Wednesday, December 07, 2011

Cartels, OPEC and the Euro

A cartel is a difficult thing to hold together. When initially set up, the power of the cartel is at its height and all of the members are doing well. But what makes a cartel work is the agreement to limit production and hence raise prices. The problem is that the members have an incredible incentive to cheat on the agreement.

OPEC went through this when cheating on quotas was rampant, and the Saudi's kept reducing output to keep things working. Eventually they got tired of everyone else cheating and doing better than they were. Their solution was to open the taps until all of the other members screamed in pain. The cartel agreement resumed and while there was still cheating, it was at a lower more tolerable level.

I sense that the Euro Zone is going through the same process. The southern European countries have been cheating on their agreement, (budget deficits less than 3% of GDP) and it has become unsustainable. Now the swing producer, Germany, is holding them accountable and refusing to take up the slack. (No we won't use our excellent credit rating to bail out your debt.)

I predict much screaming and tales of woe. Eventually there will be a renewed agreement. There will still be cheating, but at a lower and more tolerable level.

HT: Coyote Blog

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