Germany, Greece, and the Euro...

Let the Greeks ruin themselves

Germany has Europe’s deepest pockets, but it does not want to pay to save troubled euro-zone economies

Feb 18th 2010 | BERLIN | from the print edition

LESS than a year before the euro became the currency of 11 European countries in January 1999, a declaration signed by 155 German-speaking economists called for an “orderly”—ie, long—delay. The prospective euro members, they said, had not yet reduced their debt and deficits to suit a workable monetary union; some were using “creative accounting” to get there, and a casual attitude towards deficits would undermine confidence in the euro’s stability.

Now the prediction is coming true, says Wim Kösters, of the Ruhr University in Bochum and one of the original signatories. ...

This dilemma is felt especially keenly in Germany. It was a wrench to surrender the Deutschmark, symbol of post-war recovery and economic success. On the eve of monetary union 55% of Germans were against it, making their nation the euro zone’s most reluctant founders. When a “rescue” is mentioned, all eyes fix on Germany, Europe’s biggest economy and most creditworthy borrower. Germans fear that a rescue of Greece would, in effect, extend their welfare state to the Mediterranean.

... A harsh austerity plan, they hope, will be enough to deter speculators—and to reassure their voters at home that Greece is not getting off lightly. The model is Ireland, whose brutal spending cuts restored market confidence without aid from its European neighbours.

A bail-out, Mrs Merkel fears, would break the bargain Germany struck in accepting the euro: that the single currency’s members would never jeopardise its stability nor ask Germans to pay for anyone else’s mismanagement. ...

The path out of the crisis is unclear. Greek bonds remain under pressure (see chart). Arguments rage over which chain reaction would be more damaging: serial bail-outs or serial defaults. ...

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How to save the euro


It requires urgent action on a huge scale. Unless Germany rises to the challenge, disaster looms


Sep 17th 2011 | from the print edition

... It is a sobering thought that so much depends on the leadership of squabbling European politicians who still consistently underestimate what confronts them (see article). But the only way to stop the downward spiral now is an act of supreme collective will by euro-zone governments to erect a barrage of financial measures to stave off the crisis and put the governance of the euro on a sounder footing.

The costs will be large. Few people, least of all this newspaper, want either vast intervention in financial markets or a big shift of national sovereignty to Europe. Nor do many welcome a bigger divide between the 17 countries of the euro zone and the EU’s remaining ten. It is just that the alternatives are far worse. That is the blunt truth that Germany’s Angela Merkel, in particular, urgently needs to explain to her people.

... A rescue must do four things fast. First, it must make clear which of Europe’s governments are deemed illiquid and which are insolvent, giving unlimited backing to the solvent governments but restructuring the debt of those that can never repay it. Second, it has to shore up Europe’s banks to ensure they can withstand a sovereign default. Third, it needs to shift the euro zone’s macroeconomic policy from its obsession with budget-cutting towards an agenda for growth. And finally, it must start the process of designing a new system to stop such a mess ever being created again.

... So far the euro zone’s response has relied too much on two things: austerity and pretence. Sharply cutting budget deficits has been the priority—hence the tax rises and spending cuts. But this collectively huge fiscal contraction is self-defeating. By driving enfeebled economies into recession it only increases worries about both government debts and European banks (see article). And mere budget-cutting does not deal with the real cause of the mess, which is a loss of credibility.

... Instead of austerity and pretence, a credible rescue should start with growth and, where it is unavoidable, a serious restructuring of debt. Europe must make an honest judgment about which side of the line countries are on. Greece, which is unambiguously insolvent, ought to have a hard but orderly write-down. ... Freeing up services and professions, privatising companies, cutting bureaucracy and delaying retirement will create conditions for renewed growth—and that is the best way to reduce debts.

How to prevent contagion? ... Core countries like Germany and the Netherlands have enough cash to look after their own banks, but peripheral governments may need euro-zone money. Ideally that would come from the European Financial Stability Facility (EFSF).... But it also makes sense to set up a euro-zone bank fund, together with a euro-zone bank-resolution authority. ...

None of this will work unless the Europeans create a firewall around the solvent governments. That means shoring up euro-zone sovereign debt. Spain and Italy owe €2.5 trillion. ... The ECB must declare that it stands behind all solvent countries’ sovereign debts and that it is ready to use unlimited resources to ward off market panic. That is consistent with the ECB’s goal to ensure price and financial stability for the euro zone as a whole. ...

Even so, this is a huge step. The ECB’s German officials have taken to resigning in protest at the limited bond-buying undertaken so far. ...

