Angela Merkel “vows to build fiscal union,” we were told on Friday, after the German Chancellor’s speech to the Bundestag. I just don’t buy it. Market denizens are desperate for “fiscal union” before the end of the year. The phrase is code for the mighty Germany agreeing to stand behind the liabilities of the more profligate single currency members – something that frazzled debt markets crave.
Berlin will only allow the European Central Bank to let rip, the argument goes, firing up the “virtual” printing press like the US Federal Reserve and the Bank of England, if Germany exerts more control over the spending of other eurozone governments. So “fiscal union”, while under-pinning bond prices, would also spark the mother of all equity market rallies, as the ECB sprayed-out QE funny money. Shares would surge across the globe – which would be nice, just in time for Christmas.
All last week, speculation rose that “a grand European bargain” is coming. Germany, we’re told, will soon agree to clean-up the eurozone’s mess, in return for a more assertive pan-European role. On cue, Italian 10-year sovereign debt traded below the crucial 7pc level, beyond the “bail-out” zone. Spanish sovereign bond yields similarly eased.
I have to say, though, analyzing what Merkel actually told the deeply-suspicious lower house of the German Parliament, I see scant evidence of “fiscal union” happening any time soon. On the contrary, the aspects of the concept the markets are willing – German-financial back-stopping and unashamed eurozone QE – look less likely than ever.
I accept Merkel feels the single currency has no hope of survival unless the Stability and Growth Pact is toughened, with binding annual limits on the budget deficits of individual eurozone governments. That’s what she means when she said Germany would pursue “the goal of achieving treaty change” – the phrase leapt upon by desperate investors.
The fact that both France and Germany ignored the SGP from the time of the single currency’s 1999 launch meant the old system was a joke. Supra-national fiscal rules will always be broken, though, however tough the language in whichever of the endless treaties the eurocrats decide to amend.
When it comes to something as fundamental as tax and spending, democratically-elected governments will always do what their local electorates want, rather than following strictures from Brussels. It’s as simple as that. A stiffer fiscal treaty will just mean that the rule-breakers need to apply more fudge. And apply it, they will.
Aside from “treaty change”, which amounts to very little, Merkel was clear the more fundamental aspects of “fiscal union” won’t fly. “Any discussion about euro bonds is pointless,” she said. So Germany won’t allow the issuance of eurozone-wide sovereign instruments, whatever the “fiscal union” crowd claims. Such a development, says Merkel, would be “unthinkable”. And when it comes to QE, the German Chancellor was similarly unequivocal. “The role of the ECB is different from that of the Fed in the US and the Bank of England,” she insisted.
The market rallied anyway. It was Friday, after all, and who wants to spend the weekend feeling gloomy? In a bid to bolster stocks and bond prices, “sources” close to Mario Draghi also span that the new ECB boss had “given the go-ahead” to explore ways for the Bank to lend to the International Monetary Fund, which could then extend credit lines to Italy and Spain.
So, by “round-tripping” via Washington, maybe the rules forbidding ECB bail-outs of eurozone governments, as oppose to banks, could be bent without actually being broken? It is telling Draghi didn’t dare make such a suggestion on the record. That’s because Merkel would have strangled any such plan at birth.
The easing of eurozone bond yields last week had very little to do with the prospect of imminent European integration. Genuine “fiscal union” of the type needed to maintain the single currency in its current form won’t happen in my lifetime or that of my children, requiring as it would the reversal of 500 years of European history.
The catalyst for last week’s rally, instead, was the far more arcane move by the Fed to cut the penalty rate that it charges the ECB on dollar liquidity from 100 to 50 basis points. This action was taken in conjunction with China and Brazil, which shows just how alarmed the non-European world has become about a full-on “euroquake”.
After two years of anti-inflationary policy-tightening, Beijing reduced the share of deposits banks must hold in reserve with China’s central bank. Brazil, meanwhile, cut its benchmark interest rates by 50 basis points for the third time since August, citing “adverse global economic conditions”.
While the market cheered these moves, providing more liquidity to the eurozone will do nothing to address the fundamental issues behind the region’s sovereign debt crisis and the single currency’s inherent incoherence. The cheaper “dollar swaps” facility may anyway be barely used, given the stigma it puts on banks that are desperate enough to use it.
Most observers remain convinced that such trifling details don’t matter, seeing as Germany will soon relent and loosen the ECB’s balance sheet, allowing fully-fledged QE. I still don’t think it will happen. One reason is that Merkel knows full well that “special monetary measures” would cause the patience of German voters to snap.
Across the world, the eurozone’s economic powerhouse is being berated for its determination not to give way. Berlin stands accused of wanting to stage some kind of Southern European Anschluss. It is “absurd”, as Merkel said on Friday, to claim that Germany is trying to “dominate” Europe. Yet, still, idiot protestors across the “Club Med” countries wield banners showing Merkel’s face on a swastika. Such disgusting and entirely unjustified historical parallels, I’m ashamed to say, have also been made in Britain.
The German elites agreed to the set-up of the eurozone as they wanted to be seen as “good Europeans”. Given that the country was still struggling with Eastern “re-unification”, Germany entered at a punishingly high exchange rate. Since then, through a combination of hard work, and productivity gains, Germany has become a world-class economy once again.
The German people themselves, though, were never given a referendum on euro membership. Prior to entry, not a single opinion poll recorded a majority in favour of entry. German voters accepted all this and, regardless, battled their way back to prosperity. They will, I suspect, philosophically endure the current mud-slinging too. But they will not, repeat not, accept money-printing. If Merkel allows this to happen, I truly believe the German people will riot.
On top of that, eurozone-QE won’t work. It would kick the can down the road, but the same debt-driven problems would return, the same but even worse. Despite official denials, we’ve already seen some QE in the eurozone, the region’s base-money supply having soared in recent years. But this hasn’t prevented a stagnation of bank lending, the real cause of the region’s economic torpor, just as in the UK.
Eurozone banks have yet to be recapitalized. They’re still sitting on hundreds of billions of euros of unreported sub-prime related liabilities, the true extent of their losses having yet to be “fessed-up”. That’s why the eurozone’s inter-bank market remains locked, gumming up the wheels of finance and starving the broader economy. Until this nettle is grasped, and the region’s banks restructured, Europe won’t escape its spiral of economic decline – a vortex that, eventually, will suck in the rest of the world.