Greece – one month on

It is now one month since Syriza came to power in the Greek general election. Much has been said across Europe, many meetings held but little has changed.

Syriza said, both ahead of and immediately after the election, that they would immediately and unilaterally throw out the Troika (the term for the EC, ECB and IMF group that oversaw Greece’s adherence to the bailout conditions imposed) to regain sovereignty over economic policy and end austerity. They said that they would demand a haircut on the amount of debt owed and that the rest of Europe would agree to this because it was (a) fair and just and (b) Europe would be scared that Greece might pull out of the euro and set off a chain reaction amongst other members that would call into question the very existence of the single currency.

Over the last few days Syriza has backed down from all of these demands, with apparently very little gained in return. Europe has stated very clearly that any write-down in the value of the outstanding debt is unacceptable to them, and Europe has continued to demand that the same trio of institutions (though now called the institutions rather than the Troika) determine whether Greece is complying with its obligations under the original bailout agreement. Also rather than anything happening immediately as Syriza demanded further discussions will take place over the next four months and conclude just before Greece is required to repay the next tranche of its debt.

It seems difficult to argue anything but that Syriza has failed miserably to deliver what it had promised the Greek voters – and indeed the risk now is that Syriza is unable to get its own MPs to give parliamentary approval to what it has agreed with Europe – which would lead to a new crisis.

With a finance minister who was formerly a professor of game theory, everyone was interested to see the negotiating techniques that Syriza adopted. At the time, and even more so with hindsight, they do not seem to have been very smart. The first acts of Tsipras and Varoufakis (the prime minister and finance minister) seemed designed to upset and offend the Germans, which may have good for domestic politics, but not ideal for bringing on board the key decision-maker in reaching agreement with Europe. They also made significant concessions very early – within a few days of coming to power, Tsipras was saying that Greece intended to repay every euro of its debts. Syriza’s maximum leverage was always likely to be immediately after the election, when “democracy” was on their side – by allowing discussion to go on for another four months they will lose that benefit. Finally it became clear as time went on that the “disaster” scenario of Greece pulling out of the euro, was something that Germany was quite prepared to live with (indeed many Germans are actively campaigning for it) whereas Syriza did not have a mandate to allow that , given that 70% of Greeks want to remain in the euro.

By contrast, Europe, led by Germany but strongly encouraged by both other Northern countries such as Finland who share the German approach to economic discipline, and by Southern countries such as Spain and Portugal, who have been through similar austerity programmes to Greece without (much) complaint and did not see why Greece should get any special treatment, played their hand in a very robust style. Schauble, the German finance minister seemed to revel in the role of “euro-enforcer”, and has insisted on Greece backing down on almost every substantive element of their demands.

The lessons from the last month seem to be (i) when going into a negotiation you need a credible fall-back position if you can’t get what you want – Syriza rather put a gun to their own head and threatened to shoot, (ii) Syriza, by conceding externally in Europe, may well have lost credibility internally, disappointing both many of their own party members and many Greeks who voted for them and (iii) Europe does not recognise democracy as an appropriate reason to go against past agreements and the rule of law (Juncker has made this point explicitly) – it should now be abundantly clear that being a part of the euro means a substantial loss of sovereignty for a nation, especially if they have a weak financial system.

Not much has changed in the last month. Greece is still stuck with debt it will never be able to repay, the Greek government has almost no say in how its economy is to be run, and the European political class have asserted their right to ignore the results of democracy in their quest to maintain the structurally-flawed single currency. This is not a long-term equilibrium – there are more crises to come.

“Alptraum” – German for nightmare

Recent events in Europe have seen many of Germany’s worst fears come true.