The issue now is not whether the euro was mis-sold or whether it was a terrible idea in the first place; it is whether it is worth saving. Would it be cheaper to break it up now? ... The sobering truth about the single currency is that getting in is a lot easier than getting out again. Legally, the euro has no exit clause. ...

Attaching hard numbers to any of this is difficult. Analysts at UBS, a bank, reckon that euro break-up could cost a peripheral country 40-50% of GDP in the first year, and a core country 20-25% (see article). ... [T]he immediate bill for a break-up of the single currency would surely be in the trillions of euros. By contrast, a successful rescue would seem a bargain. ...

German taxpayers might accept that the immediate costs of our rescue plan are smaller than break-up. But what they detest is the idea that it might let feckless Italians and Portuguese off the hook. Safe in the knowledge that the ECB stands behind their bonds, they may shy away from reform and rectitude.

Two risks flow from this. The immediate (and real) one is that furious Germans will demand that Greece is thrown out (or bullied out) of the euro to frighten the others. Such a horrific event would indeed scare Portugal and Ireland, but a threat to expel Italy or Spain is empty: they are too big and too tightly tied into the EU. Simply chucking out Greece because it was convenient would permanently undermine the security of small members of the EU. Besides, once Greece defaults and restructures, its economy stands a good chance of making a credible start on its long journey to economic health.

The longer-term risk has to do with “more Europe”. Fans of political integration say that the only way to enforce discipline is to create a United States of Europe (see Charlemagne). ... The ten countries, including Sweden, Poland and Britain, that kept their own currencies may face a choice: to join the euro or be excluded from a new “core Europe”, which in effect starts setting policies. ...

... The euro has reached the point where nobody is going to get what they want—something that needs to be spelled out to the Germans more than anybody. ... For the ECB to stand behind less prudent countries may be unwelcome to Germans; but letting the euro fall to bits is much, much worse. Spell that out clearly to your voters, Mrs Merkel.

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The future of the EU


Two-speed Europe, or two Europes?


Nov 10th 2011, 2:23 by Charlemagne | BRUSSELS

NICOLAS Sarkozy is causing a big stir after calling on November 8th for a two-speed Europe: a “federal” core of the 17 members of the euro zone, with a looser “confederal” outer band of the ten non-euro members. ...

You cannot make a single currency without economic convergence and economic integration. It's impossible. But on the contrary, one cannot plead for federalism and at the same time for the enlargement of Europe. It's impossible. ... We are 27. We will obviously have to open up to the Balkans. We will be 32, 33 or 34. I imagine that nobody thinks that federalism—total integration—is possible at 33, 34, 35 countries. ... [T]he single currency is a wonderful idea, but it was strange to create it without asking oneself the question of its governance, and without asking oneself about economic convergence. 

... The European Union is, in a sense, made up not of two but of multiple speeds. ... But Mr Sarkozy’s comments are more worrying because, one suspects, he wants to create an exclusivist, protectionist euro zone that seeks to detach itself from the rest of the European Union. ...

In other words, France, or Mr Sarkozy at any rate, does not appear to have got over its resentment of the EU’s enlargement. At 27 nations-strong, the European Union is too big for France to lord it over the rest and is too liberal in economic terms for France’s protectionist leanings. Hence Mr Sarkozy’s yearning for a smaller, cosier, “federalist” euro zone.

This chimes with the idea of a Kerneuropa ("core Europe") promoted in 1994 by Karl Lamers and Wolfgang Schäuble, who happens to be Germany's current finance minister. Intriguingly, it is the first time that Mr Sarkozy, once something of a sceptic of European integration, has spoken publicly about “federalism”.... It echoes the views of Mr Sarkozy's Socialist predecessor, François Mitterrand.

... Mr Sarkozy probably wants to create a euro zone in France’s image, with power (and much discretion) concentrated in the hands of leaders, where the “Merkozy” duo (Angela Merkel and Nicolas Sarkozy) will dominate. Germany will no doubt want a replica of its own federal system, with strong rules and powerful independent institutions to constrain politicians. ...

Done properly, by keeping the euro open to countries that want to join (like Poland) and deepening the single market for those that do not (like Britain), the creation of a more flexible EU of variable geometry could ease many of the existing tensions. ... But done wrongly, as one fears Mr Sarkozy would have it, this will be a recipe for breaking up Europe. Not two-speed Europe but two separate Europes. ...

