The intrigue out of Europe has picked up this week:
- Uncertainty has intensified around the design and likely impacts of a Spanish bank bailout.
- In speeches, German Chancellor Merkel has been drawing yet more lines in the sand.
- And markets are holding their collective breath over the next round of Greek elections, scheduled for this weekend.
We still believe Europe presents an opportunity to astute investors who are able to bear the risk:
Electorates, along with some policymakers and political parties, are pushing back on the type of austerity programs that have only served to worsen government debt-to-GDP ratios. For example, according to the Financial Times,
[Merkel] faced strong criticism from the opposition in the German parliament for her excessive emphasis on austerity before growth.
Frank-Walter Steinmeier, parliamentary leader of the Social Democratic party, said the chancellor had dug herself so far into a concept of fiscal consolidation that she now found it hard to escape.
Renate Künast, co-leader of the Greens, said it was essential to create new opportunities for economic growth, while Gregor Gysi, leader of the far-left Linke party, said Ms Merkel's austerity measures had been "voted down" in Europe, and she should abandon them.
On the face of things, Merkel may appear to be drawing a hard line, but the reality is more nuanced. From the same FT article:
Angela Merkel, the German chancellor, warned her partners in Europe and the G20 leading world economies on Thursday not to overburden the German economy in the battle to end the crisis in the eurozone.
"Germany's resources are not unlimited," she told the German parliament in a declaration of her government's stance before next week's G20 summit in Mexico.
Merkel is absolutely right about this. Although Germany has a wealth of real economic resources, including productive human and physical capital, these are never unlimited.
Even more importantly from the standpoint of managing the risk of a Continent-wide banking, financial, and government-debt crisis, Germany, like all nations in the Economic and Monetary Union (EMU), is a currency user. In that regard, its resources are strictly limited, even though its debt is currently viewed as a safe haven.
The German government abdicated its role as monopoly currency provider when it converted from marks to the new euro currency and accepted the authority of the European Central Bank (ECB).
As such, there truly is no way that Germany can resolve the European crisis. However, it can stop acting as an impediment to efforts that would redesign the role of the one institution that can-the ECB. And to some extent, there seems to be movement in this direction. From the FT article:
Instead of short-term measures for crisis resolution, the chancellor said Europe must embark on the "Herculean task" of forging closer political integration to underpin the common currency in the eurozone.
"It is our task to catch up with what we failed to do" with the launch of the euro, she said. "We must do this not the day after tomorrow, but at least in a rather short time."
Officials in Berlin say privately that Chancellor Angela Merkel is willing to drop her vehement opposition to plans for a "European Redemption Pact", a "sinking fund" that would pay down excess sovereign debt in the eurozone.
"It is conceivable so long as there is proper supervision of tax revenues," said a source in the Chancellor's office. The official warned that there would be no "master plan" or major break-through at the EU summit later this month.
This all implies that Germany, along with the European Union, is still willing to blink when markets force policymakers' hands (a process that continues to accelerate).
It also implies a softening stance among some German political leaders, which means that the reactions of electorates in France and Greece to poorly designed austerity programs is having some positive political effects thus far. Unfortunately, as the passage above reveals, the Chancellor (and presumably many if not most others) still believe that tax revenues fund government spending.
We continue to believe that no one in Europe wants Spain to depart the EMU, and it looks to us as though events are leading inexorably to a more fully integrated fiscal and monetary union. While potentially very bullish for investors, there are two very important things to consider.
First, given that the ECB is the only institution currently capable of acting as sovereign issuer of new, unencumbered euro, Mario Draghi now becomes the political figure at the margin (yes, central banks are eminently political institutions, despite the advertising). What Merkel refers to as German leadership is also an act of acquiescence. But Draghi, and technocrats within the EU and ECB, have to come up with a plan that allows the ECB to fund government budget deficits and the creation of net financial assets in the eurozone. And while Draghi started out his term in OK fashion last fall, he, like the short-lived effects of the ECB's LTROs, has been an utter disappointment since. It may take some courage to admit that neoliberal macro models have failed-as we recently wrote, "the mainstream macroeconomics profession is in as anxious and uncertain a position as it was in 1932"-but the ground on which to take such a stand grows stronger with every passing crisis. Draghi and the other technocrats of Europe must step up and lead.
Second, the comments from Merkel's office reveal that Germany still believes in the gold standard-era bifurcation of fiscal and monetary policies, which under an inconvertible fiat currency are essentially the same thing (apart from the many different forms they can take). This probably means that even with a sound monetary framework in place, the EMU will follow a path similar to Japan's over the long term. So while we think a bet against imminent destruction of the EMU makes sense, we don't foresee it as a spectacular investment opportunity once the pessimism has been wrung out of the markets.
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