The updated Eurozone briefing
Posted: Thursday 30 Aug 2012
UPDATE: 30th, August 2012
That was in the Autumn of 2011 and you can read the original, still relevant briefing here.
The crisis has now dragged on, and so we present our updated briefing. We've kept the original briefing (above) for the sake of transparency and we haven't modified our original views and analysis in the original briefing.
Here, in this updated Eurozone briefing, but have added new sections that refect the questions we have had since the Autumn, including Spanish banks, French and Greek elections and the latest from Berlin.
We hope this is a useful briefing.
Hollande has contributed a crucial shift in the debate from a focus on "austerity yes or no" to "austerity or growth". What is missing is political agreement at the highest levels of European leadership. Right now the debate is focused on how European Central Bank (ECB) President Mario Draghi is trying to promote his future vision for the ECB's role within a more integrated monetary union. Once again, German Chancellor Angela Merkel is resisting the idea that the European Central Bank's mandate - price stability in the Eurozone - should in anyway be changed to include a growth promotion role. Largely, that is because any contribution to growth promotion that the ECB could make would almost certainly contradict its price stability role, at least over the short term, as that change in role would entail ECB stimulus of some kind, and so the risk of inflation, however mild or severe.
So all Hollande and other countries has to do is make a convincing argument that inflation can be controlled in order to persuade Germany to compromise on the role of the ECB?
No, not quite: the argument is also about EU institutions, their proper roles and how Member States will relate to them in the future. Take the example of how, during a meeting in August between Angela Merkel and Italian PM Mario Monti, the latter spoke of how he sees the crisis and Euro itself as fluid. Monti said the situation should: “be seen in the perspective of a broad mosaic...Some things that aren’t possible today under current conditions could become possible tomorrow under different conditions. Modifications to the treaties can be asked for."
Merkel's response was of course very clear: "It is my conviction, as far as the ESM [European Stability Mechanism] is concerned, that a banking license for the ESM is not compatible with the treaties".
The essential issue right now is therefore the legality or otherwise of any moves to solve the Eurozone crisis.
President Hollande is making an essential contribution to the European crisis debate - adding growth to an agenda previously dominated only by austerity - but we are still witnessing an Angela Merkel both stubborn in her committment to resisting Hollande and under pressure from her domestic constituency not to give significant ground.
Why is Germany still so keen on austerity? Surely it's obvious by now that it hasn't worked?
This is the thing: Germany is not keen on austerity only for its own sake, or only because it fits in with the German model of fiscal discipline, but because, as we suggested above, Germans also consider the Eurozone crisis one grand legal debate. In short, most Germans look to Merkel not just to promote sound money management and debt reduction in smaller European countries, but also to act as guard against European leaders and institutions expanding on their mandates while bailing out smaller European countries.
In other words, the sheer tenacity Merkel displays in high-level Eurozone meetings is not just an economic argument, but a legal one too.
That's all very well, but as all this drags out, what's happening to those smaller countries suffering from austerity?
Well, this is just the problem. Countries like Portugal, Greece and Spain are now confronted with only three outcomes: one, deficit deadlines being extended, which is unpopular in Germany and a large part of the current argument, two, further and deeper austerity measures, which will only hurt any prospects of growth in those economies, or three, shared European debt in the form of some kind of Eurobonds or equivalent. That third outcome is the best chance for smaller European countries to achieve sustainable borrowing in order to invest in the sort of growth that will end their need for bailouts.
So what is the problem in a nutshell?
Simple to explain, very hard to solve, the Eurozone crisis remains in essence three concurrent crises: economic, fiscal and political.
Economically, Europe is in crisis because it needs more growth, not just for the jobs countries like Spain so desperately need, where youth unemployment is around 50%, but for that growth that will put an end to market and investor doubts about whether European countries can achieve sustainability in borrowing the sort of money any government needs in order to govern.
Fiscally, Europe's crisis comes in the threat to its single currency. Essentially the question is if the Euro can survive at all, given that some members of the Euro, in essence, cannot afford to borrow their own currency. Excessive sovereign debt has been identified as the problem here, and it has pushed up borrowing rates for smaller countries. However, all debt has now been labelled the problem, and Germany is refusing to acknowledge one essential distinction in solving the crisis - that between individual sovereign debt and pooled sovereign debt. Unsustainable levels of indebtedness in the former may well prove easier to manage if converted to the latter, especially as markets will calm at the removal of the key uncertainty: will Germany back the Euro no matter what?
Politically, the inability to find solutions to the above two issues - how to tackle debt short-term without damaging longer-term growth - has caused a rift between those countries desperate for relief, led by France, and those more concerned at the prospects of losing control over inflation in the Eurozone, led by Germany.