Mr Sarkozy’s words seem to have caught the attention of Joschka Fischer, elder statesman of Germany's Green party and a former foreign minister, who said that the EU at 27 had become too unwieldy. “Let’s just forget about the EU with 27 members—unfortunately,” he told Die Zeit, a German weekly newspaper. “I just don’t see how these 27 states will ever come up with any meaningful reforms.” Indeed, some think the euro zone itself might be smaller than the 17 members (Greece may soon default and leave the euro).

The speech that everybody is waiting for now is Mrs Merkel’s. The chancellor wants to change the treaties, and on November 9th she called for “a breakthrough to a new Europe”. ...

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The German problem


To save the single currency, Angela Merkel must take on her own country’s economic establishment


Nov 19th 2011 | from the print edition

... At her party’s conference on November 14th the chancellor, Angela Merkel, left no doubt about the gravity of the euro crisis (see Charlemagne). “If the euro fails, then Europe fails,” she said.

On the same day Jens Weidmann, the president of the Bundesbank, roiled financial markets with hardline comments ... [ruling out reliance on] the European Central Bank (ECB) as a lender of last resort to governments, arguing it would be illegal and wrong for the bank to hold down bond yields. ...

Mr Weidmann is not a lone ideologue. Mario Draghi, the ECB’s new Italian president, has ruled out acting as a lender of last resort to governments, albeit less categorically (see article). Mr Weidmann has his supporters among the Finns and the Dutch, too. But the rigidity of his argument is embedded in the solid rock that is Germany’s economic establishment, which holds that big rescues are counterproductive because they both dull governments’ incentives to act and create new dangers. ...

The problem is that the dogmatic prescriptions of the “German orthodoxy” are pushing the single currency towards collapse. If Mrs Merkel wants to save the euro, therefore, she must challenge her country’s economic establishment, and explain to voters why the revered Bundesbank’s rigidity is wrong. ... German orthodoxy ignores the possibility that rising bond yields are being driven by a self-fulfilling panic in financial markets. ...

The euro zone’s most recent plan—to amplify the existing rescue fund with financial engineering and money from China—has failed miserably. ... Either Europe’s governments will have to assume explicitly some joint liability for each other’s debts. Or they will have to do so implicitly, by allowing the ECB to counter a panic with purchases of government bonds: in effect, letting it act as a lender of last resort. The danger lies in eschewing both options. ...

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Is this really the end?

Unless Germany and the ECB move quickly, the single currency’s collapse is looming

Nov 26th 2011 | from the print edition

EVEN as the euro zone hurtles towards a crash, most people are assuming that, in the end, European leaders will do whatever it takes to save the single currency. That is because the consequences of the euro’s destruction are so catastrophic that no sensible policymaker could stand by and let it happen.

A euro break-up would cause a global bust worse even than the one in 2008-09. The world’s most financially integrated region would be ripped apart by defaults, bank failures and the imposition of capital controls (see article). ...

Yet the threat of a disaster does not always stop it from happening. The chances of the euro zone being smashed apart have risen alarmingly, thanks to financial panic, a rapidly weakening economic outlook and pigheaded brinkmanship. ...

Add the ever greater fiscal austerity being imposed across Europe and a collapse in business and consumer confidence, and there is little doubt that the euro zone will see a deep recession in 2012—with a fall in output of perhaps as much as 2%. That will lead to a vicious feedback loop in which recession widens budget deficits, swells government debts and feeds popular opposition to austerity and reform. Fear of the consequences will then drive investors even faster towards the exits.

Past financial crises show that this downward spiral can be arrested only by bold policies to regain market confidence. ...

Without a dramatic change of heart by the ECB and by European leaders, the single currency could break up within weeks. Any number of events, from the failure of a big bank to the collapse of a government to more dud bond auctions, could cause its demise. ...

The only institution that can provide immediate relief is the ECB. As the lender of last resort, it must do more to save the banks by offering unlimited liquidity for longer duration against a broader range of collateral. ... One promising idea, from Germany’s Council of Economic Experts, is to mutualise all euro-zone debt above 60% of each country’s GDP, and to set aside a tranche of tax revenue to pay it off over the next 25 years. Yet Germany, still fretful about turning a currency union into a transfer union in which it forever supports the weaker members, has dismissed the idea.

This attitude has to change, or the euro will break up. ... Debt mutualisation can be devised to stop short of a permanent transfer union. Mrs Merkel and the ECB cannot continue to threaten feckless economies with exclusion from the euro in one breath and reassure markets by promising the euro’s salvation with the next. Unless she chooses soon, Germany’s chancellor will find that the choice has been made for her.

