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Germans Dig In As Eurostorm Calms

The eurocrisis is a marathon, not a sprint, Chancellor Angela Merkel told the German parliament yesterday.  Thanks to the massive, Fed-organized central bank interventions of the last couple of days, she could be right.

While the European financial system is still under great stress, world business leaders are not going to bed at night wondering if the financial system will still be there in the morning as they were last weekend and early this week.  The euro is back to being in trouble as opposed to being on its last legs.

It is not clear how long this new quasi-calm will last, but Germany has won a big victory in its game of chicken with France.  Germany let the markets tremble on the edge of the abyss and did not blink; the ECB did not become the lender of last resort for troubled European states and the financial system held.

Merkel was encouraged in her decision not to panic because her voters have kept their heads.  A new article in the Financial Times notes that German consumer confidence is growing ahead of the Christmas shopping season:

It is not as if people are not anxious. Germany would not be Germany without a healthy dose of angst. They are worried about the euro, and the safety of their savings. They are worried about government debt and the return of inflation. But they simply do not share the view that the eurozone is in imminent gdanger of collapse. […]

Glühwein merchants rejoice; it is going to be a good year.

Merkel and her compatriots have resisted the efforts by financial markets and the PIIGS and allies to stampede her into accepting eurobonds, joint debt guarantees or otherwise extending Germany’s credit umbrella to its beleaguered neighbors.

Now comes the hard part.  Germany is ready to help the other European countries if the conditions are right.  Germany wants the other euro countries to adopt much more rigid fiscal standards than they like.  This implies massive social change in countries like Italy, Greece and Spain.  They can only have the welfare states they can pay for; Germany can afford a very large one.  With balanced budgets, Italy’s would have to shrink.

It is not just entitlements and social programs.  All democratic systems embrace political favor swapping to some degree.  You vote for my earmark and I will vote for yours.  But in most of southern Europe, the link between national politics, local politics and business is much closer and more incestuous than in many northern countries.  This implies a loosely managed national budget; there has to be enough gravy to go around.

Germany wants to shut down the gravy train; this effort faces many obstacles.  In the first instance, some very clever people will now try to write regulations and treaty articles that look tight enough to make the Germans happy, but that when administered by bureaucrats and tested by lawyers and courts will turn out to have enough loopholes and workarounds so that nothing much will change. There are some extremely clever civil servants in Italy, France and Spain.  Look for some elegant proposals to emerge.

Now that the Germans have been roused — the dragon has heard the footsteps of robbers approaching the treasure hoard — they will be more vigilant than usual in trying to protect themselves against Latin chicanery.  But the task of the German negotiators will be tricky: there are practical limits to how strict European requirements can be, how stringent the penalties can be, and how rigid the procedures by which violations can be assessed and consequences imposed.  In dealing with those natural limits, the skilled and subtle drafters and diplomats from the Latin capitals will have many opportunities to introduce language that will undermine German demands even as they appear to yield to them.

More, Italy is likely to have a lot of power in these negotiations.  Greece could drop out of the euro and many would see that as simply remedying the mistake made when Greek politicians lied and cheated their way into it.  An Iberian departure (Portugal and Spain) would be regretted, but if Italy is forced from the eurozone both the economic and political consequences would be so grave, to the Italians but also to the rest of Europe, that some kind of catastrophe would likely ensue.

Italians are good at playing weak hands.  They will use the fragility of their economy and the their importance to Europe for all it is worth to make any new European monetary system flexible enough for their current political system to survive.

The underlying impasse at the heart of the eurocrisis remains.  Everyone wants a European monetary system, but the Germans won’t enter a Latin monetary system, and Latin Europe can’t live in a German one.  Something will have to give: either one side or the other must cave, or Europe must give up its common currency.

At any moment, the crisis could become urgent once more.  But if that doesn’t happen, and negotiations over the future of the eurozone shift into bureaucratic trench warfare, watch out.  Chancellor Merkel, to say nothing of the rest of us, will grow very weary by the time the marathon comes to an end.  And Germany will have to beware; it faces smart and desperate negotiating partners who will use every resource at their command to fight the kind of Europe that Germany wants to build.

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  • OJFL

    I think the Euro is doomed Mr. Mead. There is no political will to dismantle the entitlement states that have been built in what you call the Latin Europe. And there is also political animus towards Germany dictating how the rest of Europe should behave. I see no solution.

  • Otiose8

    The possibility of ECB acting as lender of last resort for bank depositors and for bank holdings of sovereign debt are two very different proposals that in the media are often confused. The former while flawed might work, but the latter won’t in part because no amount of German ingenuity in signed agreements can overcome those extremely clever civil servants in Italy etc. The cuts needed will not happen until the markets cut off funds.

    However, most of the big banks including German ones in Europe have hopeless levels of sovereign debt holdings, and will need to be recapitalized. How that is to be done remains open as does who will pay.

