Why has it seemed like pushing water uphill for so long?

I’m in my mid-60s, having been born six months before the end of WWII.  From the earliest days that I can remember, my parents loved to holiday in France and Spain.  In those days if one was to motor into Europe then it was a case of the car being craned aboard the ferry from England to France.  How things change!

Much later on in life, I did business extensively in many European countries and, for a while, taught sales and marketing at the international school, ISUGA, in Quimper, NW France.  (Indeed, fellow Blog author Chris Snuggs was my Director of Studies at ISUGA – that’s how we came to meet.)  I like to think that I have a reasonable understanding of the variety of cultures that is Europe.

So while acknowledging the convenience of a common currency (sort of) and ease of border transits, the one thing that has remained in my mind is that each country in Europe is very, very different to the other.  These core differences have always struck me as so strong and deep-rooted that any form of real union was a ridiculous concept.  The present deep problems with Greece seem to be the tip of this fundamental issue.  Thus a couple of recently published articles, on Baseline Scenario and The Financial Times seem worthy of being aired on Learning from Dogs.

First, the article by Simon Johnson on Baseline Scenario:

If watching the twists and turns in European politics – “should we bailout Greece?”, “should we bring in the IMF?”, “should the Greeks go directly to the IMF, cutting out the EU?”, etc – has your head spinning and reminds you of overly complicated and opaque episodes from the history books, then you have actually caught the main point.  European power structures and alliances webs are being remade before your eyes.

Is this all random – just the collision of disparate national interests with no coherent plans on any side?  Or are there some strong, deliberate, and very personal hands at work guiding key pieces into place?

Prince Metternich worked long and hard to manoeuvre countries and people before and after 1815, cynically and cleverly building a system of interlocking interests that suited him – and his employer, the Austrian/Habsburg Emperor.  Is there a modern Metternich now at work?  Most definitely: Yes.

If you’ve followed the twists and turns of the global dimensions that emerged from the financial crisis of 2008-09, you’ll know that the IMF was transformed from an organization that was being euthanized by the G7 to an important element in the G20’s back-up financing for emerging markets (with the most dramatic turn of events in the run-up to the London summit in April 2009) – and definitely part of what helped stabilize confidence around the world.

This sequence of events created a great opportunity for the IMF’s Managing Director, Dominique Strauss-Kahn (known to friends and foe alike as DSK), to relaunch his political career in France – he previously ran for the presidency but could not secure the socialist nomination, and taking the IMF job seemed to everyone (including President Sarkozy, who lined it up) as akin to being marooned on a desert island.  But DSK is – like Metternich – a master of the opportunity, a man who knows when to move and when to stand still, and someone always working a network of long-cultivated European political contacts (including socialists in Greece).

DSK’s objective is to cast himself as the savior of Europe – undoubtedly this would play well with the French electorate – and of course he is greatly aided by the serious underlying problems within the eurozone in general and for Greece in particular (back story is here).  As he controls the IMF absolutely and completely, he has access to the best global economic intelligence as well as the means to make large loans to countries at low interest rates.  He must of course bring others with him, but this is not hard – the White House, for example, could not care less about who ends up running Europe and at what growth rate, as long as it does not blow up.

President Sarkozy’s aim at this point is naturally to keep DSK and the IMF as far from the action as possible.  But Sarkozy has three problems.

1. The Greeks have learned fast how to play international economic diplomacy – threatening to bring in the IMF in a way that would embarass the European leadership.  Without question, they are being coached by people close to DSK.  Watch the masters at work.
2. German voters really do not want to be involved in anything that looks or feels like a bailout.  A low interest rate loan to Greece would really upset them.  The Germans could do something off-balance sheet (i.e., get their banks to provide cheap credit to Greece), but the German banking system is already so ridden with governance problems and hidden bailouts that this is not appealing to the elite.
3. If you provide financing to Greece at anything other than low interest rates, the numbers simply do not make sense (we take you through this here.) Merrill Lynch pushed back against us this week with a report arguing that if Greece can borrow again at the level of German interest rates, everything would be fine – this is, of course, a legitimate point, but a cursory look at Merrill’s relatively sanguine research reports on Greece prior to the crisis (and also at their assessments of global credit markets prior to fall 2008) does not suggest that the “don’t worry, be happy” scenario is high probability.

Sarkozy is also an expert tactician and he is not finished yet – entering the weekend, the ball is definitely in his court.  Expect further “let’s do it without the IMF” options to surface now – in particular, Sarkozy will try to scare the Germans regarding how the European Central Bank (ECB) would be undermined if the IMF enters the arena.  Sarkozy can also commit, behind the scenes, to support Axel Weber for the ECB presidency – something top Germans want more than they want almost anything else in the world.

