2017 Is The Eurozone's 2019

by: Adam Whitehead


What happens in 2017 will decide if there is a Eurozone in 2019.

The German consolidation of control at the EU level, that is coincident with an alignment of interest with the European defence sector, is under attack from President Trump.

Mario Draghi has been forced to acknowledge that the unprecedented event of a nation leaving the Eurozone is now a possibility.

Rising Eurozone economic confidence is confounding the ECB’s last decision and is contradicted by the liquidity preference of consumers that is causing deep distress for the banking system.

The IMF is changing its position on the Eurozone’s fiscal strategy for survival in line with other American global economic infrastructure constructs.

The recent EU summit on the island of Malta provided the evocative setting and opportunity for policy makers to galvanize their resistance to President Trump's assault on the European Project. The Eurozone "crisis" observed in the last report focussed on the election calendar across the region this year. This "crisis" should not be viewed as an isolated historic event, because it has a rolling calendar out to 2019. Indeed, 2019 is another massive year for the Eurozone as it faces the end of Mario Draghi and Jens Weidmann's current terms at the ECB and Bundesbank respectively; the end of generous fiscal support to the emerging EU members in Eastern and Central Europe and the loss of Britain's fiscal contribution. A successful conclusion of the 2017 election calendar will therefore determine the challenges to be overcome in 2019, and more importantly, if there is a 2019 for the Eurozone. 2019 can be seen as the year when the Eurozone has to deal with the outcome of the decisions made in 2017… assuming that there is a Eurozone after the 2017 election results come in.

Currently, the outlines of a 2019 grand survival strategy can be discerned, in which Mario Draghi moves on to save Italy as its Prime Minister and Jens Weidmann takes his job at the ECB in order to remove the QE stimulus that is worrying Northern Europeans. With Weidmann in charge, German populist anti-Eurozone sentiment would be dealt a serious blow. The German politicians have reluctantly got behind this programme by complaining about continued QE, in order to assuage their voters, whilst tolerating its continuation to save the periphery. Confluent with this strategy, the German CDU has asserted greater German control of the levers of power within the EU itself. Standing in the way of this grand strategy are President Trump and a few good men and women, from the Eurozone populist parties that he inspires and supports, to engineer regime change.

The theme of Eurozone "crisis" suggested in the last report was recently illustrated perfectly by the awarding of the Cavour Prize to Mario Draghi. The namesake of the prize was an Italian statesman famed for his efforts to unify the country. In his acceptance speech, Draghi drew parallels between today's fight against the populist forces whom he equated with Europe's "dark pasts." Within Italy, all attempts are being made to maintain the unity of the Eurozone. The latest attempts involve the continued harassment of the Five Star party that wishes to hold a referendum on the Euro. Draghi then followed up with a call for deeper Eurozone capital markets integration in a later speech.

ECB Executive Board member Peter Praet had a more practical suggestion to make, as to how these "dark pasts" can be avoided. According to him, the real issue is the erosion of Eurozone social welfare since the financial crisis. To sustain the generous social model of the Eurozone requires the monetizing of budget deficits by the ECB and/or wealth transfers from the German fiscal surplus. An objective observer might comment on how these two solutions are motivating the populists in Northern Europe to head for the "dark past" that Praet claims to be avoiding with the same policy tool.

Mario Draghi went on to follow in the footsteps of Cavour, when he was the headline speaker at the tenth anniversary celebrations of the Euro's adoption. It must be said that, amongst all the populism and the elections in 2017; this event has been relatively low profile in order to avoid creating further political resistance. The title of his speech "Security through unity: making integration work for Europe" clearly showed that he was in no mood for celebration, and also supported the thesis of collective security through unity that policy makers have been using to save the Eurozone Project. Draghi believes that it can be saved by accepting the mistakes of the past and refusing to make further ones by adopting the spirit of trust amongst nations that will allow deeper integration.

Draghi's performance in testimony to the European Parliament unfortunately did not live up to Cavour status. In rhetorically answering questions about the legality and the process for a nation to exit the Eurozone, he inadvertently signaled that such an event that had been hitherto assumed to be impossible is in fact possible. Given that Marine Le Pen is openly talking about France leaving, this possibility now has an estimative probability value. The big signal from Draghi's response is that there is no legal precedent for the EU to prevent a nation from leaving the Eurozone. Sovereign democracy has not yet been snuffed out, and indeed may require referendums within each nation to accept the passing of power to legislate and the backing of the Euro with pooled tax revenues.

As with the punitive attitude taken towards the Brexit, Draghi simply affirmed the penalty for any nation leaving the Eurozone. Said nation would have to settle its debts to the other nations. The assumption is that said debts would be crippling if said nation's new currency devalued against the Euro. If there was no Euro as a result of other nations following suit, the logic in Draghi's explanation and its implied threat is moot. European lawmakers Marco Valli and Marco Zanni, who also seem to question this logic, have become interested in the valuation of a leaving nation's obligation to those it leaves behind. They have asked Mario Draghi if the Target 2 balances go in some way to accurately valuing these obligations. Draghi refused to be drawn on this matter and simply offered to provide them with a written comparison of Target 2 with Federal Reserve System's interstate balances. This offer is one that compares apples and oranges. The Eurozone is not a Federal political system with an elected President and indeed may never become one. His evasion is a signal that the Eurozone is staring into the abyss.

