We'll begin with a quote from Evans-Pritchard from Britain's The Telegraph, who said it shorter and better than anyone else:
Let us be clear, the chief reason why Greece cannot meet its deficit targets is because the EU has imposed the most violent fiscal deflation ever inflicted on a modern developed economy - 16pc of GDP of net tightening in three years - without offsetting monetary stimulus, debt relief, or devaluation. This has sent the economy into a self-feeding downward spiral, crushing tax revenues. The policy is obscurantist, a replay of the Gold Standard in 1931. It has self-evidently failed. As the Greek Parliament said, the debt dynamic is "out of control."
It should be, and probably is, obvious to anyone that this serves no purpose (apart from satisfying the German electorate, or Bild Zeitung, but even on that part it's failing). Yes, the Greeks misbehaved for a decade or so, but this kind of retribution is pretty self-defeating.
Why persist with this ritual?
Basically because of bank exposure to Greek debt (and the weak state of many European banks). However, as we argued elsewhere, this exposure is not terribly high. Greek debt is 340B euro, but this is by no means all on the books of European banks, and it's by no means going to be a 100% default.
This brings the euro-area bank exposure to a rather manageable 50 billion euros, closer to 100 billion euros if you include exposure to private Greek debt (like Greek banks).
But the problem with the Germans is that they're not proposing any credible alternative:
- They're against ECB bond buying (two of their best ECB officials even resigned over it and even the German President slammed it)
- They're against a larger European rescue fund (EFSF)
- They're against the introduction of eurobonds.
However, they're so wedded to their (otherwise fine) monetary condition and they're so used to the rest of Europe falling in line with that, that this is too much of a rude awakening for them. What is that German monetary tradition that seem so deeply engrained in the German psyche, even their identity?
A Birds'-Eye View of the German Monetary Tradition
It all started with the loss of WOI and the draconian repair payments imposed on the Germans at Versailles. Or at least that is the myth (in reality, the reparations were an important element, but by no means the only one).
The ensuing hyperinflation (above you see some iconic pictures, the proverbial wheelbarrow of banknotes needed to buy a loaf of bread) paved the way for political chaos and ultimately Hitler rising to power.
After the Third Reich was defeated in 1945, the Germans, a proud culture with many achievements, were ashamed of themselves. Hard work leading to the Wirstshaftswünder, beginning in 1948 with the strong D-mark as its symbol, was the main way of self-rehabilitation.
It's hardly an exaggeration to state that the post-WOII German identity was tied up with the strong D-mark, the currency which was never devalued against any other European currency in its entire existence.
Other countries began to take note, and tied their currency to the D-mark to 'import' part of the German monetary credibility, and so the European Monetary System (EMS) was born. In this system, the D-mark was the central currency (not unlike the US dollar under the Bretton Woods system). In the Dutch central bank, people quipped that they had 45 minutes of monetary independence.
If German interest rates changed, so should the others, as not doing so risked the ties to the D-mark. Small countries like The Netherlands and Austria didn't have a problem with this, but such was the German monetary dominance that bigger countries like France and Italy started to look for an alternative.
The alternative was found in creating a European Central Bank (ECB), managing a single currency (the euro) under a new arrangement, the European Monetary Union (EMU).
In essence, it was a way for France and Italy to escape some of the German monetary dominance, as each country has one vote at the ECB Council, its policy-setting board. Keep this in mind, because this is what's playing up right now.
The Germans (reluctantly) went along, because the political class (like Helmut Kohl, the then Bundeskansler) taking that decision was deeply scarred by WOII and wanted to tie Germany more firmly to Europe. There were also some economic benefits for the Germans -- the currency crisis of the EMS were supposed to be a thing of the past, and Germany would not alone bear the consequences of a weak US dollar.
As Good as the D-mark
In exchange for giving up the mighty D-mark, the Germans insisted that the euro would have to be as good as the D-mark, and "guarantees" for this were provided by the German design of the EMU, consisting of the following main elements:
- A Stability pact; member countries should not exceed a 3% of GDP public deficit and a 60% public debt (apart from temporarily under 'special' circumstances). It didn't help matters though that Germany and France were its first violators (albeit temporarily).
- Frankfurt (which is where the Bundesbank is housed) was chosen as the first location for the ECB.
- Former Dutch central banker Wim Duisenberg was chosen as the first ECB president. The Dutch are the most ardent admirers and followers of the German monetary tradition.
- The ECB was to be completely independent from politics.
- A no-bailout clause: The ECB is prohibited from directly buying Government bonds.
- Inflation-fighting as its sole aim (no dual mandate like the Fed has).
In essence these elements were to provide the safeguard for the Germans that the euro would be as good as the D-mark, and indeed for most of the time, it has been. Jean-Claude Trichet (the present ECB president) mentioned just the other day how the ECB has delivered unprecedented price stability, even for the Germans (averaging 1.6% per year for the first decade of the euro in Germany).
But during those 10 years, things were rotting in the euro periphery. Countries like Greece, Portugal, Ireland, Spain, and the like experienced a sharp fall in their interest rates as a result of EMU membership, and this led to a public spending spree (in Greece), a private spending spree resulting in a housing bubble (in Spain and Ireland) and countries that failed to take advantage accumulated a large inflation differential that slowly deteriorated their competitiveness.
While these events could be swept under the carpet for quite some time, the financial crisis of 2008 and the following steep recession made these festering problem suddenly very acute.
Alarm in Germany
If having their two finest officials (Axel Weber, once the anointed successor of Trichet, and Jurgen Stark) resign in disgust wasn't a clear sign of German nausea at the 'Europification' of the ECB and the crumbling of its German characteristics, consider some of the language coming out of Germany:
Hans-Werner Sinn, one of the most authoritative German economists, is actually calling for a boycot of the ECB until there is a new stability pact. In the meantime, Bundesbank president Jens Weidmann should no longer participate in ECB Council meetings, and Jörg Asmussen, the prospective successor of Jürgen Stark, would wait taking his place.
Sinn also argues for the German Parliament to vote down the proposed new powers of the European rescue fund, the EFSF (which involve bond buying and refinancing banks), according to Dutch quality newspaper NRC Handelsblat.
Even the German president has weighed in, with an unusually strong statement (you have to realize that in Germany, being president is mostly a ceremonial job):
“I regard the huge buy-up of bonds of individual states by the ECB as legally and politically questionable. Article 123 of the Treaty on the EU’s workings prohibits the ECB from directly purchasing debt instruments, in order to safeguard the central bank’s independence,” (The Telegraph)
Remaining solutions?
Is all this helping? It's needless to say that, although it might play well domestically, it's only worsening the crisis, which needs a solution of some kind right now.
How is this going to play out if the Germans don't want to play ball and keep insisting on austerity, which is so clearly not working?
Well, the way it's heading seems a preparation for a Greek default (it is near completely priced into the CDS market, for instance), even if Merkel denies this:
German Chancellor Angela Merkel said that Greece is taking the right steps to get its next bailout payment, warning against allowing a Greek default because of the risk of contagion for other euro-area countries. (Bloomberg)
Using lots of money to safeguard German banks is a lot easier to sell to the German electorate than using the same money in a rather senseless exercise to prop up Greece.
But whether a Greek default can be contained to Greece alone remains to be seen. Merkel is right to be skeptical:
“The top priority is to avoid an uncontrolled insolvency, because that wouldn’t just hit Greece, and the danger that it hits everyone, or at least a number of other countries, is very big,”
However, what is needed to avoid such contagion is big ECB action (propping up banks and the yields of the likes of Spain and Italy), but funny enough, that's exactly what the Germans are so dead set against.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
