European Stability Mechanism (ESM) a banking license and issuing common euro-zone debt. US stocks and the euro fell sharply following the news. 

"It looks like it's (the opposition) coming from Germany. That just spells more trouble ahead in the days to come," said Peter Cardillo, chief market economist at Rockwell Global Capital in New York.

More than 44,500 S&P E-Mini futures contracts traded between 3:40 p.m. and 3:45 p.m., when the Germany headline appeared. This was the busiest five minutes of the day, other than the last five minutes of trading, which typically has the highest volume.

Banks slide


The S&P financial sector index was the biggest loser, falling 3.7 per cent. That followed sharp losses in European banks' shares as sources told Reuters the European Banking Authority (EBA) sees the capital shortfall at European banks at 114.7 billion euros ($154 billion).

Shares of Morgan Stanley, a barometer of risk aversion due to its perceived exposure to Europe's crisis, fell 8.4 per cent to $15.88.

The latest developments from Europe overshadowed a cut in the bloc's interest rate to a record low 1 per cent and extra liquidity provisions for banks.

The Dow Jones industrial average tumbled 198.67 points, or 1.63 per cent, to end at 11,997.70. The Standard & Poor's 500 Index fell 26.66 points, or 2.11 per cent, to 1234.35. The Nasdaq Composite Index lost 52.83 points, or 1.99 per cent, to close at 2596.38.

The decline comes after three days of gains for US stocks when the S&P 500 tried and failed to stay above its 200-day moving average, which has been a key level for investors to watch this year, and one that could prove tough to break.

But Thursday's pullback, concentrated in economically sensitive areas, was a far cry from the wild swings of recent months when uncertainty over Europe has dominated headlines. That is being seen as a sign of resilience by many investors who are hoping for seasonal strength into the end of the year.

Yields on European sovereign debt spiked. Ten-year Italian government bond yields rose 44 basis points to 6.51 per cent - the day's high. German Bund futures hit a session high of 136.89, up 109 ticks on the day.

Earlier, data showed US jobless claims fell more than expected in the latest week, a sign the labor market recovery was gaining momentum. Claims slid to a nine-month low.

Reuters



Read more: http://www.smh.com.au/business/markets/us-stocks-fall-on-europe-woes-20111209-1olzd.html#ixzz1fzHBjN8R

Mervyn King: “The crisis in the euro area is one of solvency and not liquidity.”

'Systemic' crisis looms for Europe's banks

 December 2, 2011 - 7:59AM

Bank of England Governor Mervyn King urged banks to enhance efforts to bolster their defences against the euro area’s debt turmoil, which now looks like a “systemic crisis”.

“An erosion of confidence, lower asset prices and tighter credit conditions are further damaging the prospects for economic activity and will affect the ability of companies, households and governments to repay their debts,” threatening banks’ balance sheets, King told reporters in London.

“This spiral is characteristic of a systemic crisis.”

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The US Federal Reserve cut the cost of dollar funding for European financial institutions yesterday in a coordinated move with other central banks. That measure came two days after King said there are “early signs” of a credit crunch in the euro region, where leaders face increasing pressure to resolve intensifying turmoil.

“Sovereign and banking risks emanating from the euro area have intensified and remain the most significant and immediate threat to UK financial stability,” the central bank said in its Financial Stability Report. It said that if banks’ earnings aren’t enough to build capital, they should limit payments of bonuses and dividends and “give serious consideration” to raising external capital.

Credit squeeze

The central bank’s Monetary Policy Committee restarted bond purchases in October to aid the recovery and cut its growth forecasts this month. Officials warned today that the strains in interbank markets could threaten economic growth.

“Against a backdrop of slowing global growth prospects, concerns about the sustainability of government debt positions of smaller economies have broadened to larger euro-area economies,” the central bank said. “The current funding pressures facing banks could lead to a renewed tightening in credit conditions for real economy borrowers.”

The central bank also published the recommendations of its Financial Policy Committee, which met on November 23. The panel said the Financial Services Authority should encourage banks to disclose leverage ratios to investors by the start of 2013, two years earlier than Basel rules originally required.

The Bank of England said in the FSR that UK banks have 140 billion pounds ($215 billion) of term funding due to mature in 2012, concentrated in the first half of the year. It said short-term money market funding conditions have “been fragile over the past few months, with banks finding it harder to roll over all of their maturing funding and tenors shortening.”

Contingency plans

UK authorities are working on “a wide range of contingency plans” to deal with a further intensification of the crisis, including a possible breakup of the euro, King said. The central bank is working with the Financial Services Authority and the government on plans, he said.

After a series of stop-gap accords failed to protect Italy and Spain from surging bond yields, Europe is under growing pressure from US leaders and international financial markets. European leaders will meet next week to discuss the next steps in resolving the debt crisis.

The cost for European banks to borrow in dollars fell for a second day after the coordinated central bank action. The three-month cross-currency basis swap, the rate banks pay to convert euro payments into dollars, was 118 basis points below the euro interbank offered rate in London. The gap had widened to 162.5 below Euribor yesterday, the most in three years, before the Fed move.

Underlying problems

King said the central bank measure was “designed to deal with clear evidence that there were problems in banks around the world finding difficulty in accessing dollar funding in particular.” Still, he added it can only provide “temporary relief” and is not a “solution to the underlying problems.”

