Cyprus – who next?

The starkest lesson that should be taken from the Cyprus crisis from all in the eurozone is that no bank deposit is guaranteed.  It is always ultimately a loan from the depositor to the bank with the possibility that your government may mitigate any loss.  Depositors with more than €100,000 in local Greek, Portugese, Spanish and Italian banks should now be giving serious consideration to moving their money to stronger banks in safer countries, as also might those with less than €100,000.

Cyprus represents 0.2% of the eurozone economy, so the amount of bailout money required for it to avoid defaulting on its debts was never a major economic problem.  However, it has posed significant political problems, not least because many Northern European nations saw the Cypriot banking system as profiting from black money from Russia and elsewhere, and therefore less deserving of rescue.  The crisis has underlined that, though the euro is the currency of one of the two largest economies in the world, its economic policies are driven by politicians of what are, in global terms, rather small economies, who do not appreciate the wider implications of the decisions that they make.

Until last summer, the euro crisis was spiralling out of control as banks with poor asset bases required government bailouts from governments, which themselves were struggling to raise money to fund their deficits.  The capital that was injected into the banks was then invested in government debt of the home country because (i) it was the patriotic thing to do and (ii) the yields on offer were very attractive.  Thus weak bank finances created weak government finances which further weakened the banks.  At the July EU summit last year, a major breakthrough seemed to have been achieved when it was agreed to try and stop this vicious circle by using the ESM to directly recapitalise weak banks, in a way that this would not be a liability of the national government.  In addition, it was agreed that the eurozone needed a full banking union in order for the monetary union to work.

This analysis was sound.  However, by September Germany was backtracking on this agreement, and now does not support using ESM money to recapitalise banks, insisting that this is a matter for the individual country to sort out.  Further, one of the fundamental elements of a banking union is a Europe-wide deposit guarantee insurance programme, and here again Germany has insisted that this is the responsibility of the individual country.  The political will in Germany to provide money for more bailouts has declined markedly since last summer.  It should also be noted that Cyprus did admit at the height of the crisis, that it did not have the money to honour its deposit guarantee scheme – this is also likely to be true in several other weaker economies.

A crisis in the next few months, ahead of the German elections would bring together the “austerity fatigue” that is evident in many Southern European countries like Greece, Spain and Portugal with the “bailout fatigue” that is evident in Northern European countries like Germany, Finland and the Netherlands.  It could thus be that the tiny Cyprus bailout debacle is the first in a chain of events that leads to the end of the euro.  The withdrawal of deposits from weaker banks in the weaker countries could lead to bank failures which require their governments to recapitalise them with money that has to be borrowed, pushing up their bond yields and creating another sovereign debt crisis.  A similar tough approach from the Northern European countries, to that they adopted with Cyprus, could set the terms of a bailout so high that the debtor countries will not accept them and instead choose to exit the Euro.  It will be the peoples of these countries, rather than the politicians, who make this happen.

The investment conclusion is to remain very wary of most euro-denominated investments until a more sustainable monetary system is in place in Europe.

Paying for the privilege of lending

Investors who wish to buy Swiss government bonds and would like to be repaid within 4 years, now have to accept not a low interest rate, nor even a zero interest rate but a negative interest rate. That is to say the lender pays the borrower real money for the privilege of lending. Similarly in Germany, a 2-year bond was recently issued with a 0% coupon, and on June 1st was trading in the market at above 100 – investors were happy to guarantee a loss if they held the bonds until maturity. Elsewhere government bond yields in the US and the UK are trading at just about their lowest ever levels – lending to governments has never been a less well-rewarded activity and this at a time when governments owe more money than ever before. Greece, has just defaulted, and the media are full of stories of sovereign credit risk. The fundamentals would indicate that this is a very risky time to be lending to governments but most can borrow large amounts very easily and at astonishingly low interest rates.

