by Anthony Harrington
The Summit of European leaders on Thursday and Friday 28th and 29th of June takes place against a backdrop of German intransigence to the one idea that France, Italy and Spain, and probably Portugal, Greece and Ireland as well, feel can save the EU, namely joint guarantees for euro bonds. Germany is also vehemently opposed to the new French President Francoise Hollande’s other idea, a joint guarantee of EU bank deposits to stop the mounting capital flight from troubled peripheral states – a flight that is itself ratcheting up bank solvency issues. With Germany being seen as the odd one out GaveKal analyst Anatole Katletsky argues that a staggering but logical outcome of the Summit might well be that Germany is identifed as “the problem” and asked to fall into line or to leave.
If this sounds far fetched, remember that there are many in the peripheral states who feel that Germany has profited greatly from having a currency that is much weaker than the Deutschemark would have been. It’s export industries are at multi year highs in terms of earnings and profitability. Also, Germany cannot shrug off responsibility, in their eyes at least, for providing much of the credit that allowed the likes of Spain to run up huge debts in the first place. There is also the fact that it is simply logical, given that Germany wants closer fiscal union, for the others to ask Germany to recognise that the big picture requires fiscal transfers from the strong core nations to the peripheral nations, in order to restore peripheral economies to health. Again, German intransigence, which is all we are likely to get from the present summit, is going to continue to be deeply frustrating for most of Germany’s european partners. As I pointed out in a recent blog, Austria, the Netherlands and Finland are just as opposed as Germany to the introduction of euro bonds, but they do not control the ECB, and Germany itself, as Kaletsky points out, has just two seats on the ECB. From this it follows that if push comes to shove and the peripheral nations combine, they can force through policies for the ECB that Germany will absolutely hate and that the German public would riot over.
As Kaletsky puts it, the debtor countries, faced with a decade or more of grinding austerty and deepening debt (since all the austerity programme is achieving is to diminish tax revenues and push governments still more deeply into debt) could elect instead to turn the tables on Germany, since Germany is clearly the odd man out “and the chief obstacle to any political resolution of the euro crisis”.
“It is Germany that refuses even to talk about mutual debt and banking guarantees. It is Germany that insists on self-defeating fiscal austerity and intolerable political conditions for the debtor countries. It is Germany that vetoes quantitative easing by the ECB, which could cap bond yields and relieve deflationary debt traps. And it is Germany that makes the other euro countries uncompetitive, discourages devaluation of the euro against the dollar and refuses even to relax its own domestic fiscal policies to reduce its trade surplus and support growth.”
Looked at in this light, it is not impossible to imagine a club of peripheral and secondary EU states saying to Germany, “You’d better leave, we’ll be better without you.” Kaletsky points out that while such a request could not, of itself, compel Germany to leave, the other states could make life impossible for Germany and unacceptable to the German public by driving the ECB down a hugely growth centric, inflationary road in the teeth of German opposition. Pushing the ECB into quantitative easing would do it nicely. Kaletsky pushes his argument further, noting that while a German exit would hammer German insurance companies and banks “because of a mismatch between their euro assets and their new D-Mark liabilities”, the German government would be able to bail them out since it would no longer have to spend huge amounts on bailing out peripheral EU states. Moreover, and this is a very telling point, unlike a threatened Greek exit, a German exit would not prompt a capital flight from German banks since the D-Mark would be expected to appreciate in value against the euro, not depreciate. And with Germany outside the eurozone, Kaletsky notes, the Club Med countries would be in a much better position to devalue and promote export growth and inflation to eliminate their legacy debts. The German government would gain since it could elect to repay existing German bunds in legacy euros rather than in appreciating D-Marks. German bond holders would get burned, but that’s their problem. The alternative, as Kaletsky notes, would be the German government handing bund holders a windfall by repaying them in appreciating D-Marks.
It is a fascinating idea, but one that is highly unlikely to come to pass, no matter how annoyed Mario Monte and other leaders get at the conference. (Kaletsky’s essay on what if Germany went, can be found in John Mauldin’s excellent “News from the Frontline” “Out the Box” newsletters).
Sometime between Thursday evening and the small hours of Friday morning Italy and Spain, combining to block any agreement on anything until they won significant help, forced Merkel to agree to two surprising “fudges”, a single bank supervisor across the EU and that the European Stability Mechanism will henceforth be responsible for bailing out failing banks, not the sovereign governments. The implications of this are going to need time to sort out, particularly as they relate to German politics. Merkel is going to have to try to sell this fudge to the German people as a large step closer towards fiscal integration and German control. This is true enough for the single bank supervisor, which would give much more Bundesbank like control over dodgy lending by the peripheral banks during property booms at some future date. However, the main outcome from Thursday is a clear demonstration of just how much power Italy and Spain have when they get pushed to the brink – and part of this comes from the latent threat that maybe, just maybe, the EU doesn’t need Germany after all… It does, of course, but late at night anything can happen. At the time of writing (Friday morning) there was still one full day’s session to go and much could still happen.
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