OK, what can we expect now? What's the key?
Former ECB chief economist Jurgen Stark recently described the ECB's current Eurozone rescue measures as a "dangerous path" saying bond-buying was having "negative effects for the credibility of the bank."
Germany must now decide which is the greater risk - a loss of credibility for the European Central Bank, or a loss of credibility for the Euro itself. In short, despite obstacles such as required treaty changes and German public opinion, only when there is a realisation in Germany that German and European security rest on the Euro itself, rather than how strictly it is governed, will the crisis be solved. It may well take until the next German federal elections, scheduled for the latter part of 2013, for this realisation to either occur or be acted on, at which point if Germans themselves are clamouring for more growth, German leadership may align more closely with the French.
For now, it seems only a rapid or dramatic escalation of the crisis could prompt Merkel to soften on the ECB. The risk is that escalation could be a fatal heart attack for the Euro itself. German compromise must come; but how, why and when remain worryingly obscured.
UPDATE JULY 2012
What is going on, who's important and why hasn't the crisis been solved by now?
The crisis has yet to be solved as the essential problem is still the same. A combination of German domestic politics, conservative fiscal governance and historical experience are preventing Chancellor Angela Merkel from accepting shared European debt.
Each of those points is worth considering in full. The first, German politics, is important.
Germans have spent the last decade or so enjoying a hard won economic success story. After German reunification in the 1990s, West Germany saw fit to exchange its currency on a 1:1 basis with East Germany's money, when something more like 4:1 might have been a better reflection of the currencies' respective values. For many in West Germany, this was a form of "bail out," painful but necessary as the former Communist part of Germany was simply too far behind the West ever to be expected to catch up of its own accord. This memory is still fresh - even still resented - with many Germans. Helping out countrymen is one thing, many in Germany simply don't want to rehash the experience with Greece.
In addition, many Germans pride themselves on thrift, and having rejected the credit-card culture of many other European countries while diligently pursuing their strategy of export-led growth and low unemployment, hold negative stereotypes about Greece and other smaller European countries.
Second, Angela Merkel is a fiscal conservative. She does not want to accept the thrust of what most experts consider the way out of the Eurozone crisis: spending, to counter the problem of lacking growth. She is also reluctant to accept Eurobonds in order to tackle her main concern of European sovereign-debt.
Both ideas - stimulus and shared debt - are more socialist than conservative, so do not appeal to Merkel's instincts. In addition, she is under the domestic pressures described above, and so has stuck to her position. Merkel believes it is not only a conservative to reject spending and Eurobonds, but also the popular course of action in Germany.
Of course, Germans do understand the urgency at hand. German Finance Minister Wolfgang Schaeuble recently said "it's clear. We have to attain the next step of political integration in Europe".
"The crisis is forcing the necessary transformations to take place more quickly." But the fiscal aspect of this integration is what German leadership is still reluctant to embrace.
Third, Germany has a troubled past, one in which inflation figures large, something most Germans cite as having contributed to the 20th century disaster of Nazism. When adopting the Euro, Germans only parted company with the Bundesbank - their traditional guardian against such inflation - by stressing the new European Central Bank's mandate was to be nothing more than price controls in Europe, or fighting inflation. As Eurobonds would mean an ECB acting more like the American Federal Reserve, and in essence creating inflation in the Eurozone, many in Germany point to the hyper-inflation of the past and argue passionately for sound money.
OK, the Germans are reluctant to act. What exactly is it they could do to help anyway?
Money. Right now, Europe needs an injection of cash, and following success in its export-led growth strategy, Germany has that cash. Whilst Germany has helped Greece - the most troubled Eurozone country - in the past, it does not want to accept this situation on a permanent basis.
Eurobonds, or any other form of shared debt, would in essence be just that permanent basis, as they would require an explicit guarantee from all Eurozone countries to help one another in times of need. Therefore, Germany has continued with an implicit, and therefore imperfect, offer of help to Greece, at once confusing the issue by attaching the aide to austerity measures that undermine the message of solidarity in a currency union.
So if Germany can help by accepting Eurobonds, but won't, where does that leave us?
Here's the catch, still with Eurobonds - these are the only solution now.
Ironically, the outcome of Germany spending so long in a half-way house - trying to solve a crisis that requires shared debt and spending without accepting either - is that things are now much clearer than before. In other words, Europe is at an urgent cross roads. The choice is clear. Accept that a currency union is also a debt union, or end the euro currency and return to the past in a state of economic and social disjunction.
