The eurozone is in bad need of an undertaker
by Ambrose Evans-Pritchard
Posted originally 12 Dec 2010
The EU’s Franco-German “Directoire” and the European Central Bank have between them ruled out all plausible solutions to the eurozone’s debt crisis.
EVEN IF ANGELA MERKEL WERE TO AGREE PLANS THAT AMOUNTED to a European debt union, the scheme would still be torn to pieces by the German constitutional court. There will be no Eurobond, no increases in the EU’s €440bn (£368bn) rescue fund, and no mass purchases of Spanish and Italian bonds by the ECB. Nothing. The system is politically and constitutionally paralysed. Spain and Portugal will be left nakedly exposed before their funding crunch in January.
It is entirely predictable that Angela Merkel and Nicolas Sarkozy would move so quickly to shoot down last week’s Eurobond proposal, issuing pre-emptive warning before this week’s EU summit that they will not accept “a bundling together of all Europe’s debts”.
How can Germany or France agree lightly to plans that amount to an EU debt union, with a common treasury, tax system, and budget policy, the stuff of civil wars and revolutions over the ages? To do so is to dismantle the ancient nation states of Europe in all but name.
Even if Chancellor Merkel wished to take this course – and even if the Bundestag approved it – the scheme would still be torn to pieces by the German constitutional court unless legitimised by radical EU treaty changes, which would in turn take years, require referenda, and face populist revolt in half Europe.
What the German people are being asked to do is to surrender fiscal sovereignty and pay open-ended transfers to Southern Europe, taking on a burden up to six times reunification with East Germany.
“If we pool the debts of the countries in the south-west periphery of Europe, we are blighting our children’s future: the debt levels are astronomic,” said Hans-Werner Sinn, head of Germany IFO institute. Any attempt to prop up the status quo will cement the current account imbalances of EMU’s North and South, to the detriment of both sides.
“I doubt that the current leaders of Europe fully understand the economic implications of their decisions. They are repeating the mistakes that Germany made over reunification,” he told the Handelsblatt. Transfers to the East are still running at €60bn a year two decades after the fall of the Berlin Wall. There has been no meaningful East-West convergence for the last 15 years.
To those who blithely argue that EMU is a good racket for German exporters because it locks in Germany’s competitive advantage, he retorts that a trade surplus is the flip side of a capital deficit. Germany has seen €1 trillion – or two thirds of its entire savings since 2002 – leak out to fund the EMU party, gutting investment at home. This is toxic for Germany too.
It is no surprise to eurosceptics that Europe should have reached this fateful point where leaders must choose between the twin traumas of EMU break-up or giving up their countries. Nor is it a surprise to an inner-core of schemers within the EU system, who have always calculated that they could exploit such a crisis to catalyse political union.
However, it is a big surprise to Europe’s leaders, and they do not know what to do about it.
Chancellor Merkel and President Sarkozy seem unwilling even to boost the firepower of the European Financial Stability Facility, though in this they may be right.
The drama has moved beyond the point where headline “shock and awe” pledges can achieve anything. Markets are already looking beyond the debt-stricken periphery to the creditor core, fearing that bail-out costs will themselves create a chain of contamination. Credit default swaps on France have risen above 100 basis points, where they linger stubbornly.
A Fitch report on the European Stability Mechanism (ESM) said the new rescue fund “could result in lower ratings” on the risky sovereigns because the EU would have instant debt seniority, leaving private bondholders exposed to the risk of bigger haircuts. To make matters worse, debt restructuring would depend on the whim of politicians. The incoherence of the rescue machinery itself is feeding the debt crisis.
So as EU leaders flounder, the task of saving monetary union falls to the ECB. Yet it too has declined the burden, refusing to go nuclear with bond purchases. “Each country needs to be held responsible for its own debt,” said Germany’s monetary avenger at the ECB, Jurgen Stark.
He was joined last week by Mario Draghi, Italy’s governor and candidate for ECB chief, who said it was not the job of a central bank to carry out fiscal rescues. “We could easily cross the line and lose everything we have, lose independence, and basically violate the Treaty,” he said.
Indeed. Maastricht forbids the ECB from buying the debt of eurozone states except for specific purposes of liquidity management. But this saga no longer has anything to do with liquidity. Southern Europe faces a solvency crisis. The ECB has postponed its threat to pull away the lending props beneath the banking systems of the PIGS. Beyond that it has limited itself to tactical strikes in the small illiquid debt markets of Ireland and Portugal, buying enough bonds to ram down yields and burn a few hedge funds.
The effect has faded within days. It had little impact on Spanish and Italian bonds in any case. Spanish 10-year yields reached 5.45pc last week, far above 5pc level where compound arithmetic comes into play.
At the end of the day, debtor governments still have to persuade Japanese life insurers, Mideast wealth funds, or French and German banks, to put up real money to buy their bonds at a bearable interest rate.
Credit Agricole said last week that it would hold back at next week’s auction of Spanish debt because it is not yet clear whether the ECB will back-stop the country. “The risk is simply too large for our appetite,” it said.
So we drift on with rising yields into 2011, when Portugal must raise €38bn, Belgium €85bn, Spain €210bn, and Italy €374bn – according to Goldman Sachs.
Europe’s leaders still seem to hope that brisk global growth will lift everybody off the reefs. That too is wishful thinking. Recovery brings its own set of problems, and will make intra-EMU tensions even worse.
Germany will hit the inflation buffers and force the ECB to raise interest rates before the trickle down benefits of trade have begun to make any difference in the closed economies of the South. Floating Euribor rates that determine 98pc of mortgages in Spain have been shooting up already, even as wages fall. The vice is still tightening on Spain.
The reflex of the EU elites is to blame this structural mess on lack of statesmanship.
“There is something surreal about the unfolding financial crisis,” said Stefano Micossi from the College of Europe, the sanctum sanctorum of the European Project.
“Leaders grudgingly do what is needed to prevent disaster at the last minute before it is too late, and the next minute they go back to the behaviour that brought them against the wall in the first place. The eurozone is in bad need of a psychiatrist,” he wrote at VoxEU
“If the eurozone follows this path, either all of the sovereign debts become German public debt, or the euro will collapse,” he said.This is admirably candid in one sense, but is today’s crisis really just a failure of leadership? Was EMU not dysfunctional from the first day? Did it not inflict negative real interest rates on Club Med and Ireland in the boom years, driving them into distastrously pro-cyclical policies?
Did it not lock in chronic imbalances between North and South? Has it not left victim states trapped in debt deflation or slumps which have gone too far to respond an austerity cure, and from which there seems to be no escape on terms acceptable to Germany?
Should we blame the current hapless leaders, or the guilty men of Maastricht who created this doomsday machine? If the project itself is rotten, surely what the eurozone needs most is an undertaker.
Written by aurick
13/12/2010 at 1:25 pm
Tagged with Angela Merkel, bundestag, College of Europe, debt, depression, ECB, economic collapse, economic crisis, EEuropean Stability Mechanism, EMU dysfunctional, European Central Bank, european monetary union, European sovereign debt problem, eurozone bailout, Financial Disaster, Maastricht, Mario Draghi, Nicolas Sarkozy, PIGS, Quantitative easing, sovereign debt, sovereign default, Stefano Micossi