Surprise surprise, the eurozone crisis of confidence has returned with a vengeance, only this time with apocalyptic statements from the EU’s president, Herman Van Rumpoy, that if the Euro did not survive, neither would the EU. First we must strip away the hyperbole; the presumption of a continuation of europe’s ‘natural’ state of warfare and ethnic cleansing without the moderating influence of a pan-european ‘national’ identity is utter clap-trap. The reality is that if the Euro does not survive then the EU of ever-deeper political union will not survive, instead it might devolve back to something that more closely resembles the European Community of old. Whether this is a terrible thing is a matter of perspective. However, there is no doubt that the current Eurozone without full economic governance and the political mandate for a transfer-union will never function effectively, or that the current direction of sequential bail-outs as contagion spreads is destined for catastrophic failure for all members and neighbours.
So if political union is impossible, and collapse is unconscionable, what other option exists?
Greece had a 105 billion Euro bail-out due to unsustainable sovereign debt resulting from an unwillingness to deal with its competitiveness, and Ireland has been forced to accept an 85 billion Euro bail-out due to unsustainable banking practices resulting from its corrupt political system.
The problem here is that monetary union without a transfer union backed by popular mandate is incapable of accommodating for the pressures of non-optimal currency union, so the 750 billion Euro bail-out will merely chase the market scepticism from one weak European member to the next until the money runs out.
All that we have achieved with the bail-outs to date is to confirm the templates for a future bail-outs for Portugal and Spain. Portugal has the most uncompetitive labour market in the EU and thus difficulty in dealing with its deficit addiction, similar to Greece, and Spain has a vast number of regional banks that are chronically over-extended and frozen out of the bond markets necessary to refinance their debt, similar to Ireland.
Portugal isn’t much of a challenge in and off itself to the EU bail-out fund, likely within the same order of magnitude as those of Greece and Ireland, the problem lies in the fact that a third bail-out next door to Spain would inevitably start a count-down to a Spanish bail-out, which the EU cannot afford with its present mechanism.
Why is a bail-out for Portugal inevitable?
Even without its inflexible labour laws, eight-percent budget deficit and zero growth, Portugal will need to roll-over 30 billion of old debt 2011.
Why does this inevitably lead to a bail-out for Spain?
Even without its bad-banks, ten-percent budget deficit and twenty percent unemployment, Spain will need to roll-over 110 billion of old debt in 2011, something it will be unable to do as bond spreads diverge between itself and the core nations.
The markets won’t touch it, the interest rate demanded in return would be ridiculous, so it is only a matter of when. The worry about contagion is already spreading to other nominally ‘safe’ Eurozone members, such as Italy and Belgium, whose yields are now dangerously close to the 5% mark that allows them to refuse the credit guarantees that stand behind 440 billion Euro’s of the bail-out fund.
If the EU rescue fund is destined to run-out of money and thus demand a top-up, and if nations such as Austria are already threatening not to pay their share, why would Germany as the largest contributor ceaselessly pour good money after bad?
The answer might be that it doesn’t intend to, it merely has to keep the Eurozone functioning long enough to enforce a debt-restructuring regime that will survive without its membership, and thus create a soft Eurozone composed of the european fringe that will automatically devalue its way back to competitiveness without the Teutonic export machine also demanding the low-interest rates that fuelled the unsustainable booms in the Atlantic periphery.
What mechanism could force this to happen?
The answer is the second escape clause from current bail-out mechanism which states:
“The package will be “immediately and irrevocably cancelled” if it is found to breach the EU Treaty’s “no bail-out” clause, either in a ruling by the European court or the constitutional courts of any Eurozone state.”
On the subject of bailouts the infamous five German professors currently have a case lodged at the German Constitutional Court (GCC) challenging the legality of the EU bailout fund given its explicit rejection in the Lisbon Treaty.
The GCC has recently clarified its position on when it can deem an act by the EU to be unconstitutional, stating:
“if the breach of EU competences by the EU body is obvious and the act in question leads to a structurally significant shift in the arrangement of competences between the member states and the European Union to the detriment of Member States”
If the GCC rules early next year, as is expected, on the case brought by the five professors and determines that the bail-out is indeed illegal then clearly there is a mechanism that may force Germany to try and eject itself from a structure deemed incompatible with German Basic law.
But isn’t it impossible to leave the Euro without leaving the EU?