For Germany and Switzerland the reason for the negative yields is the rising expectation of a potential break-up of the Euro. The Swiss Central Bank has publicly stated that it will print unlimited amounts of Swiss Francs to ensure its currency does not strengthen further against the Euro. However this is not believed by the market due to the long history of conservative Swiss monetary policy. If the Euro were to break up, the demand to convert Euros into Swiss Francs would be enormous, and far greater than the Swiss Central Bank would be prepared to supply. Similarly in the event of a Euro break-up, Germany could be relied upon to have the currency that the world would want to hold. So the negative yields on offer represent the cost of the implicit currency option in the event of a Euro collapse. Germany is the more risky bet here, since it remains the case that one of the few remaining solutions to the crisis, is a much deeper European level of fiscal and political integration in which Germany does assume some liability for the debts of the other nations. If this occurs, Germany’s creditworthiness deteriorates and it may well lose its AAA status.

For the UK and the US, bond yields are positive but are negative in real terms after adjusting for inflation. Yields of around 1.5% over 10 years are below the respective Central Banks’ targets of 2% for the UK and 2.5% for the US. Yields this low are manifestations of demand factors as both the Bank of England and the Federal Reserve have bought large quantities of government bonds with newly printed money. Further the commercial banking systems of both countries have been forced to have much larger holdings of government bonds to bolster their balance sheets. Investor sentiment has been steadily more cautious over the last year, moving away from equity investment and towards more conservative instruments. For most individual investors though, who have to pay tax on the bond coupons, most government bonds  offer negative after-tax yields, even before inflation.

Recent dramatic declines in government bond yields outside the Eurozone periphery, are indicating that the next Euro crisis is close to hand, with attention shifting away from the Greek elections and towards who will recapitalise the bankrupt Spanish banking system. Currently Germany is against every possible solution – it is opposed to (i) common Eurozone bonds, (ii) infrastructure-spending bonds, (iii) bailing out other countries banks, (iv) reducing the drive towards fiscal rectitude, (v) a huge deficit-financed boost to public spending, (vi) the ECB printing money and (vii) any country leaving the Eurozone. Several of these are becoming mutually exclusive, and Germany will have to choose.

Elsewhere in the world, the recent economic news from the US, China, Brazil and India has been disappointing. Growth is slowing and there appears no rush from any policymaker to do anything about it other than to re-iterate their strong desire for growth to occur. Behind the scenes, concern will be growing and some policy action (quite probably co-ordinated) is likely in the next 2 months. This would be good news but may first require a crisis to bring it about. Equity markets are very oversold and cheap if one believes that growth will return again in the near future. Much negative news is priced into financial markets. Longer-term investors can begin to buy some equities at current levels, those with a higher risk aversion may prefer to see the crisis before adding to positions.

Dear Diary – possible reflections of some of those at the G8 meeting

The G8 meeting achieved nothing, despite the sense of crisis in the markets. The communiqué was bland and meant different things to different people. Below are what the leaders may well have really thought  about the summit.

Barack.  Re-election chances continue to drop – only 6 months to go. Have to say that Angela has some backbone, kept going with the German Nein all weekend long despite all of us ganging upon her to open her wallet. Played at being best buddies with Francois, the new boy in our club – it keeps David and Angela on their toes. Anyway he and I do have a lot in common, the rich should be paying a whole lot more towards getting us out of this mess, and it shouldn’t be the ordinary Joe who takes the hits all the time. Europe really worries me though – if it all blows up this summer, it could send our economy back into recession just about election time and I’ll be a very young ex-President.

Angela.  Re-election chances continue to drop – only 16 months to go. Well, that goes down as one of the most miserable weekends of my life. I know I’m still at the top of Barack’s European speed-dial, but it was horrible to watch him buttering up Francois. At heart though neither of them believe in balanced budgets and sound money like I do; they just want the money and public expenditure to keep on flowing and keep their supporters sweet. I am now only really left with David as a true right-of-centre ally in Europe; at least he is backing our drive for a political union as the best option to save the monetary union. Even so, he joined in with the others that Germany must spend lots of money we don’t have and let the ECB print and cause inflation – I was totally alone on this but stood my ground.