  • January 22 saw the ECB finally agree to initiate a policy of Quantitative Easing despite the objections of the German members on the Council. The ECB, supposedly created in the image of the Bundesbank, is now committed to a policy of money creation whose deliberate target is to increase in the inflation rate. Both the policy and its objective are in violent opposition to all that German monetary policy has sought to achieve over the last 70 years.
  • January 25 saw the Greek election result in Syriza polling far higher and thus gaining many more seats than had been expected. Instead of choosing to go into coalition with a more moderate centre-left party, Syriza formed a coalition with the far-right Independent Greeks, with whom they disagree completely on most issues but are agreed on one key policy – the tearing-up of the bailout agreements. The Independent Greeks are strongly anti-Germany and wish to reclaim war reparations they claim Germany owes to Greece. Today Greece now has what is arguably the most anti-German and authentically communist government in the European Union. The coalition are committed to tearing up the bail-out agreements signed by previous Greek governments and are demanding that much of the debt they owe be written off. Germany was a necessary, but very reluctant, party to these agreements as they appeared to compromise the key “no bailout” clause of the Maastricht Treaty.
  • January 26 witnessed Tsipras’ – the newly sworn-in Greek prime minister – first act paying a visit to the Kesariani rifle range, the site of a memorial to 600 Greek resistance fighters who were executed in a single day in 1944 by German occupying troops. The symbolism of Greek resistance to German subjugation today through opposition to the hated bailout agreements was clear and very deliberate.
  • Following this visit, the first ambassador that he decided to meet with was the Russian ambassador, who re-affirmed Russia’s readiness to provide financial support to Greece should they require it. The EU’s policy of sanctions on Russia, of which Merkel was a key influence and driver last year, has to be extended in the summer and requires unanimity from EU members.
  • The first domestic policies that the new government intends to enact are an end to planned privatisations, a large increase in the minimum wage, the re-establishment of thousands of public sector jobs that have been cut in recent years and increases in pensions. All of these will make meeting the targets for the Greek budget deficit impossible to achieve in the short term – they will also hit the competitiveness of the Greek economy and threaten to undo the gains that have been made in this area in recent years.

Though both the German and Greek governments are saying they do not want Greece to leave the euro, the possibility of this occurring is now very real as the halving of the prices in Greek bank shares since Syriza’s victory is indicating (Greek banks would be immediately bankrupt should they lose the liquidity support of the ECB). Many Germans are now quite prepared to take the risk of another eurozone crisis should Greece leave the single currency, and in domestic political terms, Merkel has little in the way of compromises that she can offer. Until quite recently Syriza was calling for Greece to leave the single currency, but in recent months softened their rhetoric as polls show that three-quarters of Greeks wish to remain in the euro. Being effectively thrown out of the euro by the EU for standing up for Greek interests may well be seen by many in Syriza as a good outcome.

The last week has seen each side harden their positions. Whilst the history of the EU tends to be one of finding the minimum necessary compromise at the last possible minute, the philosophical differences between the German and Greek governments are ultimately not reconcilable and one or both of them will have to give way on key points of principle for Greece to remain in the single currency.

Beware of Greeks bearing unwelcome gifts this Christmas

2015 could begin with bad news from Greece. The governing coalition has put forward a candidate for the Greek presidency, and has said that if he is not approved by the end of 2014 then they will call a general election. For the last few months the Greek opinion polls show the Syriza party as likely to win any general election. Syriza’s major policy proposal is to call on the rest of Europe to “restructure” or forgive a large part of the money that Europe has lent to Greece. They are threatening that should this not be forthcoming, then they will unilaterally default on their debt, threatening another financial crisis in the Eurozone.

The process for selecting a president is that a candidate must win two-thirds of MPs support – this is 200 out of the 300 Greek MPs, on either a first or a second vote. On a third vote, only 60% support or 180 MPs is sufficient. On Tuesday, on the second vote, the governing coalition achieved 168 votes, essentially just the votes of the parties in the coalition and little support from other parties. The third vote is on December 29. It is not at all clear that 12 more votes can be found for the government’s candidate.