What will change in Berlin then?
Perhaps more importantly is what changed in Paris - the election of Francois Hollande as President.
Hollande will be able to present an argument to Berlin, not just for Eurobonds - which he supports - but also for less emphasis on austerity, which he, his new government do not and so many ordinary people in Europe do not.
There is also a good chance he will be able to offer Merkel a way out with her own electorate. The German chancellor can now claim French influence in making any compromises, that is, claim she is protecting the Franco-German unity so important to the modern German outlook if she finally accepts the shared European debt that Germans have so far rejected.
What does Greece have to say about all this?
Look out for the Greek election on June 17 for an answer to this question, but in short, Greece is clearly suffering the most from the Eurozone crisis. Riots, protests, the fall of governments and the election of MPs from extreme parties, all these show how Greeks feel passionately about their country's plight.
This is largely because the Greeks are being asked to deal with two issues, one held in common with the rest of Europe, the other their own unique problem.
The first problem facing Greece faces us all: economics. The recession that continues in Europe is of course much more keenly felt in Greece than many other countries. Austerity has demanded much more of Athens than is expected of others. Some commentators feel this is fair, citing Greek accountancy in the past, and others feel it to be counter-productive, pointing to how European unity is on the line. What's most important, however, is the second problem facing Greece - sovereignty. Greeks feel that Berlin, and bodies such as the IMF, are deny Greeks the right to govern themselves.
This has contributed in no small part to the scenes we have all witnessed in Greece. More importantly, it is an issue that is slowly creeping up on the rest of Europe too, insomuch as it will soon become critical that Europe pulls together in news ways in order to end this crisis.
If Greeks are so upset, why doesn't Greece just leave the euro and end the crisis like that?
A Greek exit from the Euro would spell disaster for all concerned. Athens and Berlin must surely know this - hence pulling the trigger on Greek exit has not happened, despite everything to suggest that it might.
Various commentators have different ideas about just what kind of a disaster a Greek exit would mean for Europe and the world economy, but suffice to say that several of issues are in plain sight.
For a start, if Greece is finding it hard to borrow money from international investors now, any exit from the Eurozone would also mean defaulting, actually or in essence, on many debts owed by the Greek state. Nobody would lend to Greece for a very long time, akin to the experience of Argentina today which is still locked out of international money markets following the country's 2001 sovereign default.
Any debts owed would also be dominated in Euros, with only a new, weaker drachma with which to repay them. Questions over Greek membership in the EU would also be raised, perhaps damaging any export advantages Greece would gain from a weaker currency. And the situation would not bode well for richer European countries either: the Euro itself would come under question, and other countries might exit leaving the remaining Eurozone members with a currency considered so safe - and hence so strong - as to be an unworkable liability for any European export success.
This is why a solution must be found, and fast. One factor in this urgency is how Greek banks are losing deposits in the start of something that looks like a mild bank run. This kind of event could lead things out of control very quickly and the banking sector in Europe is as important to aide as are individual countries in solving this crisis.
What about Spanish banks? They are also in the news, so what's happening there?
Spain also has a banking sector under strain, and will now receive up to 100bn Euros in loans to help banks from Eurozone funds.
Eurozone finance ministers - the Eurogroup - decided on the move, saying "the Eurogroup supports the efforts of the Spanish authorities to resolutely address the restructuring of its financial sector and it welcomes their intention to seek financial assistance from euro area Member States to this effect."
"The financial assistance would be provided by the EFSF/ESM for recapitalisation of financial institutions... The Eurogroup considers that the Fund for Orderly Bank Restructuring (F.R.O.B.), acting as agent of the Spanish government, could receive the funds and channel them to the financial institutions concerned."
All this is a very technical way of saying that the EFSF (European Financial Stability Facility, explained above in the original briefing) is being used for the purpose for which it was set up: "to safeguard financial stability in Europe by providing financial assistance to euro area Member States." This can only be welcomed by anyone with an interest in seeing this crisis end, which must include Britain and its trading interests with Europe.
France and Germany will find a way to agree, helping Greece stay in the Euro. Spanish banks will still have questions raised over them, but any extra money needed will be smaller than the amount offered from the Eurogroup, itself a sum which will go a long way to solving problems - both current and potential - in the Spanish banking system.
Things are of course urgent. Watch the Greek election of June 17 keenly, as it will decide a great deal. However, Hollande and Merkel will know that this following period is the final chance to save the Euro, and they will act.
Read more from Claude Moraes MEP on all the key issues:
Read and watch the latest events as they unfold:
Posted by: Admin on Thursday 30 Aug 2012
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