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HOW GERMANY COULD SAVE THE EURO

25 NOVEMBER 2011

BY John Muellbauer, Official Fellow, Nuffield College; Professor of Economics, Oxford University (Originally published at VOXEU)

For months economists have been arguing that Germany holds the key to ending the Eurozone crisis. Should it relax its anti-inflation stance and allow the ECB to inflate away sovereign debt? Or should it write a cheque of its own to the EFSF? Neither, says this column. ... Eurobonds are the answer – but with conditions.

... The German Ministry of Finance could offer a two-year loan to the Italian government at 3% above what it pays, and promise that next year, if the Italian reform programme is showing visible signs of success, the spread could fall to 2.5% and then to 2% if progress continues. With backsliding, the cost would rise. This solidarity gesture would be highly profitable for the German taxpayer. The conditionality of the offer would keep the new Italian government committed to reform, aiding Italy’s credibility as a Eurozone member. Conventional Eurobonds, meanwhile, with the same funding costs for every country but with risk collectively underwritten, would likely be a recipe for disaster. They would encourage lax fiscal policy, backsliding on reform, and moral hazard. ...

Conditional Eurobonds would institutionalise, for all Eurozone countries, the simple example above of Germany lending to Italy. The conditional Eurobonds, issued on new borrowing, would be collectively underwritten by member governments of the Eurozone. ... The proceeds of the payments could be distributed in several ways. In the simple example of a bilateral loan from Germany to Italy, Germany would retain the entire spread. With multilateral underwriting, all Eurozone countries would receive shares of the payments into the central fund. The shares would be determined by the size of their own borrowings and their spreads relative to Germany. Per unit of borrowing, less risky countries such as France would receive more than riskier countries such as Belgium, but less than Germany itself. ...

A hugely important point about conditional Eurobonds with spreads is that they address the German fear about the Eurozone becoming ‘a transfer union’. The point is also not made clearly enough that this kind of bond, by creating the right fiscal incentives, allows a kind of fiscal decentralisation or subsidiarity....

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Beware of falling masonry

The crisis in the euro area is turning into a panic and dragging the zone into recession. The risk that the currency disintegrates within weeks is alarmingly high

Nov 26th 2011 | from the print edition

FIRST Greece; then Ireland and Portugal; then Italy and Spain. Month by month, the crisis in the euro area has crept from the vulnerable periphery of the currency zone towards its core, helped by denial, misdiagnosis and procrastination by the euro-zone’s policymakers. Recently Belgian and French government bonds have been in the financial markets’ bad books. Investors are even sniffy about German bonds....

Worse, there are signs that the euro zone’s economy is heading for recession, if it is not there already. Industrial orders in the euro zone fell by 6.4% in September, the steepest decline since the dark days of December 2008. ...

European banks are dumping the bonds of the least creditworthy, and other assets, in an attempt to conserve capital and improve cashflow as a full-blown funding crisis looms. Governments are promising ever more severe budget cuts in the hope of pacifying bond markets. The direct result of these scrambles is a credit crunch and a squeeze on aggregate demand that is forcing Europe into recession. ...

Consider the three ingredients for recession: a credit crunch, tighter fiscal policy and a dearth of confidence. ... A downturn of such severity will hugely increase the pressures within the zone. Investors will be even less willing to finance banks, as more garden-variety loans to businesses and householders turn bad. As unemployment rises, tax receipts will go down and welfare payments up, making it harder for governments to rein in their deficits and hit the targets they have set, and causing bond markets to question their solvency more pointedly still.

... With a few exceptions, the benchmark cost of credit in each euro-zone country is related to the balance of its international debts. Germany, which is owed more than it owes, still has low bond yields; Greece, which is heavily in debt to foreigners, has a high cost of borrowing (see chart 2). Portugal, Greece and (to a lesser extent) Spain still have big current-account deficits, and so are still adding to their already high foreign liabilities. Refinancing these is becoming harder and putting strain on local banks and credit availability.

The higher the cost of funding becomes, the more money flows out to foreigners to service these debts. This is why the issue of national solvency goes beyond what governments owe. The euro zone is showing the symptoms of an internal balance-of-payments crisis, with self-fulfilling runs on countries, because at bottom that is the nature of its troubles. ...

