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Ambrose Evans-Pritchard: Should Germany bail out Club Med or leave euro itself?
By Ambrose Evans-Pritchard
The Telegraph, London
Sunday, January 31, 2010
Germany faces a terrible dilemma. Either Europe's paymaster agrees to underwrite a Greek bailout and drops its vehement opposition to a de facto EU economic government, treasury, and debt union, or the euro will start to unravel, and with it Germany's strategic investment in the post-war order.
The spike in yields on 10-year Greek bonds to 400 basis points above German Bunds has been shockingly swift -- a warning to Britain too that markets can suddenly strike any country that takes creditors for granted.
We can argue over whether Greece, Portugal, or Spain are at risk of being forced out of the euro. But there is another nagging question: whether events will cause Germany and its satellites to withdraw, bequeathing the legal carcass of EMU to the Club Med bloc.
This is the only breakup scenario that makes much sense. A German exit would allow Club Med to uphold contracts in euros and devalue with least havoc to internal debt markets. The German bloc would enjoy a windfall gain. The D-Mark II would be stronger. Borrowing costs would fall. The North-South gap in competitiveness could be bridged with less disruption for both sides.
To be sure, Germany is happily placed in the current EMU system. By compressing wages for a decade it has stolen a march on EMU. Critics unfairly call this a beggar-thy-neighbour policy. It is simply the way Lutheran society operates, in deep contrast to the way Latin society operates -- a cultural clash that should have given pause for thought before Europe's elites launched headlong into their adventure.
German goods are flooding the South. In the 12 months to November, Germany-Benelux had a current account surplus of $211 billion: Spain had a deficit of $82 billion, Italy $74 billion, France $57 billion, and Greece $37 billion. German industry will not give up this edge lightly. However, the matter will in the end be decided by democracy. German citizens were given a pledge by their leaders in the 1990s that loss of the D-Mark would not lead to monetary disorder, or leave them liable for Club Med debt. That is the sacred contract of EMU.
"Politically," said Bundesbank chief Axel Weber, "it's not possible to tell voters that they are bailing out another country so that it can avoid painful austerity measures that they themselves have gone through. Such aid, whether conditional, or -- even worse -- unconditional, is counterproductive."
Dr Weber is right on both counts. Fresh loans for Greece can achieve nothing useful at this stage. Greece already has a public debt hurtling towards 138 percent of GDP by 2012 (Standard & Poor's). It is already in a debt compound spiral. The EU elites have yet to acknowledge that Greece and much of Club Med need gifts -- not loans -- akin to transfers paid to East Germany after unification, or North Italian perma-subsidies to the Mezzogiorno.
Athens has promised to slash the budget deficit by 10 percent of GDP over three years, though the country is sliding deeper into slump, faces 20 percent unemployment by the year's end, has a tottering banking system, and has already lost control of its streets before spending cuts have even begun. Such a policy is economically self-defeating -- since it risks tipping the country into depression, and causing tax revenues to collapse -- but will it be tolerated by Greek society?
The Papandreou government has craftily invited the European Commission to set up a vice-regal inspectorate in Athens, to become the focus of popular fury. The media talks of "guardianship." Ta Nea, an Athens newspaper, writes of "ultimatums" and "suffocating deadlines" for wage and pension cuts. "Either we obey the commands of unprecedented austerity and face the risk of widespread social unrest or we refuse to implement the orders."
Spain's troubles are less immediate, but it lost as much competitiveness during the early EMU boom, that debt trap of negative real interest rates. External corporate debt is dangerously high. The budget deficit was 11.3 percent of GDP last year. Madrid has drawn up E50 billion of cuts to sweeten the markets, even though unemployment is already 19 percent. The jobless typically receive 50 to 60 percent of former earnings for around 18 months; then the ax falls. The social distress hits with a lag. How much more tightening can Spain endure before Catalan, Basque, and Galician seperatism rocks the Spanish state?
Fiscal austerity in these circumstances without monetary and exchange stimulus to offer a lifeline is incoherent. These policies must fail because they are based on EU wishful thinking that high-debt nations can regain competitiveness within EMU against a zero-inflation Germany. Such a strategy will drive them into a debt-deflation spiral.
Europe will have to embrace "fiscal federalism" if it is to hold monetary union together. That is when we will probe the limits of EMU solidarity. Hedge funds are betting that Berlin will pay to ensure stability. No doubt Chancellor Angela Merkel is of that mind, but the Free Democrats are not, nor are Bavaria's Social Christians, or the Bundestag's finance committee. Economy minister Rainer Bruderle said last week that there would be "no bailouts" regardless of risks to EMU. Is that just brinkmanship?
EMU architects were warned in the early 1990s that monetary union would prove unworkable as constructed. They scoffed, sure that any crisis could be exploited to force the pace of economic union. Commission chief Romano Prodi later admitted as much. "The euro will oblige us to introduce a new set of economic policy instruments. It is politically impossible now. But someday there will be a crisis and new instruments will be created."
We will soon learn if this gamble will pay off, or prove catastrophically wrong.
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