I thought it was a pretty smart idea to take 3 hours off from our discussions to watch the Champions League Final – it would be 3 hours not having to defend sound economic principles and a chance for Germans to show the football world how good we are (again) – but it didn’t work out. Bayern lost (on penalties – Germans never do that) and the symbolism was so awful – a team of foreign imports on huge salaries from the part of London inhabited by investment bankers, managed to overcome the bulk of the German national team, who were so strong, courageous and disciplined, and from Munich, the most successful centre of the German export industry. Worst of all that photo of us all watching the game has gone viral thanks to Twitter.

David. Re-election chances starting to drop – though still have 36 months to go. Politics is a rum old game. Who would have thought that a British Conservative Prime Minister would be telling the nations of Europe that their best (and only) hope was to move toward a full-on political union led by Germany? Yet George keeps on telling me that really is the best hope for our economy until the next election. Maybe, but it would be terrible for Britain’s influence with the US and China if Europe was truly one country with an elected President. I really can’t see it happening though, but I just don’t know if that is a good or a bad thing. That photo should do me the world of good with all the ordinary footy supporters in the country though – not many Posh Boys really like association football. Like Angela I had to be grovel a bit to Francois.

Francois. Chances in the parliamentary elections in 4 weeks definitely on the up. Life is amazing right now. Two weeks I was M. Normal, a French Socialist leader that had never had responsibility for anything in my life except for other Socialists, and now the President of the United States of America is telling me and the others what wonderfully interesting ideas I have. Also quite a nice feeling for Angela and David to have to be extra nice to me right now – I shall make good use of that back home in the next few weeks ahead of the elections.

Mario. Politicians are so transparent, always worrying about their election prospects.

Vladimir. Why are these guys so afraid of elections? Everyone’s beating up on Angela. I reckon she needs a good friend like me, and then just maybe we can get Germany to see Russia as their best European ally, instead of always looking westward.

An open letter to the voters in Greece

Congratulations! Your votes in the general election last week have humiliated the two main parties which have dominated Greek politics over the last 30 years. Traditionally they have between them garnered 2/3 of your votes which has meant that one or other of them has always been in power. They have failed you miserably, by i) permitting many of your fellow citizens not to pay the taxes levied by government, ii) making up for it by creating swathes of public-sector jobs where everyone receives two extra months pay each year to compensate for the fact that they do have to pay taxes, iii) tolerating corruption across most parts of the economy, iv) persistently running large budget deficits and borrowing heavily from anyone who will lend to them, and v) fiddling the figures to hide this from you.

Pasok and New Democracy, the two parties which signed up to the bailout package with its attendant further austerity, between them only managed 1/3 of the vote this time round and so even together they do not have a majority in parliament, under the system which so favoured them. 2/3 of your votes went to small parties which said they would not accept more austerity. Sadly, I have to tell you that these other political parties are not explaining the reality to you either. In recent weeks opinion polls have shown that around 70% of you want an end to austerity and to remain as members of the Eurozone, and so this is what these parties have had as their campaign platforms. Clearly this would be a good outcome for you if it could be brought about, but unfortunately this is not an option that is available.

The harsh truth that no one seems to have told you yet is that you have to choose between further austerity whilst staying in the euro and coming out of the euro with only a bit more austerity. The euro is a club for economies which wish to organise themselves along German lines – it requires real control of public finances and does not tolerate desires for pay increases which have not been earned through productivity improvements. Your economy, whilst it has been straitjacketed within the euro, has become hopelessly uncompetitive. This now requires that you go through a devaluation process and your only choice is whether this devaluation is internal or external.

The internal devaluation process means that you can stay in the euro but that you regain competitiveness via cutting the costs in your economy. This means reducing both the quantity and price of labour and in quite significant terms, both in the public and private sectors. This is difficult and very painful and will take several years, but that is the price you will have to pay if you wish to remain as part of the euro. Latvia is a recent model of how this approach can work.