The prospect that one country might break its ties to the euro, voluntarily or not, would cause widespread bank runs in other weak economies. Depositors would rush to get their savings out of the country to pre-empt a forced conversion to a new, weaker currency. Governments would have to impose limits on bank withdrawals or close banks temporarily. Capital controls and even travel restrictions would be needed to stanch the bleeding of money from the economy. Such restrictions would slow the circulation of money around the economy, deepening the recession.

External sources of credit would dry up because foreign investors, banks and companies would fear that their money would be trapped. A government cut off from capital-market funding would need to find other ways of bridging the gap between tax receipts and public spending. It might meet part of its obligations, including public-sector wages, by issuing small-denomination IOUs that could in turn be used to buy goods and pay bills. ... Scrip of this kind becomes, in effect, a proto-currency. In a stricken euro-zone country, it would change hands at a discount to the remaining euros in circulation, foreshadowing the devaluation to come. To pre-empt further capital outflows, a government would have to pass a law swiftly to say all financial dealings would henceforth be carried out in a new currency, at a one-for-one exchange rate with the euro. The new currency would then “float” (ie, sink) to a lower level against the abandoned euro. The size of that devaluation would be the extent of the country’s effective default against its creditors.

... [T]he likeliest trigger for a disintegration of the euro is unknowable. But there are plenty of candidates. One is a failed bond auction that forces a country into default and sends a shock wave through the European banking system. ... Another danger is a disagreement between Greece and its trio of rescuers (the EU, the IMF and the ECB) over the conditions of its bail-out. ...

The few left in the euro (Germany and perhaps a few other creditor countries) would be at a competitive disadvantage to the new cheaper currencies on their doorstep. As well as imposing capital controls, countries might retreat towards autarky, by raising retaliatory tariffs. The survival of the European single market and of the EU itself would then be under threat.

Such a disaster can still be averted. The ECB might launch a programme of bond-buying on the pretext that a deep recession in the euro area threatens deflation. If done on the scale that the Bank of England has undertaken, it could restore stability to Europe’s panicky bond markets. ... But any lasting stability for the euro must lie with governments, particularly in the degree to which they are willing to give up fiscal sovereignty in return for pooling liabilities. Germany stands firmly at one extreme of this debate. Its chancellor, Angela Merkel, wants big changes to force probity..., but has opposed the idea of jointly guaranteed “Eurobonds”. German officials have argued that any open-ended commitment to joint liabilities would encourage errant governments to profligacy, violate Germany’s constitution and raise its borrowing costs. Even now, the head of the Bundesbank, Jens Weidmann, appears to believe that the imposition of fiscal rigour will be enough to restore calm to Europe’s bond markets.

... Another new proposal is intriguing—thanks, in part, to its provenance. Germany’s Council of Economic Experts recently proposed a “European Redemption Pact”. This scheme would place the debt, in excess of 60% of GDP, of all euro-zone governments not already in IMF rescue plans into a jointly guaranteed fund that would be paid off over 25 years. Modelled in part on the federal government’s assumption of the debt of America’s states begun by Alexander Hamilton in 1790, the fund would provide joint liability for these debts under strict conditions. ...

At its peak, the redemption pact would be huge: the joint liability would amount to €2.3 trillion. But it would technically be temporary. For all these safeguards, Germany’s government has so far poured cold water on the idea. But time is running out. And the scale of the impending catastrophe demands radical answers.

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Can Germany save Europe? Will it?

By Thomas Mucha, Created 6220-11-29 13:22

An extraordinary plea today aimed at Berlin. It comes from an unlikely place.

Europe's ongoing debt crisis took another very dramatic turn today.

And it came from a most unlikely place, considering Germany's long and difficult history: Poland.

Here's what Polish foreign minister Radoslaw Sikorski said in a speech Monday in the German capital, as reported by the Financial Times [3]:

"I demand of Germany that, for your own sake and for ours, you help it survive and prosper,” he said. “You know full well that nobody else can do it. I will probably be the first Polish foreign minister in history to say so, but here it is: I fear German power less than I am beginning to fear German inactivity. You have become Europe’s indispensable nation."

... It's an incredibly lucid and forthright account of the troubles facing Europe (and Germany) right now, so I'll point you to three more key points that the Polish diplomat made.

... Sikorski ended his Polish pep talk with this dire warning:

"What, as Poland’s foreign minister, do I regard as the biggest threat to the security and prosperity of Poland in the last week of November 2011? It’s not terrorism, and it’s certainly not German tanks. It’s not even Russian missiles which President Dmitry Medvedev has just threatened to deploy on the EU’s border. The biggest threat to the security of Poland would be the collapse of the eurozone."