He also said that said resolving the wider problems of global financial imbalances are beyond the UK authorities to deal with on their own and “only the governments directly involved can find a way out of this crisis,” referring to the euro-area debt turmoil.

“The crisis in the euro area is one of solvency and not liquidity,” he said. “Here in the UK we must try and find a way to bolster the resilience” of the financial system.

While Britain’s banks have 15 billion pounds of exposure to sovereign debt in the most vulnerable euro-area economies, they have “significant” exposures to the private sectors of Ireland, Spain and Italy, the Bank of England said. This amounts to about 160 billion pounds, or 80 per cent of their core Tier 1 capital.

“UK banks have made significant progress in improving their capital and funding resilience,” the bank said. “But progress has been set back recently and they have been affected by strains in bank funding markets.”

Bloomberg

Read more: http://www.smh.com.au/business/world-business/systemic-crisis-looms-for-europes-banks-20111202-1o9s3.html#ixzz1fKaV6Jr2

A common Euro currency defies common sense

Martin Feldstein

December 2, 2011

The politicians who introduced the euro ignored warnings that it would create serious problems.

EUROPE is now struggling with the inevitable adverse consequences of imposing a single currency on a very heterogeneous collection of countries. But the budget crisis in Greece and the risk of insolvency in Italy and Spain are just part of the problem caused by the single currency.

The fragility of the major European banks, high unemployment rates, and the large intra-European trade imbalance (Germany's $US200 billion current-account surplus versus the combined $US300 billion current-account deficit in the rest of the euro zone) also reflect the use of the euro.

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European politicians who insisted on introducing the euro in 1999 ignored the warnings of economists who predicted that a single currency for all of Europe would create serious problems.

The euro's advocates were focused on the goal of European political integration, and saw the single currency as part of the process of creating a sense of political community in Europe.

They rallied popular support with the slogan "One Market, One Money", arguing that the free-trade area created by the European Union would succeed only with a single currency.

Neither history nor economic logic supported that view. Indeed, EU trade functions well, despite the fact that only 17 of the union's 27 members use the euro.

But the key argument made by European officials and other defenders of the euro has been that, because a single currency works well in the US, it should also work well in Europe.

After all, both are large, continental, and diverse economies. But that argument overlooks three important differences between the US and Europe.

First, the US is effectively a single labour market, with workers moving from areas of high and rising unemployment to places where jobs are more plentiful. In Europe, national labour markets are effectively separated by barriers of language, culture, religion, union membership, and social-insurance systems.

To be sure, some workers in Europe do migrate. In the absence of the high degree of mobility seen in the US, however, overall unemployment can be lowered only if high-unemployment countries can ease monetary policy, an option precluded by the single currency.

A second important difference is that the US has a centralised fiscal system. Individuals and businesses pay the majority of their taxes to the federal government in Washington, rather than to their state (or local) authorities.

When a US state's economic activity slows relative to the rest of the country, the taxes that its individuals and businesses pay to the federal government decline, and the funds that it receives from the federal government (for unemployment benefits and other transfer programs) increase.

Roughly speaking, each dollar of gross domestic product decline in a state such as Massachusetts or Ohio triggers changes in taxes and transfers that offset about 40¢ of that drop, providing a substantial fiscal stimulus.

There is no comparable offset in Europe, where taxes are almost exclusively paid to, and transfers received from, national governments.

The EU's Maastricht Treaty specifically reserves this tax-and-transfer authority to the member states, a reflection of Europeans' unwillingness to transfer funds to other countries' people in the way that Americans are willing to do among people in different states.

The third important difference is that all US states are required by their constitutions to balance their annual operating budgets. While "rainy day" funds that accumulate in boom years are used to deal with temporary revenue shortfalls, the states' "general obligation" borrowing is limited to capital projects such as roads and schools.

Even a state like California, seen by many as a poster child for fiscal profligacy, now has an annual budget deficit of just 1 per cent of its GDP and a general obligation debt of just 4 per cent of GDP.

These limits on state-level budget deficits are a logical implication of the fact that US states cannot create money to fill fiscal gaps.

These constitutional rules prevent the kind of deficit and debt problems that have beset the euro zone, where capital markets ignored individual countries' lack of monetary independence.

None of these features of the US economy would develop in Europe even if the euro zone evolved into a more explicitly political union.

Although the form of political union advocated by Germany and others remains vague, it would not involve centralised revenue collection, as in the US, because that would place a greater burden on German taxpayers to finance government programs in other countries. Nor would political union enhance labour mobility within the euro zone, overcome the problems caused by imposing a common monetary policy on countries with different cyclical conditions, or improve the trade performance of countries that cannot devalue their exchange rates to regain competitiveness.

The most likely effect of strengthening political union in the euro zone would be to give Germany the power to control the other members' budgets and prescribe changes in their taxes and spending.

This formal transfer of sovereignty would only increase the tensions and conflicts that already exist between Germany and other EU countries.

Martin Feldstein, professor of economics at Harvard University, was chairman of Ronald Reagan's council of economic advisers and is a former president of the National Bureau for Economic Research.

Read more: http://www.smh.com.au/business/a-common-currency-defies-common-sense-20111201-1o940.html#ixzz1fKXkPP7N