And what if Strauss-Kahn prevails and the IMF makes a loan to Greece, would this save the day?  Not necessarily – remember that DSK’s goal is to just to look good until he leaves the Fund to run more openly for the presidency, which is probably no more 12 months from now.  His incentive would be to put in place a relatively small program of funding that does not ask Greece to do too much up front; if this explodes later (as seems likely), that would not be his problem.

Sensible program design and dealing with the core underlying issues in a reasonable manner – including confronting the looming issue of “debt restructuring” – is not likely.  This is French electoral politics after all.

Then the article from the Financial Times:

At last we are heading towards a resolution, albeit a bad one. After weeks of pledges of political and financial support, Angela Merkel appears ready to send Greece crawling to the International Monetary Fund.

Germany cites legal reasons for its position. In past rulings, its constitutional court has interpreted the stability clauses in European law in the strictest possible sense. These rulings have left a deep impression among government officials. It is hard to say whether this argument is for real or is just an excuse not to sanction a bail-out that would be politically unpopular. It is probably a combination of the two.

I have heard suggestions that a deal may still be possible at this week’s European summit, but only if everybody were to agree to Germany’s gruesome agenda to reform the stability pact. That would have to include stricter rules and the dreaded exit clause, under which a country could be forced to leave the eurozone against its will. I am not holding my breath.

But either outcome will mark the beginning of the end of Europe’s economic and monetary union as we know it. This is the true historical significance of Ms Merkel’s decision.

While Greece faces the most acute difficulties, it is not the only member in trouble. There are at least four – Greece, Spain, Portugal and Ireland – that are probably not in a position to maintain a monetary union with Germany under current policies indefinitely. There may be several more, where the problems are not yet quite so evident. In the presence of extreme current account imbalances and a lack of bail-out or fiscal redistribution mechanisms, a monetary union among such a diverse group of countries is probably not sustainable.

In a column several weeks ago I put forward three conditions necessary for the eurozone to survive in the long run: a crisis resolution mechanism, a procedure to deal with internal imbalances, and a common banking supervisor. Since then, things have been moving in the wrong direction on all three counts.

For a start, we have come from a situation in which the “no bail-out” clause of the Maastricht treaty, having been almost universally disbelieved for 10 years, is suddenly 100 per cent credible. The minute the IMF marches into Greece, all ambiguity will end.

The debate on imbalances is also regressing. It would be unreasonable to ask Germany to raise wages or cut exports, but there is a legitimate complaint about Germany’s lack of domestic demand. Berlin should accept it needs to develop a strategy. But the opposite is happening. Rainer Brüderle, economics minister, said last week there was nothing the government could do about demand because consumption was a decision by private individuals. A senior Bundesbank official even compared the eurozone to a football league, in which Germany proudly held the number one slot. The long-term direction of fiscal policy is even more alarming, as the gap between Germany and the others will widen.

On banking supervision, the main reason for a common European system is macroeconomic. In a monetary union, imbalances would matter a lot less if the banking system were truly anchored at the level of the union, not the member state. As banks can obtain liquidity from the European Central Bank, even extreme and persistent current account deficits should not matter in good times. But they matter in times of crisis. For as long as bank failures remain a national liability, persistent imbalances could ultimately lead to a national insolvency. If the banking sector were genuinely European, imbalances would still be an important metric of relative competitiveness but we would need to worry a lot less, just as we do not worry about the current account deficit of a city relative to its state.

The lack of a bail-out system, of an agenda to reduce imbalances and of a common banking system are realities that investors should take into account when making long-term decisions, as should policy-makers when they make important choices for citizens. The reality is that the eurozone, as it works today, is not a monetary union but a souped-up fixed exchange rate system.

Wolfgang Münchau goes on to conclude:

In the past, global investors have placed a lot of trust in European politicians. They believed Peer Steinbrück, the former German finance minister, in February 2009 when he ended a speculative attack on Ireland, Greece and others with a simple statement of support. They also believed, as I did myself, that political leaders would ultimately do the right thing to save the system, having first explored all the alternatives. As I follow the political debate in Berlin, I am no longer certain that is the case.

Ms Merkel is not a politician driven by a strong historical destiny, unlike Helmut Kohl, her predecessor but one as chancellor. However real the constitutional problems may be, I suspect Mr Kohl would never have hidden behind a technical or legal argument on such a crucial issue.

Europe’s current generation of leaders lacks this accident-avoiding instinct. So when Ms Merkel and her colleagues in the European Council see the iceberg coming, they will tend to rush not to the helm but to the nearest constitutional judge.

I am not predicting a catastrophe. I am merely pointing out that the present policy choices are inconsistent with the survival of the eurozone in its current form.

Rights in both articles remain with the publishers. If you wish to reproduce this Post then permission must be sought with the original publishers.

By Paul Handover

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