Don’t expect this to be over before 2013
I’ve talked before about laying out why I doubt we will find a definite solution to the Eurozone crisis in my two previous posts on this subject (I, II). So, after a crazy Greek day yesterday, here goes.
While the Greek Prime Minister’s announcement of a forthcoming referendum – which might or might not actually take place – impacts this analysis to some extent, it does so only on the fringes. If the Greek public were to disapprove of the most recent measures agreed upon by the Eurozone, Greece most likely will be dropped by Europeans and then – officially – go bankrupt. In this scenario Greece will probably be forced to not just leave the Euro but because of legal restraints the European Union also – ironically taking away the common market, which in theory holds the biggest promise for a currency-deflated Greek economy. Greece in other words would go through a harsh, sudden recession, but then it will go through a maybe less harsh but probably longer recessionary period otherwise. Who knows which one of those evils were actually worse for the Greek population, I tend to believe that leaving the Euro would be less advantageous (at least even more disadvantageous), but that is not the question I am looking to answer here. For the Eurozone as a whole, a Greek default and the end of its Eurozone (and EU) membership would not fundamentally change any of the underlying structural problems and imbalances of European Monetary Union without an accompanying fiscal or economic governance union. In fact, speculative attacks (and rising interest rates in the periphery) would more than eradicate the benefits of the biggest intra-Eurozone debt imbalance falling out. The overall picture of the Eurozone being obliged to work towards a resolution to these problems, this crisis, would not change thus.
As discussed on this blog, last week’s summit conclusions serve as another temporary fix to a problem that is two-fold. The main and underlying problem lies with a common market and currency for differing economies with no fiscal transfer and de fait limited labor mobility serving as a valve to assuage emerging capital and currency account imbalances. There are tepid signs of the EU’s labor market truly Europeanizing itself with for example Spaniards increasingly moving to Germany (you should walk around Berlin one of these days!), this process is developing at a crawling rate though and comes far too late to solve the current crisis. The second main cause for this crisis or rather the way it is being played out on the markets, lies with the differing perceptions of time and the speed of developments within the political and the financial realm. International agreements move slow, look at international climate change negotiations or WTO-trade rounds if you believe this is only true for EU negotiations. Financial markets of course are acting within seconds of whatever event dominates the day (even faster with computerized trading), markets want a satisfactory proposal to ease their doubts on the Eurozone not today but yesterday.
Whenever a positive agreement is reached then, euphoria fuels a short rally before traders (and others) realize that once again an enduring solution has not been reached. On the other side of the coin European Union leaders – justly so – believe they have acted with unprecedented speed in bringing about bailout packages (remember the no bailout clause anyone?) and bringing about structural change to the Eurozone (with the EFSF, the ESM, the six-pack in economic governance, and now envisaged treaty changes and other moves towards common economic governance). While politicians are moving with unheard of speed – in light of their usual decision-making mode – they are moving far too slow for markets measuring time in far smaller units. Neither of these will change and we can expect the current cycle of emergency summits, inconclusive conclusions leading to short-term rallies and once again rising interest rates for periphery states to continue for at least another year, maybe even two or three.
The reasoning for this belief can be laid out rather easily. The German government is extremely reluctant to pour additional money into bailout-programs that are at an increasing speed seen as insufficient anyway. With Germany as the most relevant AAA-rated country essential for any kind of conclusive solution, this is the baseline that we are operating from. One way to work around this would be for the ECB to either buy up much more debt itself (or at least promise to continually do so, which would in itself put a significant damper on speculation) or to allow the EFSF to tap into the ECB to do the same. Germany of course is opposed to either of these options also. While it has – de facto – veto power over anything the EFSF does, its influence on ECB decision-making is more limited. Yet, it seems doubtful that the ECB will massively act against its biggest contributor, the Bundesbank, on this issue. In other words, while monetization will remain an option to temporarily assuage interest pressure on the periphery and will – I would guess – increasingly be relied on, it looks like an unlikely end-all solution considering the the ECB’s charta and astounding – and seemingly exaggerated – fear of inflation.
With both of these options out for the time being we are then looking at what Germany will allow in terms of an incrementally growing bigger commitment to a stability union, to common economic governance, even a European economic union and the dreaded fiscal union. The Eurozone has only started out on this path. It will require treaty change, which in turn will have to be ratified in national parliaments maybe even via referendums in some countries. It might also require constitutional change in Germany because of the Constitutional Court’s strict limits imposed on the Bundestag’s powers to sign away its own constitutional budgetary prerogatives. All of this will take time. Most importantly though, the current German government will not go any step further than absolute necessary to prevent the Eurozone from blowing up. For Germany to underwrite some of the debt currently carried by Southern Europeans a new government from 2013 onwards (or before in the shape of a Grand Coalition) will have to take power. Such a government, without the FDP most importantly!, would have much more leeway either giving a Eurozone wide promise to underwrite European bonds, create some kind of a version of Eurobonds, or simply allow periphery countries to default on some or all of the debt currently held by the ECB (~170 billion € at the moment, by that point somewhere in the high 200s?) , the latter of which initially would be a relatively creative and easy way to avoid some of the uproar related to an taxpayer’s participation in yet another bailout.
To sum up an already too long post then, I believe Germany has the will to assure the survival of the Eurozone and – indirectly and because of it – bring about an ever deeper – economic – union, but it will take the installation of stringent conditionality and punishment mechanisms on the European (supranational or intergovernmental) level and a different coalition at the helm of Germany’s political and economic decision-making levers. In other words, don’t expect this to be over before 2013.