The external devaluation process means that you come out of the euro, and bring in a New Drachma as your currency, which is then allowed to float freely. Many economists estimate that it would immediately fall by about 50%, which would double the value of all your euro-denominated debts, so it would make sense to default on all such debts. You will become poorer but competitive overnight and you can start to rebuild your economy from a lower base –  you will still require a little austerity as even without paying interest on all its debt, your government is still running a deficit, and there will be no one prepared to lend to them, so some further cuts are required. In the first year or two there will also be very high inflation, which will reduce your real standard of living as the costs of imported goods soar. Iceland is a good recent example of this approach.

It appears that you will soon get another chance to vote – I hope that this is the clear choice presented to you by your politicians. The second option is I believe, by far the better of the two.

With best wishes,

Jeremy

Democracy – the antidote to Eurozone austerity

Over the last twelve months of Eurozone crisis, the politicians in Europe have in the main been talking to each other rather than their electorates. In fact the conversations have involved Northern Europeans (mostly from Germany) telling Southern Europeans to slash government spending and find ways to collect more tax revenues and the Southern Europeans promising very solemnly that they have always intended to and will do so just as soon as they receive some extra money from the Northern Europeans. The voters have never been asked their opinion either in the North as to whether they want to commit funds to support those in the South, or in the South as to whether they want to go through with the austerity measures their politicians have agreed to. Over the next 18 months there are important votes in France, Greece, Holland and Germany, when the politicians will be courting votes and saying things that are odds with current policy settings.

It is said that in the French presidential elections, in the first round the French vote with their hearts and in the second round with their heads. Well, 30% of the electorate voted for the extreme left or the extreme right in the first round; both reject entirely the idea of deeper European integration and the economic policy of austerity. Further, the centrepiece of Francois Hollande’s platform is the rewriting of the fiscal compact set out in the new treaty to pursue a much more aggressive growth strategy and greater powers to the ECB to lend directly to countries. In this he is on a collision course with Angela Merkel and impact is likely to occur very soon after the May 6 run-off election. The received wisdom is that he will not seek dramatic change to what has already been agreed, and will be satisfied with language that has an aspiration for greater growth without meaningful measures – this would probably the best he would get from Merkel and Germany. The key though is that a clear majority of the French electorate rejected the current policies of austerity.

May 6 is also the date of the Greek general election. The technocrat Papademos who was put into power as the head of a coalition government of the 4 major parties in order to agree the terms and conditions of the Greek bailout, has completed his job and is stepping back to allow normal politics to resume. Northern Europe insisted that all 4 parties in the coalition individually signed up to the terms and conditions of the bailout, in order to prevent any backsliding after the agreement, but there are already problems. Recent polls indicate that 67% of Greeks want to stay in the euro but don’t want the austerity, which can be interpreted as wishful thinking, economic ignorance or that their politicians are allowing them to believe that such a choice exists. It is not clear that those 4 parties would command 50% of the seats in the new parliament, even if they could be persuaded. Already Venizelos, the head of the Socialist party has been floating the idea of Greece going back to the drachma as an alternative to austerity.

The Dutch too are struggling despite being seen as part of the Northern European bloc. The coalition government fell over the weekend because the far right party refused to accept the austerity measures necessary for the Netherlands to get their budget deficit in line with the Eurozone targets. An election now looks likely in Holland.

Once these elections are settled, attention will begin to shift to Germany’s election in September 2013. Here though the politics is reversed, what is popular with the Germans is the notion that the rest of Europe should engage in the austerity necessary to get their public finances in order as Germany has had to earlier this century, so that no further calls on the German purse are made from bankrupt Eurozone nations.

Exposure to the votes of their peoples is going to cause politicians to say and do things that make continued agreement on austerity and bailouts increasingly hard to do.

Just what do you get for a trillion euros?

A trillion is a seriously large number. Counting E500 notes at the rate of one per second, it takes a lifetime (63 1/2 years to be more exact) to get to one trillion euros.  In two operations over 10 weeks, under the new leadership of Mario Draghi,  the ECB lent this much to the European banking system at a fixed rate of 1% for a term of 3 years and backed by much weaker collateral requirements than it has historically permitted.

