- European financial markets have been relatively calm over the past 18 months.
- Germany is now suggesting that it is time to consider a political union that would provide oversight over eurozone member budgets.
- This is the last step needed to strengthen the economies of Europe and secure the place of the euro.
Right now, the economic climate in Europe looks relatively stable. Oh, there are problems. Economic growth is not what one would like it to be. And, the fear of deflation is in the air.
If you look at the financial markets, things have been very quiet for a sustained period of time.
Could it be that although the economy is recovering more slowly than desired and unemployment remains at much too high a level; could it be that the investment community looks at what is happening in Europe and believes that Europe is moving in the right direction?
The yield on the 10-year German Bund is around 1.55 percent. One has to go back to the middle of June 2013 to find this rate as low as it now is. Then in April and May of 2013 this yield was down around 1.20 percent. In the six months or so before this, the rate varied between 1.20 percent and 1.50 percent. For about 18 months, the interest rate on this 10-year sovereign debt remained very, very low.
In contrast, one can look at the yield on the 10-year US Treasury bond. In the fall of 2012, this yield was in the 1.60 percent to 1.80 percent range. In May 2013, the rate went up above 2.00 percent and by the middle of August it rose to around 3.00 percent. Today, the yield trades in the 2.60 percent to 2.70 percent range.
In other words, the yield on the 10-year German security has seen much volatility than has the yield on the same maturity US issue and has risen only modestly as compared with the US rate.
But, another thing has happened. The yields of other sovereign debt have dropped relative to the yield on the German bund. The "bad" guys, the peripheral countries, have seen the spreads over the German rate drop precipitously. For example, 10-year Greek debt was trading to yield 1,500 basis points to 2,000 basis points over the German rate in the fall of 2012. Now, this spread and dropped to around 500 basis points…or less.
Portuguese debt was yielding around 750 basis points above the German yield in the fall of 2012 and now is only about 250 basis points higher. Spain yielded 450 basis points more at the earlier time, and is now in the 165 to 175 basis point range. Italy, close to 400 basis points earlier, is only 170 to 180 basis points now. Even France is paying a smaller spread over the German yield now than it was 18 months ago.
The point is, the European capital markets have stabilized to a great extent, indicating investor confidence that the eurozone is moving in the right direction to resolve some of its deepest issues. A reflection of this, I believe, is captured in the title of a post I wrote in the middle of December, "The Euro Remains Strong: Germany is Winning."
It is my belief that Germany, under the strong leadership of its Chancellor Angela Merkel, has been the guiding force behind the European recovery. For many reasons, Merkel…and Germany…could not just blaze ahead attempting to impose their view on the rest of Europe. But, step-by-step, the German leadership has been the primary force guiding the continent into its future.
The reason it has been able to do this is that Germany got its act together better than any other nation in the eurozone. And, as a consequence, it was in a position to lead. Countries that are in a relatively strong fiscal and economic position can take the lead over others. Germany was just careful not to overplay its hand and stir up too many ghosts from Europe-past, but it would not give into the demands of other countries seeking an easier yet less viable way out of the economic recession.
It is my belief that the stability of European markets is a result of this leadership and it is this stability that has allowed the eurozone to address important issues that are vital to the future success of the European Union and the euro. Over the past year or so, the eurozone has been moving ahead on a banking union - one of the most important structural changes needed for a strong European future.
Now, we are apparently at the next stage. Germany - along with, it seems, England - is raising up the issue of a strong political union.
"Germany is pushing for EU treaty change 'as soon as possible' after the May European elections, in an overhaul to fuse eurozone economic governance behind a budget chief and euro area parliament." This quote is from the Financial Times.
Wolfgang Schäuble, Germany's finance minister, recently has been speaking out about "Berlin's vision for a refashioned and more centralized eurozone." He has outlined a vision "for changing the EU treaties to establish a 'budget commissioner' empowered to use a common funds and reject national fiscal plans if the 'don't correspond to the rules.'"
Schäuble has even co-authored an op-ed piece in the Financial Times with George Osborne, England's finance minister, that argues for a consolidation and for doing it in the near future.
The piece includes the following: "future treaty change must include reform of the governance framework to put euro area integration on a sound legal basis, and guarantee fairness for those EU countries inside the single market but outside the single currency."
That is, Europe should move on to the second part of the needed restructuring, a more unified governing body that has oversight over country budgets. Not only must there be a banking union…there must also be a political union.
Schäuble and Osborne state that this is the right time because "Germany and the UK are performing well economically.... Our countries lead the way in Europe on jobs-in each country employment reached a record level in 2013.
This validates the tough decisions we have taken to consolidate our public finances and reform our economies..."
In other words, it is time that this discipline should be expanded to include the whole European Union.
Obviously, this effort will not be a pushover. The advancement of the continent, economically and fiscally, and in terms of banking reform, has been full of stops and starts. But, the advancement has gone forward. There will be a lot of "local" toes to step on…hence, a lot of resistance.
There are also more and more signs that the reforms and restructuring that have been imposed in Europe are working. Even France seems to be taking small steps to change itself.
A greater political union, however, would be huge for the future of Europe. It is the next step. There is a long way to go, but it appears as if the timing is right. It is my guess that these early suggestions are just trial balloons sent out into the air to get the discussion going.
One needs to remember that four or five years ago, the thought of even being where Europe is now was only a dream…and to some…a not very realistic dream. But, if Europe…and the euro…are going to be a major force in the world…this political union will need to take place.