Sarkozy's 'Landmark' Speech, Merkel Remains Adamant
Evidently Angela Merkel senses that the recent change in market sentiment may actually create an obstacle to her ambitious plan of bringing the fiscally profligate nations in the euro area to heel. She is quite right about this: whenever the pressure exerted by the markets has lessened, the urgency with which reform was pursued has immediately lessened as well.
Unfortunately the 'way forward' envisaged by Merkel and Sarkozy is precisely the one that sets into motion the creation of a socialist super-state - as 'fiscal union' of the euro area is held to present the solution to the crisis.
To be sure, Sarkozy's speech contained a number of points that are well worth heeding.
He declared some of the sacrosanct cornerstones of the French socialist economic model to be 'grievous mistakes,' including the 35 hour work-week and retirement at the tender age of 60. The only way for France to overcome the crisis, so says Sarkozy, was by 'working more and cutting spending.' Hear, hear. The post WW 2 welfare state model he maintained, has become 'unsustainable in a new world with open borders' (this will likely entice Marine LePen to call for closing the borders).
It is both amusing and distressing that the first half of Sarkozy's speech – the half that contained the above morsels and hence is the portion of it that we think is of the utmost importance – was met with disdain by most observers and declared to be a mere 'campaign speech' (Sarkozy faces an election next year).
The second half, where he discussed the steps France and Germany envisage the euro area to take next, while not offering anything by way of concrete proposals, was the one everybody focused on. From the NPR report on the speech:
"After this long road, we are coming back to essentials. That's why France and Germany want a new European treaty, in order to rethink the organization of Europe," he said.
Sarkozy said European treaties should mandate a balanced budget for every member of the eurozone and punish violators. He announced that German Chancellor Angela Merkel would be going to Paris Monday, where the two leaders would announce new measures to guarantee the future of Europe.
If it really is only about ensuring that fiscal spending is held in check and mandating balanced budgets, then there should be no problem with these proposals. However, it appears that the centralizers have a much more far-reaching program in mind. This was confirmed by Angela Merkel's speech to the Bundestag today, see the excerpts below:
Anyone who, a few months ago, had said that at the end of the year 2011 we would have taken very serious and concrete steps towards a European stability union, a European fiscal union, for introducing such drastic intervention, would have been considered crazy.
Now, this is exactly what's on the agenda. We're almost there. Of course, there are difficulties to be overcome. But the necessity of such action is widely recognised. We're not just talking about a fiscal union but starting to create one. I believe you can't overestimate the importance of this step.
There it is again, the 'fiscal union' – the very step Germany's supreme court in Karlsruhe says Germany's government can not take without first altering the constitution. Not surprisingly, the German government seeks to disempower the court with regards to European policy. As German news magazine Der Spiegel reported a little while ago:
The judges must decide how heavily members of parliament are to be involved when the government once again tries to rescue Europe.
But behind the scenes, much more is at stake: the loss of power of the Constitutional Court in itself. The government and the court are locked in one of their biggest power struggles to date. One judge at the court described it as a "latent constitutional crisis." The government, he said, was trying to free itself of the restraints imposed on it by the constitution, and by the court.
The president of the court, Andreas Vosskühle expressed it a little more cautiously. The perception of his court was at present, he said "ambivalent in parts." On the one hand, the court had been credited for ensuring that European unity remained on a secure legal and democratic footing, he said. But on the other hand, it "is seen by some as an obstacle in overcoming the current crisis."
As a result, efforts underway in Berlin to change the constitution are being viewed with mixed feelings in Karlsruhe, where the court is located — because they are aimed at opening up greater room for maneuver in future dealings with the court.
If the constitution were to be replaced with another version through a popular referendum, this would be radical, but couldn't be criticized. But it appears that some among Chancellor Angela Merkel conservatives are considering removing the court's control over the political process through a normal amendment of the constitution. The legislature could simply deprive the judges of their jurisdiction in questions of European integration.
This is how the eurocracy generally tends to handle legal and obstacles. It removes them by what must be considered highly questionable means. The court in Karlsruhe is no doubt viewed as a major obstacle by the EU's centralizers.