So a New Year election is a distinct possibility. A Syriza victory is also a distinct possibility although it is expected that EC leaders will make speeches making it very clear to the Greek people that a Syriza vote is a vote for chaos. There is little support, particularly from Northern European countries, for the idea of writing off loans to Greece, though Portugal and Ireland will be watching with keen interest, having also borrowed heavily in the wake of the Eurozone crisis.  Syriza would though like to remain in the euro – in effect retaining the asset of the euro membership but losing all the liabilities from their debts. Cakes and eating come to mind!

From a Greek perspective, now would actually be a very good time to default on past debt. After years of savage austerity, the Greek budget is now just in surplus before accounting for debt interest or the repayment of debt. This means that Greece no longer needs to borrow money from anyone to fund itself, and so its level of debt is near a peak. Defaulting now has lots of upside and limited downside from this perspective.

The German word for debt is has very close links with the word for guilt, and Germans would regard a Eurozone country defaulting on its debt as profoundly wrong, threatening the very sanctity of the single currency. There would be a strong move to have Greece ejected from the euro, though there is no legal process for any country to leave the euro.

While the world enjoys its Christmas and New Year holidays, Greek MPs will be determining whether we return to our desks to find a new crisis threatening the Euro.

Eur-out

For the last quarter of a century, Germany has been open to monetary union with the rest of Europe, provided that three conditions were satisfied.  These are (i) no bailouts of other countries who were also in such a monetary union, (ii) the Central Bank that sat at the centre of this union was heavily modelled on the Bundesbank and its operation of monetary policy and (iii) all participating were subject to clear rules with regard to budget deficits and total government debt.  With all three conditions in place, then Germany felt that all other countries in the monetary union would be forced to manage their economies in the same way that the German economy was managed.

Since the crisis, all three of these conditions are being severely tested, causing increasing angst to many in Germany.  With regard to the first condition, it is currently true that no country has been bailed out by transfers from the other countries. However, Greece has stretched this interpretation to the very limit.  Huge amounts of money have been lent to Greece by the IMF, the EU and the ECB (and so not directly by other countries), which are officially repayable.  All non-official holders of Greek debt have had their arms twisted to agree to their holdings being substantially written off.  Most investors expect the official holders also to agree to write-offs (at which point the money is no longer lent but in reality given), but this will not occur until 2014, after this year’s German elections.  Germany’s first condition (no bail outs) will be breached next year.

Under its first two Presidents, Duisenberg and Trichet, the ECB did, in fact, model itself heavily on the Bundesbank in its operation of monetary policy. Draghi, however, took over at the height of the crisis.  His first act was to provide a trillion euros of extra liquidity for weak banks from the peripheral countries, in exchange for collateral of very dubious quality, a tactic which drew criticism from the Bundesbank, but great acclaim from most other quarters.  Then last summer, as Spain appeared to have lost the confidence of markets to issue its debt, Draghi invented the concept of Outright Monetary Transactions, which permitted the ECB to intervene in government bond markets to an unlimited extent. The Bundesbank, saw this (rightly) as tantamount to the printing of money, as was being practised in the US, Japan and the UK, but was the lone vote against within the ECB Council.  Crucially for Draghi, Merkel decided to over-rule the Bundesbank and gave Germany’s blessing to this very un-Bundesbank action.  Germany’s second condition has already been breached.

The third condition is the one which matters most, and which Germany will least be prepared to see breached.  To emphasise the point, Germany has brought forward its draft of the 2014 budget, demonstrating that it continues to cut government spending to meet its target of a balanced budget in 2015.  The message to the rest of the eurozone is unambiguous – they too must meet their promises of cutting government spending to achieve balanced budgets in the medium term.

