Germany cheerfully leads the Eurozone towards misery – November 2011

At the previous G20 meeting, European leaders were sent away with the message to agree a solution to the debt problems of the Eurozone which were hitting the economies of the rest of the world. The Brussels agreement on the latest round of measures to be adopted by the Eurozone was a triumph for Mrs Merkel but does nothing to resolve Europe’s economic problems despite the initial positive reaction from markets. In the agreement, Germany commits no more money to the Eurozone bailout programme than it had previously agreed to, it has not given any guarantee of the debts of any other country, it has kept down the amount of recapitalisation required of the banking system to a level that its banks should be able to raise from the private sector alone and so avoid another unpopular state bailout of banks and it has blocked French attempts to get the ECB to intervene massively to support the Spanish and Italian bond markets. On top of that, all Eurozone countries are now committed to balanced budget constitutional amendments and Italy was forced to bring to the summit, in an almost schoolboy-like manner, a detailed plan as to how it would take further steps to reduce its spending. On Greece, the inevitable default is acknowledged but only for private sector lenders, and not public sector lenders such as the ECB, the IMF and the EU, who remain favoured creditors.

Unfortunately, what the Germans believe to be a good plan is terrible news for the near term health of the Eurozone economy. Greece will still owe a very high 120% of its GDP by 2020 (on optimistic assumptions) – this is double the old Maastricht Treaty maximum of 60% and leaves the capacity of the Greek economy to grow its way out of its problems severely hampered. For the other Eurozone countries the ability ever again to use fiscal policy as a tool to boost their economies in future times of trouble will disappear, leaving the ECB and monetary policy as the only route to stimulate economies. Germany is securing an economic straitjacket around its Eurozone partners, at the exact moment when their economies have become hugely uncompetitive compared with Germany.  Their only path back to economic growth is for prices and private sector wages to fall by about 25% and thus re-establish competitiveness – that path means several years of a real economic Depression.

The German misunderstanding is in taking what have been sound long term economic policies for a relatively small open economy (where exports and imports are high proportions of the economy), and which have delivered a strong and stable economy for Germany since the war and more particularly since the Euro started, and assuming that they must therefore be the best policies for the Eurozone as a whole. However the Eurozone is not a small, open economy – rather it is a large and relatively closed economy (once intra-Eurozone trade is stripped out), very similar to the US economy. If the entire Eurozone is cutting back on its spending, then domestic demand within the Eurozone will be anaemic and exports outside the Eurozone are not a significant enough force to lead the whole economy back towards growth.

It is ironic that the British Conservative Party, which has always sought to avoid being drawn into European attempts at greater integration, is now one of the loudest voices calling on the Eurozone to become more integrated and adopt a pan-Eurozone approach to its problems rather than the national approach that has been adopted by Germany and France today. Their economic analysis is right though, the sum of the individual Eurozone economies is very different from any one of them. Helmut Kohl and Jacques Delors had the truly European perspective in the 1990s that is now required of, but sadly lacking in, Angela Merkel and Nicolas Sarkozy.

Sadly this latest package will merely buy a little time before the next crisis (ignoring the mini-crisis generated by the on/off Greek referendum). Worryingly, each crisis in this saga is bigger and more serious. The next problem to occur will be in Italy, where despite buying of its bonds by the ECB, yields are already over 5% for 2 year bonds and over 6% for 10 year bonds. There is little scope for these to move higher before the market comes to the conclusion that they are unsustainable and will refuse to fund them, as they have with Greece, Ireland and Portugal already. Italy is too big to save.