The net new liquidity provided to the banking system is about half of this, the other half reflecting the expiry of other ECB lending facilities which these operations have replaced. Balances held at the ECB by the banking system have risen by about E500bn over the same time period. So for now the ECB has lent money to the banks at 1% and the banks have re-deposited it with the ECB at 0.25%. The banks however have about E750bn of bond issues maturing in 2012, and so they now have a far less pressing need to borrow in the financial markets to refinance these maturing bonds – it was this huge refinancing requirement which, at the end of last year, had brought fear to the markets of another 2008 event in which the banking system froze and plunged the world into  a savage recession.

So Mr Draghi is credited with finding a solution to the eurozone’s banking liquidity crisis which threatened markets last November and December. In response the bonds and equities of banks have risen sharply and pushed up the prices of securities all over the world in 2012. In particular sovereign bond yields in Italy and Spain have fallen sharply as investors expected that many eurozone banks would use the new liquidity at 1% to buy these sovereign bonds offering much higher yields. The numbers suggests that this has not actually happened, or at least not yet, but the prevention of a crisis has pushed prices higher anyway as confidence has returned.

A full 3 cheers for Mr Draghi is not appropriate though. First, financial markets have read this operation as the European equivalent of Quantitative Easing and this together with the stated desire of Central Banks in the US, the UK, Japan and Switzerland to print more of their own currencies, has sent the gold price rising sharply as well. This has terrified the German Bundesbank which has also realised that in effect these operations have meant that the ECB has acted as lender of last resort, a role it has historically not seen as part of its remit. Further the ECB’s willingness to accept much less secure forms of collateral for this lending, because some of the weaker banks were running out of secure collateral means that the ECB itself could become theoretically insolvent in a further crisis. German support for monetary union as a result of the recent steps, is clearly weakening both amongst the people and politicians and within the Bundesbank.

Secondly, this may not do much to boost the public sentiment towards banks because it seems unlikely that much, if any, of this money will find its way into the real economy via higher lending. Instead it is likely that banks will use it to make an arbitrage profit – some UK banks have already announced that they will not be paying bonuses to their staff based on such profits, indicating that this is the strategy they will adopt for this money.. In addition, in 3 years time, this huge amount of money is due to be repaid – this could create liquidity problems for the banking system all over again. Although the ECB will be likely to be able to manage this over time, withdrawing liquidity from the system nearly always has negative effects on the real economy.

The most serious concern is that although dealing with bank liquidity issues these operations do very little for the bank solvency problems that beset so many banks within the eurozone. Lending them new money is not the same thing as providing the much-needed new capital which can then be used to offset the substantial bad losses that still need to be written off. In fact, this trillion euros has merely created even more debt in an effort to solve the problems caused by too much debt, and since this new money is owed to the ECB who demand priority over all other creditors, all other creditors have implicitly been diluted!

The Super Mario Brothers – changing European politics

Last November saw the two Marios, Draghi and Monti, take on key positions within the Eurozone; Mario Draghi as President of the ECB succeeding Jean-Claude Trichet and Mario Monti succeeding the Silvio Berlusconi as Prime Minister of Italy. Both were appointed rather than being democratically elected but importantly both are hugely experienced within European politics and highly regarded and trusted by their peers. Both have moved fast to create change in their respective areas and together can be seen to be challenging the old power balance within the eurozone away from a Franco-German dominated politics towards a more truly European version.

November was also the period of greatest intensity in the sovereign debt crisis, when Italian 10 year government bond yields exceeded 7%, threatening a global banking and financial markets disaster. Mr Draghi acted decisively in December, cutting the ECB’s key interest rate and then announcing a new policy of Long Term Repurchase Operations, offering unlimited liquidity to Eurozone banks for a 3 year period at only 1%. This new policy has turned out to a marvellous euro-fudge. To German-minded Central Bankers a LTRO is not equivalent to the Anglo-Saxon policy of Quantitative Easing (aka printing money) that they loathe so vehemently, but is a liquidity-management tool which Central Bankers would be expected to deploy at times of crisis. The liquidity is merely lent to the banking system on the basis of collateral, it is not the creation or printing of new money. However (a) the scale of the operation, being unlimited, (b) the long time period involved, prior to this the ECB had never offered such facilities for longer than 1 year and then only in the darkest days of the 2008-09 crisis, and (c) the 1% rate, a zero premium to the official rate and thus creating no stigma for a weak bank being forced to pay higher rates for emergency liquidity, all meant that the short-term effects of this policy are remarkably similar to those of a policy of Quantitative Easing. The financial markets have certainly responded in such a fashion as the dangers of a eurozone banking crisis have receded.