In further remarks Mrs. Merkel made in her speech today, she once again underscored German opposition to eurobonds and ECB intervention. The latter in our opinion now mainly represents a means of exerting pressure. In reality, the decision to involve the ECB on a broader front has probably already been taken behind closed doors (more on this particular point in our next update a little later today) :
"Europe is facing its biggest test ever. The euro has proven its value. It is stable. But it is a lot more than a currency. It represents Europe's will to unite within and to face global challenges“
"Whoever hasn't understood that eurobonds can't be used as emergency measures in this crisis, hasn't understand the essence of this crisis.“
[She adds the German constitution does not permit devolving budget control to a European institution and that any discussion about euro bonds is therefore pointless.]
"We are dealing with a sovereign debt crisis, but also with a crisis of trust.“
[She stressed that it was important to respect the independence of the European Central Bank.]
"The ECB's role is different from that of the Federal Reserve and Bank of England. Its role is stabilise the value of the currency.“
[There's also no chance of a quick-fix, she explains - adding that resolving the euro crisis will take "years".]
As our readers know, we are in agreement with several of these propositions. We neither think that a 'quick fix' is possible, nor do we approve of money printing as an alleged 'solution' to the crisis (although we think that money printing is on its way in one or another guise, regardless of the official German objections).
However, the idea that using a common medium of exchange is predicated on a 'fiscal union' is profound economic nonsense. We must reiterate here the simple example recently forwarded by Sean Corrigan (paraphrasing): say for example that your neighbor – due to his lack of financial prudence - is up to his eyes in debt, that his income is not truly sufficient to serve it and that he therefore finds himself in financial difficulties. Does this mean that you have to enter into a 'fiscal union' with him so that the two of you can continue to use the same medium of exchange? This simple example should suffice to show how ridiculous this assertion is.
In reality, 'fiscal union' is about 'restoring market confidence' in the sustainability of the very welfare statism Sarkozy has just rightly declared unsustainable – by creating the fiction that joint liability for debt can somehow make the basic flaws of the socialist economic model disappear.
An objection along similar lines must be raised against those who claim that Germany's export surplus is somehow the cause of all the problems in the euro area. Again, paraphrasing Corrigan, every single one of us probably has a 'trade deficit' with his grocer. Neither we nor our grocer have yet been harmed by this fact. To this is is important to understand that cross-border trade is not 'between nations.' It is between individuals and companies that happen to reside in different nations. There can never be a question of a trade balance being a sign of a 'negative' or 'positive' development based on whether or not a nation's balance is in surplus. All the exchanges individual and companies have voluntarily engaged in are ipso facto positive for all concerned – if that were not the case, the exchanges would not have taken place.
Euro Area Credit Market Charts
Below is our customary collection of CDS prices, bond yields, euro basis swaps and several other charts. Both charts and price scales are color coded (readers should keep the different scales in mind when assessing 4-in-1 charts). Prices are as of Thursday's close. As can be seen, risk perceptions have been altered considerably be the decision of central banks to present a united front and offer dollar swaps at a reduced interest rate. Although the fundamental problems remain unaltered, the market perception that central banks will 'do more' – this is to say, engage in a more overt inflationary policy, esepcially in the case of the ECB – have had a sizable effect on market psychology.
Consequently, bond yields and CDS prices have seen sharp pullbacks over recent days – ironically lessening the pressure on the eurocracy to pursue stringent reform.
5-year CDS on Portugal, Italy, Greece and Spain. Only CDS on Greece are once again rising, but there has been a notable pullback in CDS on the debt of Spain and Italy. Note that CDS on Portugal have ominously failed to join the party
5-year CDS on France, Belgium, Ireland and Japan. The moves in Belgian and French CDS are especially noteworthy.
5-year CDS on Latvia, Lithuania, Slovenia and Slovakia
5-year CDS on Romania, Poland, Lithuania and Estonia
5-year CDS on Bahrain, Saudi Arabia, Morocco and Turkey – as always, moves in CDS on European sovereigns redound immediately on those of Middle Eastern sovereigns
Three month, one year and five year euro basis swaps – a sizable retracement bounce across the entire maturity curve has occurred following the decision to lower the interest rate charged on dollar borrowings from the ECB via the FX swap line with the Fed. This is more a matter of market psychology than anything else however. In concrete absolute terms, bank borrowings of dollars from the ECB are at the moment a mere drop in the ocean
A long-term chart of the three month euro basis swap to provide some perspective. The bounce is as of yet not really decisive. Considerable funding stress remains in the system.