Did Germany Just Take A Step Closer To Exiting The Eurozone?

Includes: FXE
by: Jeremy Robson

I remember reading on S.A. that John Paulson has a short position in Bunds. I thought at the time that this was unlikely to be a winning trade. I was staunchly of the view that Germany would not change its position, insisting that any aid was conditional on structural changes for the recipient. It appears that this was a poor assessment. This latest summit has changed the outlook. Whatever Merkel may say or do from here, it is going to be very difficult to back away from this latest stance. Zerohedge has a piece about the potential cost of this change of position. Although I always take Zerohedge with a healthy dose of skepticism, its conclusion is that Germany has just taken on a commitment that will result in additional debt of between 32% and 56% of GDP. Even if the actual figure is substantially less than the estimates, it is a game changer. Germany has a debt/GDP of just under 82%.

Imagine that you are a German reading that France has just moved its retirement age back to 60 and that Greece has a retirement age of 50 (Germany currently has a retirement age of 67). Spain's banks need €125 billion, Cyprus has just applied for aid, Slovenia has said that it may require aid in the next month, if it cannot get its budget in order. Portugal and Ireland are already receiving aid. Italy cannot push through substantive changes to its employment laws (although it did get some small changes passed) and Mario Monti has said openly that the Troika will never come to Rome. So Italian aid will come without any conditionality. Lining up, as the next basket cases, are Belgium and Slovakia. I would be expecting that after this summit, the periphery will be missing their budget targets by an even greater amount than they are presently. More and more money will be needed from the Germans.

I am amazed that the Germans are still so set on the euro experiment. I am British and I would have given up a long time ago. I guess the Germans are made of hardier stuff. The question that comes next - Are the German people behind this change of position? I often disagree with the policies of politicians. I think, that with all of the negative information above and the potential for an increase in debt/GDP of 50%, if I was a German, I would be very aggrieved. German elections are not due until September 2013, but the reaction in opinion polls and local elections will come almost immediately. I would be amazed if Merkel's rating is not falling. Wolfgang Schaeuble has talked recently of a referendum on eurozone integration. I have stated in a previous article that the most likely outcome is that the Germans leave the eurozone. If there is a referendum in Germany the result will clear up the present uncertainty. If the vote is 'no' to further integration and the movement of fiscal policy to Brussels, the euro will die. If it is 'yes', the Germans will have agreed to pay. Will there be a referendum in Germany as the next move in the European game of chess?

One wonders what the Finns, Austrians and Dutch were saying as this summit progressed and what they will say over the next few days. I will be interested to watch any media coverage of these nations' responses.


This week's summit has seen the Germans give substantial ground. I am surprised how easily they have given in. They have done this in every summit that has come at a crisis time. They are slowly but surely agreeing to pay for the rest of the eurozone. If this help comes without conditionality, the bill will be much greater than Germany can afford. There seem to me to be only 2 ways forward:

  1. The Germans have a referendum and decide to throw out further integration and moving fiscal policy to Brussels. The Germans leave the euro.
  2. The Germans stay with their commitment to Europe (either with or without a referendum). Ultimately the Germans do not have enough economic strength to pay for the rest of the eurozone's ongoing financial needs. Either each state has to manage its fiscal policy with the current level of help through austerity (the current position) or the ECB has to have the license to print the eurozone out of the crisis.

I have previously said that I think that Germany leaving will be the ultimate resolution to the European crisis. After this latest summit, I can now envision a scenario where the Germans stay in the eurozone and when the crisis next hits fever pitch, agree to the ECB monetizing individual states' debt. This will most likely come with the granting of a banking license for the ESM. If asked to choose, I will stay with the Germans leaving the eurozone, but it has become a close call. I would stress (as I have done previously) that guessing the outcome of the eurozone crisis with certainty is a mug's game. However it is imperative if you are investing in the current markets to try.

As for Mr Paulson - his position in German debt is looking a lot healthier!

I recently wrote that I was hoping to see 1388 for the S&P500 (NYSEARCA:SPY) to initiate some short positions. I think it more than likely, after this summit, that I will get the opportunity.

Disclosure: Long RWM, RIMM, various U.K. corporate bonds, USD/JPY. Short EUR/USD

Disclaimer - This article is not intended as investment advice. Before taking any action, please do your own research. Do not rely on any opinions or facts included in this article for decision making.