Mr. Monti was effectively installed by Merkel and Sarkozy after they forced the departure of Berlusconi. Despite having enormous wealth and a population and an economy equivalent in size to France, the lack of growth in the Italian economy and its enormous level of national debt meant that it was seen as the weakest of the large European economies. Monti earned his stripes as the EU Competition Commissioner, taking on and defeating both Microsoft and Hewlett Packard in well-publicised battles over their monopoly powers. He has surprised many with the speed and ambition of the fiscal and economic changes he has forced through the Italian parliament, taking on many of the protected special interest groups which benefit from rigidities in the regulatory system. He is clearly aiming at delivering the significant structural reform to the Italian economy which is so badly needed and which Berlusconi failed to deliver.

Having gained credibility with his actions within Italy, Monti has used the fact that Merkel likes and listens to him to argue with Germany about its single-minded focus on austerity as the only tool to restoring the European economy. In recent weeks the tone of German thoughts on the European economy has changed towards the need for greater pro-growth policies. Italy now has a seat at the top table when these matters are discussed.

Sarkozy and France appear to be the losers in this power shift. Sarkozy was very quick to ensure that he maintained a French presence at the top of the IMF by getting Christine Lagarde to replace Dominique Strauss-Khan, but that has cost him a key voice within Europe, where she was well regarded but it has not really helped in terms of getting the IMF to be pro-Europe. It is noticeable how much quieter Sarkozy has been since Monti’s arrival at the top table. This may reflect his domestic political weakness – he faces re-election in May and with current polls suggesting he is set to lose, he has been forced to ask Merkel to campaign for him in France. The Franco-German axis in Europe which has dominated European politics for the last few years is breaking down as Germany is now the clear leader and then below are a newly-weakened France and a newly-strengthened Italy. A greater Southern Europe perspective is just beginning to have an effect on the way in which Europe is now being run.

Is “Europe” more important than democracy or the rule of law?

The desperation of Europe’s leaders to protect their banking systems from the effects of the sovereign debt crisis is leading to startling decisions and actions which call into question their commitment to the principles of democracy and the rule of law.

Last year Merkel and Sarkozy made it clear that Europe required Italy and Greece to install technocratic leaders in order to force through the austerity and structural reform measures that Europe deemed necessary if it was to consider continuing to support these countries through their financial crises. When the previous Greek Prime Minister suggested holding a referendum on adopting austerity measures last November, he was told in no uncertain terms by Germany and France that this was unacceptable. European referenda have a nasty habit of delivering results that the political elites do not like.

Then last week, Wolfgang Schauble proposed that Greece should postpone its general election due in April and extend the life of  its technocratic government. The sub-text was very clearly that Germany feared an inappropriate result that might lead a new Greek government to renegotiate the terms of the E130bn bailout after it had been agreed and Europe had committed substantial sums of money. From the rulings of the German Constitutional Court in recent years, it is quite clear that if anyone tried to push the Germans in similar ways, the reaction regarding the primacy of German sovereignty and democracy would have been extremely forthright. To a great extent these demands resemble the power battles between debtors and creditors in a failed company, where the creditors can take full control of a company’s assets when it cannot meet its obligations, but countries are not companies and voters are not shareholders that are automatically disenfranchised upon bankruptcy.

Perhaps even more worrying is the ECB’s action to ensure that it has greater rights than any other owner of  equivalent securities in the financial markets. By demanding that its Greek government bond holdings be converted into other bonds that will have priority over all other Greek debts, a few weeks ahead of a plan that will see all other Greek government bond holders lose approximately two-thirds of the value of their holdings in a “voluntary” haircut, the ECB is at the very least flouting financial market convention that all holders of a security should be treated equally. At its worst interpretation, in a situation where there will be limited assets to repay the debts, it can be construed as theft.

