Recently I’ve turned more bullish on prostitutes and illegal drug sales. 

This is not some newfound libertarian streak. I’m really just thinking about what’s best for the eurozone. 

This takes a bit of explaining…

Last week Italy announced that beginning next year it will include revenues from drug trafficking and the sex trade, in addition to contraband tobacco and alcohol, in calculating GDP. 

You’re probably hoping that someone will pinch you, but in the Maastricht Treaty that established the euro in 1992, member states were asked to meet strict criteria, including a budget deficit of less than 3% of GDP.

Unfortunately, Italy – whose economy is contracting rather than expanding – cannot meet that criterion, unless it includes black market activities. Will that really be enough to make a difference?

Surprisingly, the answer is maybe. Last month Britain said including revenue from drugs and prostitution into European Union accounts would total $16.8 billion a year, equivalent to 1% of output. 

In Italy, it seems, gross criminal conduct may become an essential part of gross national product. (I can just see a few economists from the Chicago school shouting “at last!”)

This Isn’t Working

The real eye-opener here is just how far the European Union and its central bank are willing to go to try to patch up an inherently unworkable currency.

Bear in mind, the euro is still very much an experiment. That surprises some investors since the euro is the world’s second-largest reserve currency and the second-most traded currency after the U.S. dollar. With approximately $1 trillion worth in circulation, the euro also has the highest combined value of banknotes and coins in circulation. And, considered as a whole, the eurozone is the world’s second-largest economy.

But the problem is that the currency must serve different countries with different governments, different political and economic needs, and different strengths and weaknesses.

At Cross Purposes

In Germany and the Netherlands right now, for instance, economic growth is increasing. (Not enough but at least the figure is a positive one.) However, Greece and Spain have seen their economies contract for six years now. Unemployment in both countries is at 25%. 

The Greeks and Spaniards would love to see a weaker currency to boost exports and attract international tourists to their seaside resorts. But that can’t happen because they have outsourced their monetary policy to Frankfurt. 

And much of their fiscal policy, too. Another plank of the Maastricht Treaty is that fiscal deficits must be less than 60% of GDP. This was widely flouted after the euro’s introduction but stronger European nations still pay lip service to the idea and encourage “austerity” for profligate member states Portugal, Italy, Ireland, Greece and Spain (the PIIGS).

Unclear Path Forward

How will all this play out? Your guess is as good as mine. After all, the geniuses that dreamed up this common currency didn’t even create an exit. There is no pathway or precedent for dropping out. And it would be a nightmare for any countries that did – since their new currencies would plunge and their borrowing costs would soar – as well as those of the countries holding their sovereign debt. 

And so I suppose we will see the Italians keeping closer tabs on their streetwalkers and meth dealers. (You really couldn’t make this stuff up.) 

In addition, eurozone depositors will start receiving negative interest on their bank balances. That’s right. They’re going to have to pay to keep their money in cash.

You might ask why the European Central Bank doesn’t take a page from the Federal Reserve’s book and stimulate the euro economies by buying up euro-denominated government debt to lower longer-term rates. 

But the yield on the 10-year Spanish Treasury is already lower than the yield on 10-year U.S. Treasury bonds.

That looks like a bad bet. So it’s hookers and heroin for now. 

Good investing,

Alex

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