    Perhaps the ECB will be seen as a convenient vehicle to transfer the bad holdings of such debt from private to ‘public’ hands to be dealt with later.

    As long as the ECB restricts its purchases the regulators within each country are motivated to pressure their own banks to hold existing and even buy more of new issues (their own not others), but once a policy is adopted that induces the ECB to expand purchases of bonds in order to hold interest rates to some low level, it will be hard not to buy secondary offerings. And the incentives for banks and their regulators to be the first out the door unloading their holdings will be immense. Such a policy will be an opportunity for the EU to collectivize their national exposures – transfer private debt into public cost. It’s another way to delay matters that will be hard to resist.

  • Rand Millar

    The outcome of the crisis need not be either the Eurozone as is or reversion to the previous national currencies. Instead, two European monetary unions based on congeniality of national temperaments seems most practical. The French have long wished to be supreme in their own pond; let them lead a Latin currency zone including the Sicilies and Wallonia. By contrast, Germany would be the natural center of gravity for a differently-minded currency union including Flanders and Finland.

  • Todd

    It is worth mentioning again that during decades of prosperity, in addition to creating cushy welfare states, the Europeans (including the Germans) abandoned any effort to provide for their own national defence-why bother if they can get th US taxpayers to do it.

  • Mrs. Davis

    The French didn’t blink, the Fed did.

    Now the American taxpayer should be staying awake wondering from whom they will collect all the dollars they have promised to extend to European banks.

  • Jacksonian Libertarian

    The PIIGS aren’t going to change until they are forced to change, and the EU and Euro countries lack the force to change them. They will continue to kick the can down the road until they default, then the bond holders will get the haircut. The last thing they will do will be to cut government spending. They are going to suffer, as it takes suffering and pain to change a culture, because cultures always learn the hard way.

  • Luke Lea

    The best thing I learned today was by Carl-Ludwig Holtfrerich, a German economic historian and student of inflation, in this INET interview. He compares the situation in Europe today with one in the U.S. in 1840, in which several states defaulted on their bonds. Towards the end of the interview he speculates that the ECB, the Fed, and other central banks around the world will join together to paper over the crises for a couple of years or so, to give the banks exposed to Greece, Portugal, etc., time to unload some of their bad debts, or pawn them off on unsuspecting taxpayers, after which those countries will exit the Eurozone and go their own way. In other words, a temporary world central bank just to get by. A new way to kick the can down the road. Who knows? It may lead to something good.

  • Frank Arden

    The great liberal effort to create, by treaty, a United States of Europe has failed. Even if the current financial crisis is abated and averted for a time, the EU has failed because there was never created anything remotely resembling a union.

    It is easy and convenient to create almost anything when times are good, as times have been in Europe for the last twenty years, but it is another thing altogether to maintain that artificial creation when times are not.

    The European Union is not a union. It is a mere partnership created by treaty, by contract, an easy construct, and I am reminded of the English Common Law test of a partnership that holds that a true partnership exists when there is a difficult sharing of mutual losses as against the easy sharing of profits.

    The primary thought that argues against the EU is that a contrived cohesion of political union, even with the ties of geography, cannot form a true federal system against the thick gravities of sovereignty, language, culture, national character, law, and economic interest.

    In contrast, the United States of America coalesced as a geographic polity of British colonies primarily because of common language, common culture, common character, common law, common experience, and common economic interest.

    These shared polities allowed for a union that provided a federal system of shared sovereignty under the Constitution.

    The EU is not bound by a constitution, but by only a treaty among sovereign nations. The assumptions of union are being tested today. The RU has maintained its “union” up to now with the sharing of profits. Can it withstand the test of the sharing of losses?

    Will Greece, Ireland, Portugal, Spain and Italy forfeit their democratic sovereignty as Germany’s bailout tells them how to spend their money, how much they cannot spend, how much they may borrow, and when to retire? Nein, ist verboten!

    We’ll see.

    The problem of debt assumption (or bailout) was met by the United States in its infancy. The war debts of the Revolution had been mostly repaid by the southern states and unpaid by the wealthier, more populated northern states. This was a national problem.

    Would the southern states share the loss with the northern states in a true test of partnership? Would the southern states “bailout” the northern ones? What was in it for them?

    The solution came under a common polity of federal unity where a compromise was possible. In exchange for the national assumption of the northern states’ debt, the southern states forced a compromise.

    The southern states bargained that the national assumption of the northern states’ debt would require the national capitol to be located in the South, along the Potomac River, shared by the southern states of Virginia and Maryland, not on New York’s Hudson.

    This deal was cut between a farmer from Virginia over dinner with his guest, a banker from New York. I’ve always wondered how much of Thomas Jefferson’s Madeira Alexander Hamilton consumed before he agreed to the deal. At least they had no disagreement about the wine.

    As for the EU, what, oh what to serve in Brussels: Greek Orzu or a German Riesling?

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