Kowtowing to Berlin, or, Niebelungentreue bis zum Untergang?

The smoke is beginning to clear from the EU summit, and the results are not encouraging. We can now start reading between the lines to discover two main results:

1. They still don't get it, and now with a vengeance (economically speaking);
2. The purported hidden agenda has finally raised its ugly head (politically speaking).

 The "fiscal union" emerging out of the revamped Stability Pact is nothing of the sort. It does not provide for any automatic transfers from prospering to depressed regions like any true country has nowadays (in Germany it is the "Laenderfinanzausgleich" between the Federal states). What is good enough for Germany domestically apparently is anathema at the European level. Second, it is procyclical rather countercyclical, forcing countries in recession to further cut their budgets. Kevin O'Rourke spells this out thoroughly in a recent blog. Thus in the name of stability it is throwing one of the great accomplishments of twentieth century statecraft out the window - automatic stabilizers (unemployment insurance, budgetary transfers) and discretionary fiscal stimulus programs - that have succeeded in moderating the business cycle since WWII. Germany's own Kurzarbeit program is one of the best examples of such a successful policy. Not only will this not contribute in any way to the immediate problem at hand - the looming disintegration of the Eurozone - but, should the EZ by hook or crook survive, would convert it into a pact for mutual impoverishment. Germany has made no concessions to provide any expansionary impulse, placing the burden of adjustment entirely on the periphery. It is even still unclear whether this finally provides the fig leaf  for the ECB to unleash a defense of Italian and Spanish sovereign debt, something I have no doubt the markets will start testing when they reopen tomorrow. Germany has thus succeeded in foisting the "fiscal irresponsibility" fairy tale (the contemporary "Dolchstosslegende" - the "stab-in-the-back legend" coming out of WWI?) on the rest of the EZ, exploiting the Euro crisis that it has most contributed to exacerbating to bludgeon the other members into acquiescence.

And the "hidden political agenda"? Tony Corn places the European summit within the broader historical context of Germany's designs on Europe since unification in 1871. Just as Prussia converted a customs union among the German states into a Prussian-dominated German Empire, he sees modern-day Germany as freeing itself from the last shackles of the postwar European/Atlantic order to impose a naked power grab on the EU17 (Kleindeutsche Loesung), while excluding countervailing powers (Austria in the Grossdeutsche Loesung, Great Britain today in the EU27 large Europe). So no one should be shedding any tears in Berlin that Cameron has voluntarily excluded his country from the German-enforced new framework, even if outside observers can take issue with his reasons. Even Der Spiegel commentator Christoph Schult is incensed at the return of the "ugly German." While I am still reluctant to sign off on the hidden agenda theory of either Cornian or Connollian provenance, the alternative obtuseness theory is equally unconvincing.

The irony of this coup, however, is that it will inevitably be a Pyrrhic victory. Merkel has terrorized her fellow passengers on the EU17 into making her unchallenged captain of the already leaking ship by spiking it under the waterline with additional holes. She will have only a short time to enjoy the pleasures of her victory before the ship finally capsizes, mostly due to her own Machiavellian ploy. I have nothing against German leadership in Europe, but leadership requires not only an ability to intimidate one's partners, but also the ability to forge institutional ties that are mutually beneficial and elicit voluntary cooperation. This is an aptitude that has always been singularly lacking in German elites. Niebelungentreue did Germany an immense disservice in two world wars. I fail to see its value now in a post-summit Europe.

The Showdown at the EU Corral

I've been studiously trying to avoid obsessing about the Euro crisis this week, going out with friends to the (now egregiously commercial) Anjuna Beach flea market and a great dinner in Panaji. But the time has come to confront the crisis again, since this is the week of the great "Showdown at the EU Corral."

Merkel and Sarkozy seem to think they can stampede the rest of the EU into a further renunciation of national sovereignty in the name of another doomed Stability Pact (remember that Germany was the first country to violate the 3% deficit clause of the old Stability Pact in 2004, while Spain and Ireland were actually running fiscal surpluses until 2008). So is this the hidden agenda to railroad a dictatorship on the EU, simple obtuseness, or a fig leaf to provide the domestic political cover to allow the ECB to finally fire the "big bazooka" of a lender-of-last-resort bond commitment? Your guess is as good as mine.

But of course the real problem is that this approach completely fails to address the root of the problem. And everyone know this (except our hapless leaders?), from editorialists in today's New York Times and Der Spiegel, to academics like Charles Wyplosz, to the markets themselves, which are rational enough to price in the fact that austerity in a recession only makes the fiscal quandary of the peripheral states worse. So kicking the can down the road ends here. But an attempt at railroading a defective and undemocratic Franco-German "Stability" Pact will only provoke justifiable reactions on the part of the other EU nations at being treated like truant school children.

Meanwhile, in another article Der Spiegel reports that various national central banks such as Ireland's are reequipping themselves with the printing press capacity necessary for reintroducing national currencies in a hurry should the failure of the EU summit call for a Plan B. So the writing is on the wall, or going to press. I'm going to the beach...

