Judges of Karlsruhe in fresh eurozone threat
This column was going to be about emerging markets – and the potential impact on the UK of the recent slowdown in the generally resurgent economies of the East. It was going to be relatively upbeat, not least because I’m an emerging markets enthusiast and think it’s wrong to confuse a blip for a trend.
Yes, stock markets and currencies are suffering in the likes of India and China, largely due to Federal Reserve “tapering” – the reining in, by America’s central bank, of its $85bn-a-month money-printing habit. Last month, as the Fed’s funny-money machine slowed marginally, exchange traded funds focused on shares and bonds from developing nations endured withdrawals of $7bn – a January record. The MSCI EM index of leading emerging market shares shed a painful 9pc, compared to a 1.6pc drop in the S&P500, the bellwether index for Western stocks.
The UK trade with the emerging markets, though, to a relatively small extent. Our exports of goods and services to such economies amounted to 4pc of GDP last year. The equivalent Italian and German figures are 9pc and 14pc respectively, making these economies more vulnerable to an emerging markets slowdown, even if they’re better placed to tap such vital markets in the future.
So this recent emerging market volatility shouldn’t weigh too heavily on UK growth – as long as it doesn’t spark a fully blown global systemic crisis as it did back in 1997. I have many issues with the unbalanced, debt-fuelled nature of this British recovery, given that real wages are still falling and capital investment remains painfully low. But, for now, we’re relatively insulated from the slowdown of the Eastern giants.
Such countries are anyway, in a much better state than they were back in the late-1990s. The large emerging markets generally have much stronger government balance sheets, far less consumer debt and many times more reserves than their Western counterparts. Their underlying economies, with their younger populations and fast-rising productivity will, despite this market wobble, out-perform Western nations for decades to come. This is the economic mega-trend of our age and a few thrills and spills on what remain nascent and still shallow frontier stock markets won’t change that.
The news that emerged on Friday afternoon means this isn’t a column about emerging markets. Instead, it’s about a ruling by Germany’s top court that has the potential to re-open the Eurozone crisis, taking us back to the nerve-wracking summer of 2012, when the entire edifice of monetary union looked as if it would crack.
During August of that Olympic year, European Central Bank supremo Mario Draghi pledged to do “whatever it takes” to prevent single currency break-up. This statement, which a vacationing Angela Merkel didn’t contradict, was taken as a signal that the ECB could, if it chose to, buy large amounts of government bonds issued by essentially bankrupt eurozone nations. And so, as Spanish and Italian yields stopped rising and then retreated, global investors decided the crisis was over.
Ever since, the notion that single currency could implode has been largely off the news radar. Fears that monetary union is a tinderbox, and could spark another Lehman moment, have been shelved. Far from struggling, the euro was actually one of the best-performing major currencies during 2013, rising from around $1.32 to $1.37.
Why? Because Draghi’s famous words were followed by the Outright Monetary Transactions programme, allowing the ECB to buy “unlimited” bonds essentially out of printed money. Once the OMT was announced, the “doom-loop”, within which busted banks and governments drag each other down, was apparently broken. Monetary union was in danger no more.
The trouble is that the OMT isn’t real. Draghi hasn’t purchased a single government bond and nor can he. The OMT can only buy the bonds of countries that can already issue their own paper – so that rules out Greece and Portugal. And it can only be used by nations who’ve already agreed to a bail-out, involving endless humiliating conditions which big countries like Italy and Spain would never accept.
But the main reason the OMT can’t be used is that Germany has never formally approved its formation – and until Berlin does, it remains illegal under European Treaties. And despite the determination of many investors and politicians to conclude that everything is fine, the OMT ultimately amounts to the straight monetization of eurozone government debt, which cuts deep into Germany’s inflation-scarred psyche and is contrary to the ECB’s mandate.
Germany’s constitutional court, after deliberating for months on OMT’s legality, has now sent the case for “consultation” to the European Court of Justice. Such a move is unprecedented and, to justify it, the Karlsruhe-based judges have used the argument that the eurozone’s central bank, as a European body, comes under the jurisdiction of the ECJ.
Confused? The bottom line is that German lawmakers know OMT is too controversial in their home country to approve. Yet, as the metaphysical pillar propping up the Eurozone, it’s too important to strike down too. So they’ve passed the buck to a bunch of ECJ lawyers in Luxembourg.
There are “important reasons to assume” OMT exceeds the ECB’s mandate and infringes the powers of the member states”, the German judges said on Friday. Such words have the potential to re-ignite fears of a Eurozone break-up, fears that, back in 2012, resulted in by far the worst crisis on global markets since the ghastly sub-prime collapse.
My judgment is that the ECJ will eventually rule in favour of OMT, providing their German brethren – who incidentally wear rather bizarre red costumes, complete with flat red hats – with a modium of political cover. Berlin doesn’t want to look as if it has simply caved-in and accepted OMT. Hence the ECJ consultation exercise, to be followed by the inevitable cave-in.
The reality is that, OMT or no OMT, the ECB has, for some years, been breaking the spirit of Eurozone treaties. Since 2009, without overtly resorting to quantitative easing, the central bank’s balance sheet has doubled, as it has quietly absorbed the troubled assets of numerous busted eurozone banks.
Many argue that the eurozone’s banking sector is now “almost fixed”. Yet declared non-performing loans rose last year to 8pc, up from 7pc the year before. In truth, across the continent, banks’ reported financials are so opaque, and so willfully designed to be so, that no-one can really be sure who is, and isn’t solvent. Which, of course, is the point.
If you think the upcoming ex post “legalization” of OMT amounts to a grubby political fudge, wait until the autumn when the first results of an official review into the quality of eurozone bank assets will be unveiled. Previous “stress tests” judged Dexia, the Franco-Belgian lender, Laiki, the Cypriot bank, and Spain’s Bankia to be sound. Just a few months later, they collapsed.
No matter that the results of this renewed “deep audit” are almost certain also to be tosh. This tawdry exercise is needed as a prerequisite of banking union – that other great make-believe pillar of lasting eurozone sustainability.
Having contracted 0.5pc in 2012, the eurozone economy will likely shrink a similar amount this year. Sky-high unemployment in periphery nations means social tensions remain very real. Yet still, the eurocrats and their political masters continue building their monolithic construct, strait-jacketing many millions of workers in a monetary bind, condemning them to live in stagnating economies under the shadow of systemic collapse. Oh, and the UK does around half its trade with the Eurozone. So, yes, we’re pretty exposed too.