Worse still is the implication for any other sovereign European bonds that happen to be owned by the ECB. The greater the ECB ownership, the worse-off are all other private holders of other European debt as their rights to repayment now rank below those of the ECB (in credit markets this is known as subordination). Thus the creditworthiness of all European debt in which the ECB has a stake has been even further reduced. This is likely make it more expensive for these issuers (Portugal, Ireland, Italy and Spain) to raise money for a very long time to come. Future sovereign crises are now in danger of setting off vicious cycles of ECB intervention buying sovereign debt in the secondary market leading to private sector investors selling down their positions as they become less creditworthy so worsening the crisis.

To be sure there are no easy choices in solving  the euro sovereign debt crisis, but the longer term costs of some of the solutions that are being called for and implemented may well be far higher than currently understood.

PS – it also appears that Greece’s creditors will take over the national  gold reserves too.

The Iron (Germany) tells the Ship (Greece) that it is not to Pass Go and Collect E130bn

The recent film, The Iron Lady recaptured Mrs Thatcher’s steadfastness to maintain tough economic policies in the face of much opposition. Today that soubriquet should be awarded to Mrs Merkel. Throughout the last two years since the euro crisis broke, Germany’s leader has consistently stuck to her beliefs that the solution to the economic problems of the periphery is that they become more German, and adopt the policies of public and private sector austerity that followed the deterioration of their budget deficit following the integration of East Germany in the early 1990s and their competitiveness problems from entering the euro at too high an exchange rate in 1999. To German minds, what is required to resolve these problems is not a quick dose of bailout money from Germany that may merely mean the problems reappear in a few years time, but years of hard work, sacrifice and belt-tightening by the countries themselves.

At first the rest of Europe went along, knowing that there was some truth to the German analysis of their problems, but also believing that were they to proclaim that they would be more German in the long term, then Germany would actually bail them out in the short term as well. In recent months, as the crisis hit Italy, Spain and Belgium, the pressures from the other Eurozone countries demanding more German assistance have been compounded by pressure from both the US and UK governments concerned that the recession in the Eurozone will drag their own economies back down into recession again. At Davos recently where the great and the good of the world economy get together to sort out the world, the overwhelming consensus was that if only Germany would offer more money, then everything could get resolved. German leaders remained unimpressed.

In recent weeks, it has been very noticeable how many comments there have been in the press from German officials indicating that essentially Greece is bust and a major default of its debt is inevitable. To date Germany has actually put up very little cash to bail out the crisis-hit countries, however March 20 marks the due date for repayment of a large Greek bond, money that Greece does not have unless the second round E130 bn bailout plan initially agreed last summer is confirmed. Were that bailout not to proceed, Germany would save itself a great deal of money it would otherwise be unlikely to ever see again.

Otmar Issing,(the former member of the Bundesbank and the ECB Governing Council who resigned last year in protest at the ECB’s buying of government bonds in the secondary market) in a recent newspaper interview may have rather given the game away when he said that although it was legally impossible to kick Greece out of the EU, if it required external financial help then what could be done is to tell them to implement reforms you know that they cannot manage to achieve, and when they fail you can say that the basis for financial help is not there, and leave the Greeks to decide what they want to do. Schauble, the German Finance minister recently told reporters that Greece must implement the agreed measures and reforms and that all the Greek parties must agree to them as well – a remark that fits Issing’s strategy exactly.

Further the ECB’s move late last year to provide almost E500bn in liquidity to banks for 3 years at 1% in a Long-Term Repurchase Operation (LTRO), to be followed by another one at the end of February, could easily be interpreted as ensuring that all Eurozone banks have access to sufficient liquidity to survive a Greek default to permit their solvency issues to be dealt with at a later date.

A Greek default looks very near; preparations are being made by the authorities, markets are to a great extent ready for it, but the chain of consequences of such an event is very uncertain.