Germany must decide if it wants the eurozone to survive or perish
European debt and equity markets ended a tumultuous week with a rally on Friday. So shares in the US and across the rest of the world rose too. But the threat of a “euroquake” – a systemic collapse which would make Lehman Brothers look tame – is by no means over. Far from it.
Europe’s leaders don’t know how to solve this crisis because they don’t know what they want. Should attempts be made to hold the eurozone together, with Greece staying in? Or should the threat to expel Athens be followed through, at the risk of causing further defections, with monetary union being reduced to a Franco-German rump? This is an enormous question, which only Germany can answer. Until an answer is forthcoming, chaos will continue to ensue.
Amid fears the eurozone’s debt fiasco will drag the global economy into a new recession, the US and UK are exerting huge pressure on German Chancellor Angela Merkel. The Anglo-Saxon world wants Berlin to finance the expansion of the euro bail-out fund – the so-called European Financial Stability Facility – from €440bn to €1,000bn.
With global markets on the brink of another meltdown, diplomatic niceties have gone. Merkel “seems intent on sitting around until we’re living in Apocalypse Now,” quipped a Downing Street spokesman, in a particularly ill-advised reference to Francis Ford Coppola’s late-70s epic about the psychological horrors of the Vietnam War.
It isn’t only the UK government’s movie parallels that are off-beam, though. Both Britain and the US are effectively urging Germany to authorize the European Central Bank to buy eurozone government bonds with abandon, not least those issued by members such as Italy, in the cross-hairs of the bond market vigilantes. Since the summer, the ECB has quietly consumed around €200bn of government paper, in a bid to temper the borrowing costs of the eurozone’s fiscal sinners. But still, Italian yields soared way above 7pc on 10-year money last week – levels which forced Greece, Ireland and Portugal to seek bail-outs.
The eurozone’s third-largest economy, with €2,200bn of government debt, Italy isn’t only “too big to fail”, but maybe “too big to save”. President Obama wants Berlin to be “decisive”. David Cameron public says it’s “difficult to understand” why the ECB isn’t “doing more”. Jens Weidmann, head of Germany’s Bundesbank and the ECB’s dominant governor, retorts that any attempt to “leverage” the EFSF would be a “clear violation” of the institution’s legal mandate, given that European Treaties impose a clear “legal prohibition on monetary financing”.
Amidst the semantics, the outside world wants Germany to sanction massive eurozone “quantitative easing”, similar to that already carried out by the Bank of England and the US Federal Reserve. Yet Weidmann surely speaks for the vast majority of Germans when he cites fears of Weimar-style inflationary chaos, and the subsequent political disaster that ensued. German Vice-Chancellor Philipp Roesler also points out that, if the ECB launched large-scale QE, using “virtually printed money” to clean-up the debts of Italy et al, “the impetus to create lasting stability and make reforms, would disappear”.
Cheered on by investors desperate for another QE sugar rush, the US and UK accuse Germany of being “intransigent” and “sanctimonious”. That couldn’t be further from the truth. The message from Berlin is correct, of course, even if no-one wants to hear it. Printing money doesn’t work.
Having said that, Germany needs to make a decision. Either it throws caution to the wind, and does what the Anglo-Saxons want, unleashing QE to back-stop Club Med debts in the name of “European unity”. Or, far more sensibly and realistically, Germany finally accepts that the euro is an incoherent nonsense which, in its current form, is doing far more harm than good.
Taking this latter route would mean preparing for the ejection of Greece and Portugal and possible other members too. It would also mean stabilizing Italy, so giving global markets some respite and allowing the world to catch its breadth, but on condition that Rome eventually goes its own way too. This really is the only genuinely sustainable outcome.
Rather than demanding that Berlin kicks the can down the road with a deeply controversial and ultimately counter-productive QE-based quick fix, the US, Britain and all the other shrill on-lookers should be encouraging and facilitating the taking of a historic, traumatic yet necessary decision by Germany to bow to the inevitable and scale the eurozone back.
The world, in short, should be building on the stand that Germany is taking, helping Europe to make the painful and difficult transition to a more stable situation – one involving a smaller, but ultimately more realistic eurozone, rather than accusing Merkel and her ministers of bad faith. This ghastly eurozone time-bomb needs to be defused. Germany must take the decision to do that, but it can’t then implement that decision alone.
One reason Italian bond yields fell late last week, to a still painful but more manageable 6.6pc, was covert ECB secondary market intervention. The Italian Parliament also passed a new austerity package, clearing the way for the ludicrous Silvio Berlusconi – Il Cavaliere – finally to quit as Prime Minister.
There was further relief as Lucas Papademos was sworn into office in Greece, after days of political wrangling. The ECB and International Monetary Fund are now due to visit Athens next week and could authorize the release of another €8bn in bail-out funds.
Even amid the euphoria, though, fears were growing about Spain. The sovereign debts of the eurozone’s fourth-largest economy look reasonable, at around 65pc of GDP. While the Spanish banking sector is hiding some dodgy real estate exposure, much of its lending has been to Latin America businesses which are doing quite well. Modern Spain is a relatively well-run economy that has largely avoided the budgetary excesses of Italy and the fiscal mendacity of Greece.
Yet new data showing the Spanish economy slowed between July and September, an unsurprising development given what’s been happening elsewhere in Europe, was enough to spark panic regarding the country’s ability to meet its deficit-reduction targets. The resulting surge in sovereign yields says less about Spain than it does about current market sentiment. Such sentiment isn’t surprising, though, given the chaos and confusion which now passes for eurozone policy-making. Unless and until we get a big decision from Germany, solvent economies will continue to get sucked into the mire.
As French yields spiked alarmingly last week, Standard & Poor’s apparently downgraded the country’s top triple-A rating, a decision which was then reversed. Was this down-grade really an unfortunate “mistake”, as was later claimed? Or did the French government bring almighty pressure to bear on the ratings agency, forcing them to retract?
Given the current diplomatic finger-pointing, and general lack of direction in the eurozone, such questions – previously unthinkable – are now being asked. Did the eurozone’s political leaders come down on S&P like a ton of bricks? If so, the integrity of entire Western financial system, such as it is, is now on the line.
“Hey soldier, do you know who’s in command here?” asked US Army Special Operations Officer Captain Benjamin L. Willard. “Ain’t you?” the spaced-out soldier replied, in one of the most memorable exchanges in Apocalypse Now.
The unavoidable truth is that Germany, practically the only large Western economy with genuine fiscal strength, is in command of the eurozone. Berlin needs to decide what it wants and make its move. And it needs to do so now.