P.S. The combinatorially simplest breakup of the Eurozone would just have Germany and Greece exit. It would also be morally equitable, since only the truly guilty parties would be relegated from the group (Greece for being Greece - cooking the books and being a patronage state, and Germany for the fundamental problem - wage dumping - and vetoing a mutually constructive solution). I pointed this out as long ago as Sept. 11. Seems like ancient history now...

My Sincerest Apologies to the Great German Nation (for having an imbecilic government)

In my last post I got carried away and turned Polish Foreign Minister Sikorski's description of Germany as the 'indispensable nation' into 'imbecile nation.' Of course what I meant was the current German government, not the industrious, intelligent and forbearing people of Germany, who, like their similar compatriots in other EU countries, are confused and anxious about the Eurozone turmoil. The ordinary people of the Eurozone (from Germany to Greece, yes, even the Greek people are innocent) did nothing to bring this tragedy unto themselves, but they will be the chief victims of the misguided policies of their deluded leaders. I trust that intelligent followers of this blog were clear about this distinction, but I want to spell it out explicitly  once again just so that there is no misunderstanding about where I stand.

And today, what does a quick perusal (despite spotty Internet connections from Agonda Beach) of the New York Times reveal but another instance of extreme cognitive dissonance. First, we have Paul Krugman succinctly summarizing the basic economics of the Eurocrisis, and why fiscal irresponsibility does not lie at its heart. Then we have German chancellor Angela Merkel, in a speech before the German parliament, comparing her rescue efforts with a marathon that will take years to finish. And what do these rescue efforts consist of (as far as I can make out)? Fiscal control of the debtor countries and more spending cuts, just what Paul Krugman points out will only accelerate the collapse, when what is needed is expansion and more inflation in the core. Two more contradictory takes on the same reality are hard to imagine. Yes, in the words of Martin Wolf  in the FT (citing an unnamed observer from 'outside the eurozone'), 'they just do not get it.'

So, instead of years of a recovery marathon, we appear to be facing just days of unprecedented (and avoidable) economic turmoil. Ein Ende mit Schrecken, statt ein Schrecken ohne Ende.

When Even the Poles Plead for German Leadership...

When Polish Foreign Minister Radoslaw Sikorski feels compelled to make a dramatic appeal for Germany to show more leadership in the crisis, we know we are up sh-t's creek.

According to Reuters,

"You know full well that nobody else can do it," he said in a speech in Berlin Monday evening, referring to efforts to save Europe's monetary union. "I will probably be the first Polish foreign minister in history to say so, but here it is: I fear German power less than I am beginning to fear German inactivity. You have become Europe's indispensable nation."

I would rather say Europe's imbecile nation. I mooted the point that Germany, the ECB, the European Commission, somebody, anybody, might be pursuing a hidden agenda, but now I'm convinced Merkel, Schaeuble and Draghi are intent on outdoing Bruening and going down in history as the world's greatest gratuitous economic blunderers. I fail to perceive any logic in their public pronouncements. It should be clear by now that fiscal austerity and central budgetary control, not to mention ECB fiddling while Italian bond auctions burn, are not going to save the Eurozone. Some modicum of a basic understanding of the origins of the crisis are a prerequisite for solving it, and these people do not seem to partake of any. Not that Germany and other EU countries do not possess outstanding economists who have been providing sensible policy advice all through the crisis (such as Peter Bofinger in Germany and Paul de Grauwe in Belgium). So the incorrigibility of the central bankers and politicians is really inexplicable. They seem to be trapped in a simplistic, moralistic universe, not unlike Bruenings obstinate clinging to the idiotic Notverordnungen that led to Europe's twenty years of despair.

So I'll just throw my hands up in disgust and hit the beaches. Let's all enjoy the little bit of life we are still vouchsafed while the imbecilic politicians do their best to destroy it.

Why the Eurozone is (was) like a CDO

Eva and I flew into Goa on Saturday morning, so I'm just coming up to speed on the state of the world. Unfortunately, the state of the world (i.e., the Eurozone as far as I am concerned) is showing no signs of coming to its senses. Merkel is still blaming the other member governments for fiscal irresponsibility (not low German wages), and thinks a last minute installation of central fiscal administration, should this even be possible, will accomplish anything except make the situation worse (that is, as long as austerity is the call to arms). The ECB is still sitting on the fence and washing its hands of the affair, as if it were the central bank of a different planet. So the expedition to Mt. Euro has gone astray and looks like the heroic tomfoolery of Scott's expedition to the South Pole.