The forthcoming EU summit will contain no Italian government, following the post-election stalemate in which over half of the voters voted for parties which explicitly rejected the EU-led austerity programme initiated by Monti.  The French government has just announced that it now expects a deficit of 3.8% of GDP this year, compared with its EU target of 3.0% – it seems unlikely that President Hollande will make any great attempt at further government spending cuts.  In Greece, the latest tranche of official loans is dependent upon clear plans for Greece to cut 150,000 civil servants from its headcount in the next eighteen months. Greek politicians are very reluctant to agree and even more reluctant to implement such plans.  Both the Spanish and Portugese have promised their people that they have had the last round of cuts, but their budget deficits remain too high due to the continuing recession in these countries.

Austerity in the Mediterranean countries is reaching its political limits.  If Germany continues to insist on its third condition (the control of budget deficits) as Merkel will want to be seen to be doing ahead of her election in October, then the possibility of a country falling out of the euro in the short term is once more very real.  In the longer term, even if Germany gives a little ground now, it will continue to insist on governments reducing their budget deficits at a rapid pace that will mean little or negative growth in many eurozone countries for years to come.  This price will prove too high for some economies.

The investment implications of this are to maintain low exposure to euro-denominated assets until more reflationary policies are being actively pursued in the euro area – if Germany continues to stand on its principles, this may be never.

Eurocalm before the Eurostorm

That the Eurozone ends 2012 in an apparently stable condition is mainly down to the work of two people. The first is Mario Draghi with his promise of potentially unlimited intervention in sovereign bond markets.  The second is Angela Merkel’s with her summer policy decision that forcing Greece from the Eurozone would be more damaging than keeping it in.

Mrs Merkel over-ruled the Bundesbank on both of these issues, and her steady approach to crisis management leaves her as one of the most popular European leaders within her own party and country.  She has now clearly grasped that, for the Eurozone to survive in the long term, it is necessary to have a much deeper integration of Eurozone countries, which extends ultimately to national government finances, common banking supervision and control, and joint liability for debt. In short banking, fiscal and political union is required to complete the economic and monetary union.  These are not particularly popular positions to adopt, either with the German people or with the other European nations, but they are the logical steps required to ensure the long term existence of the single currency.

She understands that for this to happen, Germany will have to dip into its pockets and provide substantial assistance to the poorer countries in the transition. However, she has not been as explicit with the German people that the financial costs of such policies to them will be very great.  The German people are not in favour of lending more money in bailouts to their Southern neighbours, and they are not in favour of accepting losses on previous bailout monies already granted.  Next autumn there is a Federal election in Germany in which Mrs Merkel would like to be re-elected as Chancellor.  So ideally, from her perspective, there would not be any more Eurozone bailouts before the German elections.

The recent agreement on the next tranche of Greek aid was farcical.  Everyone (Greece, the IMF, the EU and the ECB) is pretending that Greece is not insolvent, merely illiquid and that (based on optimistic assumptions) all will be well a decade from now.  Significantly, Germany has agreed that should Greece be doing well by 2015 in delivering on its budget deficit targets, then they would be prepared to forgive some of their debt.  The truth is that if Greece does not achieve its targets the Germans will be forced to forgive the debt because it cannot be repaid.  The point though is that any debt forgiveness happens after the German elections, when European priorities may once again be more important than domestic German ones..

Southern Europe is now very close to the limits of its tolerance for austerity. The Greek, Spanish and Portugese governments have all told their people that they are on the last round of austerity measures.  With youth unemployment close to 50% in these countries, anti-euro, anti-austerity political ideas are beginning to gain ground.  German leaders still consistently state that austerity in these economies will be necessary if further bailout funds are to be provided, and this rhetoric will not be watered down ahead of the elections.

The other major Eurozone election due by April 2013 is in Italy.  Mr Berlusconi’s withdrawal of support for the technocratic Monti government and his announcement that he will fight the elections on an anti-austerity, anti-German platform are not helpful for the euro. However, it is the honest debate to be having.

