There was one thing that everyone in the investment and business press had in mind this weekend, and that was the EU summit meeting on Friday, December 9th. Certainly a great deal is being written about it, including this column. You can group them into categories, with a partition for each into European and non-European.
One group is made up of the top of the financial profession, people like Mohammed El-Erian and Bill Gross at Pimco; Warren Buffett; Treasury Secretary Tim Geithner; Fed Chairman Ben Bernanke. They are imploring Europe to act forcefully to save its system. Trouble is, they’re Americans, and one cannot hope to win elections in Europe while appearing to take the Americans seriously (except on military matters).
Another group here is more politicized. They more or less want the EU to fail, seeing it as a repudiation of something - socialism, government spending, the EU, snotty Parisian waiters. Millions may suffer, but that is a risk they are willing to take. What’s important to them is that their views and biases and prejudices get validated - not to mention their short bets.
Over in Europe, it’s a bit more fragmented. What might be called the technocrat group, the equivalent of our Grosses and Buffetts, has three sub-currents - UK, German, and continental not-German. The UK is divided: most of their better thinkers realize the perils of the collateral damage and so exhort the eurozoners to fix the problem. This is muddied though by the traditional British disdain for both the continent and the euro, such that a fair amount find it difficult to entirely forgo the pleasurable prospect of watching them first both take a header. It’s complicated.
The German technocrats acknowledge that the present course is untenable, but cannot bear the thought of those lazy Greeks and Portuguese picking the thrift from German pockets. Not only that, but give these people a quarter and who knows when they will stop begging! The rest of the continent, on the whole, wants to pursue the Big Fix, but without appearing to listen either to the Yanks or the Brits, and without offending the Germans, who have the biggest economy and the most money. It’s Germany’s ball at the moment, and if they go home, the game is over. It’s complicated.
Indeed, it looks very much like a Morton’s Fork for Germany and the EU. Morton’s Fork (named after the tax policy of a long-ago Archbishop of Canterbury, and familiar to any good bridge player) symbolizes a dilemma in which there is no winning option. In the original case, one paid taxes either because one lived well, or because one lived frugally: the former condition was evidence of sufficient income, the latter of sufficient savings. There was no escape from payment.
Similarly, Germany needs to frame its choice correctly - if it wants to avoid disaster. The key to the situation is that there is no option between paying and not paying for a resolution of the EU crisis. Germany will pay at the front door, or it will pay at the back door, and the back door tab is far higher, as the US experience in September of 2008 showed. There’s a reason the old saying, “an ounce of prevention is worth a pound of cure” has survived the centuries.
Chancellor Angela Merkel’s party may fear a fall from power if they commit German resources to supporting the union. It could happen. But if they don’t, their fall from power is guaranteed by the chaos that will follow. It may appear to be another case of Morton’s Fork, and the usual political response to all things unpleasant is to postpone the decision for as long as possible.
But that isn’t quite right, because while both options appear to be losing ones, one is far more costly. Merkel’s Christian Democratic Union needs to ask itself a question - do the members want to (possibly) go out as noble men and women who sacrificed themselves to save their country, their continent and their era from disaster, or do they want to be reviled through history as the stubborn little group of short-sighted little people who brought their houses down in catastrophe? German bund yields are right to be rising past US equivalents.
We realize that much of Germany hasn’t seen it that way. We read two lengthy pieces last week from Germany’s Der Spiegel, its prestigious weekly newsmagazine. The earlier article, written in October, focused overwhelmingly on what a mistake it was to let in Greece, that queer archaic country with its Byzantine economic system, and so on. There was exactly one paragraph on the cost of a eurozone breakup, though the authors admitted it would likely be fearsome. Filled with indignation about being hoodwinked and cheated, there was not a single word on the enormous economic benefit to Germany of the eurozone.
German exports have profited mightily from the euro, rising from 29% of GDP in 1999 to a breathtaking 47% in 2008. The Faustian bargain of the euro was that the richer countries, in particular Germany, got access to a cheaper, more export-friendly, yet still-stable currency that couldn’t rise against its neighbors in the Union. In exchange, the poorer countries got access to cheaper and better liquidity for borrowing. There are no innocent victims.
The second Der Spiegel article was only a bit more realistic, allowing that the unknown was forbidding, but still mostly wailing about the inequity to the German taxpayer and the temptation for the less-disciplined countries not to change their ways. The article is filled with head-in-the-sand proposals from “experts” who dream that if they shut their eyes tightly enough, somehow a miracle will happen and the rest of the world will pretend that the German banking system didn’t become insolvent, that the EU banking system didn’t become insolvent, and that the clock can be put back twenty-five years without anyone noticing.
These theories were already put to the test three years ago last September. The American financial authorities got an “F” when they chose to believe the outrageous fantasy that a globally intertwined financial system could painlessly shrug off a massive unplanned bankruptcy by one of the world’s leading players. Yes, and no iceberg could ever sink the Titanic.
Our authorities didn’t want to do something that might be unpopular politically. By golly, it was time to stop “bailing out” those reckless bankers. Time to teach them something about moral hazard. Does that sound familiar? Federal Reserve Chairman Ben Bernanke protested that it might cost the taxpayers upwards of fifty billion dollars to stage a salvage operation of Lehman Brothers. The Fed has since expanded its balance sheet by over two trillion dollars in an effort to contain the damage, and U.S. deficits have soared. That fifty billion dollar savings didn’t survive a single day, not one.
Sixty-odd years ago, the U.S. launched the Marshall Plan to rebuild Europe, budgeting about five percent of US GDP to do so. That sum came on top of another five percent already just spent in post-war aid. A praiseworthy effort, certainly, yet it was also clearly in America’s self-interest to rebuild its trading partner and check Soviet expansionism. It was a great success.
It is time for Germany and the EU to stand up and deliver. It is time for Germany’s own Marshall Plan, in its own self-interest. It is time to stop believing the fantasy that the European debt problem can be solved cheaply or that others will pay for it. Yes, it will cost real money. It will cost far more money if the situation is allowed to explode. It is time to stop believing the fantasies that Germany can exit the eurozone cheaply, or that the Bundesbank could borrow in marks cheaply again after the German banking system has collapsed and the continent has plunged into black recession, taking most of the globe with it. You have had three years to study the results of this examination; to fail it now would be utterly inexcusable.
Germany can lead the EU back from the brink. If it does, asset markets will soar, the EU recession already underway will ease, and a new era will begin in Europe. Italy has just agreed to cut pensions and raise the retirement age. Stop playing the victim, Ms. Merkel. You have demanded sacrifice of every other EU country, are you prepared for your own? Protest the cost to the German taxpayer if you must, but the German taxpayer will be annihilated if you fail this test.
Step forward and the Union will step forward with you. Step backward and you will be at ground zero of the collapse. You will not only lose the next elections, but be reviled for the next hundred years as the leader of a band of small-town misers and fools who let their country burn to the ground out of fear that the price of water would go up if they put it out. Tear down this wall, Ms. Merkel. The whole world is watching.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.