In the meantime, after moving into our superior cottage up the hill, in among the palm trees, I had a minor satori that the Euro was the currency-zone equivalent of a CDO (collateralized debt obligation, of subprime mortgage notoriety). Why that? The Euro, like a multi-tranche CDO, combines assets of different creditworthiness into a pooled asset which, by dint of financial engineering, has a higher creditworthiness than the weighted average of its components. The Euro amalgamated different countries with varying creditworthiness, from the marginal like Greece to the gold-standard like Germany, and, despite the no-bailout-clause of the Maastricht treaty, allowed them all to enjoy near-German creditworthiness. Spreads over German Bunds began to disappear and everyone could now borrow on near-German terms. This was even better than if, like in a normal currency union, the risks of the constituent parts were simply pooled by a Federal government (like in the US), with a bonus due to the gains of diversification. Countries like Greece were now benefiting from borrowing rates well below anything they deserved as independent countries, and even better than the weighted-average creditworthiness of the entire Eurozone, had sovereign debt been entirely mutualized in Eurobonds from the beginning. A CDO, in other words, distilling triple-A status from the dross of subprime mortgages.

The reason? As far as I can see, the 'senior tranche' of the Eurozone - the AAA-rated countries like Germany, France, the Netherlands, Austria - was assumed to be ready to pluck the chestnuts out of the fire should the EZ ever get into difficulties. Thus, the 'senior tranche' bootstrapped the creditworthiness of the group through implicit CDO-like financial engineering above the average of its underlying assets. But after the 2008 world crisis, and even more, after the haircut on Greek debt, the curtain was jerked from the emperor's new clothes and, just as in the subprime mortgage crisis, the structured asset was revealed to be naked. The irony is that the creditworthiness of the EZ member countries, due to the competitiveness straightjacket of the common currency, is now lower than if they had remained independent, and plummeting fast.

The Doomed Expedition to Mt. Euro, Last Sighted Just Below the Summit

AP reports that there were no survivors. Photo courtesy of ECB mountain rescue helicopter.

The Slippery Slope or, Is There Method in This Madness?

Why is the Eurozone like a bunch of mountaineers, roped together in a line, dangerously ascending an icy precipice overlooking a chasm, and not a group of solid economies, pooling their resources and reserves to create, via the laws of diversification and scale, a more stable and robust economic entity? After all, EZ indebtedness and deficits are lower than those of the US, the UK or Japan. The way things now work, one climber after another is slipping off the ledge and falling into the chasm, pulling the next candidate with him by the rope, the Euro, that was originally meant as a safety device. As more and more climbers slip off the precipice, the weight on the remaining climbers only increases, accelerating the tragedy and making a mockery of the rope.

But the situation is even worse than this. Well before the first climber started slipping, the lead climber was surreptitiously loading the other climbers' backpacks with stones (otherwise known as current account deficits). And a helicopter to whisk the climbers off the mountain and land them on flatter terrain was not available because the pilot did not consider it to be his job.

The Eurozone is in free fall because markets, rightly, have woken up to the fact that sovereign debt issued by countries that do not possess a central bank is almost worthless, even more worthless than the debt of emerging market countries issued in hard currency. The latter can at least devalue their national currencies to increase their export competitiveness, and adjust their central bank discount rates, while the former are locked into a currency they do not control and cannot defend.

The ECB has shown itself to be the central bank, not of the Eurozone as a whole, but in essence of Germany and the Bundesbank, the lead climber. Thus as the crisis has unfolded, yields on German Bunds have fallen while spreads on other EZ debt have soared, even on AAA rated ones like France, the Netherlands and Austria.

So today, once again, the Bundesbank's Jens Weidmann says that Italy and Spain should be able to solve the crisis by their own efforts, without ECB intervention. The only thing we have to fear is fear itself, i.e., a crisis of confidence. And Merkel reiterates that austerity, austerity, austerity is the only solution. How can they fail to see that the absence of a central bank backstopping (not financing) periphery EZ debt, and periphery austerity, are leading inexorably to exactly the crisis of confidence they think they can exorcise with incantations of more austerity?

Or is there method in this madness that we mere mortals are unable to perceive? A darker plot to impose a (Brussels/Paris/Berlin based?) Eurocratic dictatorship over recalcitrant peripheral, and with the increasing unpopularity of the bailouts, also core democracies, as intimated by former EU official Bernard Connolly (see Milken Institute 2011 panel and his 2002 Dark Vision document)?

I'm not much of a fan of conspiracy theories, but one is forced by the Euro crisis to make a choice between two incredibly difficult assessments. Either the German government and Bundesbank are being unbelievably obtuse, acting against their own long-term interests, and are just 'unbelehrbar' (German for incorrigible). Or they are complicit in some darker antidemocratic project that we mortals can only faintly adumbrate, a project that has already brought down the democratically elected governments of five EZ countries (Portugal, Ireland, Greece, Italy and now Spain), with two of them now being governed by Eurocratic unelected governments. The peripheral countries' governments are now essentially impotent to carry out any policy except that dictated to them by Germany. That's why the election of a new conservative government in Spain, and the consolidation of the Monti government in Italy, have brought them no relief on the interest rate front. The future of the Eurozone is being decided exclusively in Frankfurt and Berlin, and my impression is that these people do not have the faintest idea what they are doing. But I could be wrong, which might just be even worse.

The self-destruction of the Eurozone will be one of the signal events of modern European (and world) history. But whether it was the result of method or of madness will be a matter for future historians to decide.