The Eurozone begins 2013 in recession, and fiscal policy is being tightened further, except in Germany.  A weak European economy will mean larger budget deficits than planned, and more pressure from the southern economies for bailouts.  This will produce more demands for austerity from the northern economies, with the rapidly fading ability to deliver either.

The stability of current financial markets in the Eurozone will not survive very long into 2013 without a dramatic improvement in economic growth, which is very hard to envisage.  Ultimately, the only solution for the weaker economies is inflation. This can come about either through leaving the single currency or through overturning the Germanic culture, which controls Eurozone economic policy. The former is the more likely solution, and the investment conclusion is to remain very wary of all euro-denominated investments until a more sustainable monetary system is in place in Europe.

 

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.

Spain – sliding down the Greece-y pole

A condensed version of the Greek tragedy in recent years: 1) A new government comes to power and finds that the true state of the public finances is much worse than the previous government admitted to. 2) They want to stay in the Eurozone because their people finally have a currency they trust, and so they solemnly promise their European partners that they will do whatever it takes to ensure this occurs. 3) An eye-wateringly aggressive fiscal austerity package is announced by the new government. 4) The sharp fall in expected public sector demand in the economy leads to a significant recession, unemployment rises sharply, welfare spending rises more than expected, tax revenues come in lower than expected and the fiscal deficit does not improve. 5) The government finds that foreigners no longer want to buy the debt it needs to sell in order to finance the deficit, so it forces its bank and insurance companies to buy the debt. 6) They are not keen despite high yields and so will only buy short-dated Treasury Bills of less than one year rather than bonds with longer maturities. 7) Yields on government bonds rise to levels at which it becomes impossible for the government to issue any more bonds and the deteriorating creditworthiness of the government debt means that the sovereign debt crisis is now also an existential crisis for the domestic banking sector. 8) The rest of Europe provides funds for a bailout, not to help out the distressed sovereign but to help out their own banking sectors who have massive exposures to both government and banks of the affected country. 9) This bailout from Europe comes with a price of even greater and more immediate austerity. 10) Youth unemployment soars to tragic levels as recession bites even deeper. 11) The country is bust.

Spain’s recent history is putting it on the same road to misery that Greece has travelled in recent years. 1, 2, 3 and 4 have already occurred and 5 is coming into sight, although Spain has taken advantage of the recent period of positive sentiment surrounding the ECB’s LTRO announcements to raise a good part of this year’s debt requirements. However 10-year yields of over 6% for an economy that is likely to show barely any nominal economic growth in the next few years, are not sustainable for very long, and foreign investors are likely not to want to commit more funds to Spain. The LTROs did however facilitate a move towards 6 as the 3-year fixed-rate financing allowed the Spanish banks to make arbitrage profits by buying debt with less than 3 years to maturity – the data suggest many Spanish banks did this.

Spain’s problems are different to Greece in two ways. First, whilst the initial Greek problem was a massive under-estimate of how much debt was owed by the government due to creative accounting, Spain’s problem is that the regional governments in the country have been busily running up debts which are seen effectively as debts of the national government, even though the national government has little political or financial control over the regions. Secondly much of the Spanish banking system has urgent solvency problems following the boom and bust in Spanish house prices over the last decade – the banks need more external capital and it probably has to be the government which has to supply it. The worse the austerity-induced recession, the lower house prices will fall, the worse is the solvency position of the Spanish banking system, and it becomes even more impossible for the Spanish economy to grow its way out of its problems. A move to 7 in Spain could happen faster than many think.

Moving to 8 – a bailout for Spain would be the critical moment for Europe. Greece, Ireland and Portugal together account for about 6% of the Eurozone economy, but Spain accounts for about 12%, so the scale of bailout assistance would triple. For Northern European countries this could well be a bailout too far.

As has always been the case since the crisis started, the solution depends on which of the 3 bad options Germany decides to opt for – either a full political and fiscal union, or inflation caused by the ECB printing money or Germany leaves the euro.

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.

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.