Not quite. There is a possible mechanism discussed by Eurointelligence in their assessments of Eurozone crises:
“Another possibility is an amicable agreement for that country to leave the euro area, but to remain inside the EU. That country would then be left in a state of non-compliance with the EMU convergence criteria. The country would be back in the ante-chamber of EMU, and thus not be considered in breach of the EU entry obligations. While this is possible in theory, we cannot see why other member states should accept such an agreement, since they will not benefit from having to put up with a country that will seek a competitive advantage by devaluing, and then re-entering at the next opportune moment. Furthermore, if such a procedure were applied once, it could be used as a precedent for others, or even for the same country, in the future. This would seriously undermine the long-term viability of monetary union.”
To answer the objections above point by point:
Q. Why would other nations allow a fellow Eurozone nation to do this?
A. Because it’s Germany and the reintroduced Deutschmark would appreciate, which would allow the other Eurozone nations to devalue, and thus become more competitive with non-Euro nations.
Q. Would that nation not seek to re-join at a better rate in a few years?
A. No, because it’s Germany, their new currency would appreciate and not depreciate, and the Germany people would not agree to abandon the Deutschmark a second time round.
Q. Would it create a precedent?
A. Yes, it would create the precedent of a currency leaving the Euro on condition than any re-entry would be at a higher rate, an eventuality unlikely to be appealing to other Eurozone members.
Q. Why would Germany choose to leave the Euro?
A. It would have no choice, German Basic law contains an eternity clause declaring the executive and judiciary to be bound by the law, and if the GCC declares the bail-out incompatible with German Basic law………..
Q. Why would Germany choose to make themselves less competitive on the world market?
A. Other than the above, it would also see a return to sound money and the end of bail-outs for countries that are monetarily incompatible with Germany, and it would return the majority share of its export markets to a growth zone rather than have to rely on un-free markets in the east.
When could this happen?
Portugal is due to refinance 15 billion Euro’s of old-debt in Spring 2011, so if we can deduce anything from previous bail-outs they should be able to hold off their own crisis until February.
This puts Spain on a count-down numbered in months following any Portuguese intervention, sparked by ever rising bond rates during a period where Spain needs to refinance 65 billion Euro’s of old debt.
Would Germany seek to exit before or after the Spanish crisis?
The view of this blog is that Germany would bite the bullet and agree to a 150 billion extension of the EU bail-out fund, enough to see Spain clear, because even though leaving after this point would threaten the value of its loans the alternative could be even worse. Spain and Ireland alone represent around 250 billion Euro’s in exposure to German banks, with Greece and Portugal adding perhaps half as much again. With Spain stabilised, and Germany gone, there is a very good chance that a more competitive Europe represents a better net result for Germany even if its loans to the Eurozone end up being restructured. Such an act could even hold down the appreciation of the newly reintroduced Deutschmark. Besides, utter collapse of the eurozone resulting from failure to deal with its contradictions represents by far the worst outcome.
Why push the moment of reckoning as far into the future as possible rather than bailing out now?
The bail-outs of the PIGS will effectively turn them into satraps of Brussels in subsequent years, permitting the rest of the (post German) Eurozone sufficient fiscal harmony to create an integrated economy in the years ahead, and thus a viable long-term future. Whether representative democracy will be advanced in these new euro-satraps is another question entirely.
How much certainty does this blog place on the prediction of Germany’s exit from the Eurozone?
Not a great deal, but it is the least ridiculous solution given the need for the Eurozone to become competitive again combined with the unpalatable prospect of the only logical alternative; full economic union. The ‘alternative’ is bailing-out Italy, which is not something anybody can afford!
In short, it is too easy to treat these events as isolated and sterile observations, and thus discount human natures tendency to snowball a chain of minor dramas into an avalanche of revolution.
Update – 03/12/10 – Jeremy Warner takes the opposite view; that the crisis may in fact strengthen the long-term viability of the Euro:
There’s no rule that says there cannot be default within monetary union. The very threat of it provides a form of balance-sheet discipline that has so far been lacking in the eurozone. Periphery nations have enjoyed a free ride at the expense of the core. From now on, they will be forced to live within their means. There’s still plenty of scope for policy error, but in the round this strikes me as a reasonably credible way forward for the euro. It’s a long way short of the full fiscal, or “transfer”, union which would have been implied by unconditional cross-border guarantees of national debt and was once dreamt of by the single currency’s founding fathers, but that was always going to be politically unacceptable in Germany.
Update – 2012.01.30 – Lombard Research says Netherlands & Germany should exit euro:
Dumas noted that for the bloc to survive, it would have to become a ‘fiscal transfer’ union, saying that the ‘Club Med’ nations needed about 5% of gross domestic product in annual debt refinancing ‘more or less indefinitely’. This would amount to €150 billion a year, of which Germany would have to stump up just over €60 billion, France a little under €50 billion and €15 billion from the Netherlands, he said.