Draghi's fumbling of the exit issue highlights the current point at which real democratic national politics vitiates against the un-democratic assumptions behind the Eurozone. Greece has been kept in the Eurozone (until now as we shall see later) for precisely the reasons that Valli and Zinni are probing. It is easier to keep Greece's liabilities within the Target 2 system, even if it will never pay them because its default would be an event similar to America coming off the Gold Standard. This exit would break the accounting chain of deficits and surpluses which acts as the proof that the Eurozone is working. The ECB prefers to print the Euros that enable to the liabilities and assets of Target 2 to net off and balance, rather than to introduce the singularity of a nation breaking the neat book entry system.

A breaking of the system would create real rather than virtual systemic Euro delivery risk, that would throw the whole system into an initial liquidity and ultimately solvency crisis. Those including some ECB members, who glibly say that the ECB could simply print the missing currency, ignore the moral hazard and destruction of credibility in the Eurozone and the currency that such a response would beget. The Fed has printed dollars because it can get away with it politically. Indeed the Obama Administration was happy for it to do so, because it lowered the burden on the US taxpayer. With unified political or fiscal system, the ECB would be ill advised to print Euros in the event of a nation leaving without paying its fiscal bills to the Eurozone system.

Draghi's French Colleagues then talked up the catastrophic consequences for France, if it were to leave the Eurozone. As with Brexit, which is far less important to Eurozone survival than France leaving, they attempted to frighten French voters into believing that rather than being an American Bretton Woods exit it would be more like a Weimar Republic outcome for the French nation. Draghi's "dark pasts" of failed debt reparations, hyperinflation and the rest loomed through their words. ECB Executive Board member Benoit Coeure opined that it would "threaten savings and jobs in France." ECB Governing Council member Francois Villeroy de Galhau warned that France's debt-servicing costs would increase by over 30 billion euros ($32 billion) a year. Consistent with this no quarter French approach to all Eurozone threats, Prime Minister Bernard Cazeneuve stated that the Brexit terms must by default be worse than the fiscal price of participation in the EU.

The sense of "crisis" has now become contagious for both Northern and Southern Europe, with the upcoming French presidential elections being framed as the catalyst for Eurozone disintegration. It is interesting to observe that this "crisis" is being identified with external malign Anglo-Saxon forces. This framing supports the thesis, being tested in this series of reports, that there is a deliberate attempt to bring regime change within the Eurozone. German Vice Chancellor Sigmar Gabriel became a recent promoter of this thesis when he opined that the French elections provide the opportunity for "enemies" of the Eurozone to destroy it. He was ably supported from Southern Europe by Prime Minister Mariano Rajoy of Spain, who said that victories for the French National Front and Alternative for Deutschland would "destroy" the continent.

The last report outlined the "crisis" mode strategy that the Eurozone elite had gone into in order to preserve the Eurozone Project. This well-choreographed united front of Eurozone policy makers, industrialists, bankers and central bankers was well-orchestrated by all at Davos in order to frame global perceptions of the situation. This orchestration led to some delightful contradictions by some speakers as they sought to put out fires. Bank of France Governor Francois Villeroy de Galhau was a classic example of this trait at Davos. Before the last ECB Governing Council meeting, he deftly tried to play down the chances for a reduction in QE. Post meeting, when the focus turned to the survival of the Eurozone itself, he refocused his message on being upbeat about the prospects for growth with the comment that: "clearly (the euro zone economy) is firming. All signs point to the same direction and I don't feel that the electoral cycle will change this economic mood." Despite this contradiction, he alleged that the last ECB Governing Council meeting was "short and easy." His real concern was given away by his comment that the Eurozone "cannot be divided," which implies that he believes that there is a real process in place to do precisely that.

The "crisis" reaction within the Eurozone was also put into the context of the thesis, that collective security will be used as a theme to enable deeper political and fiscal integration. This thesis was put into context by the recent political maneuver to install the new EU President who is from the same political movement as Angela Merkel's CDU, giving this bloc unprecedented control of EU policy making. Based on the recent inflammatory remarks about cui bono from the weak Euro made by incoming President Trump, this assertive German control over the EU has been thrown into a sharp contrast with the new political reordering at the global level.

Further investigation of the background of the new EU President Antonio Tajani reveals that he comes from the defence lobby. In 2013, Tajani is on record as saying that "he wanted to promote the arms industry." As European Commissioner, Tajani also outlined several policy schemes aimed at "strengthening the European defence industry." Tajani is the honorary president of the Sky and Space Intergroup, which is closely related to the Aerospace and Defence Industries Association of Europe (ASD) lobby group.

The thesis being developed in these reports is that collective security will be the theme used to save the Eurozone. The key intelligence question is therefore whether this process remains aligned with NATO or not. Based on Tajani's background and current position, it can be concluded that the theme of collective Eurozone security as vehicle to drive deeper political and fiscal integration is confirmed. One may also conclude that German/CDU interest is strongly aligned with this process. Eurogroup head Jeroen Dijsselbloem evoked this collective security theme when he recently opined that: "I've made my mind up that in the coming years we are on our own, which may be a good thing." Emmanuel Macron's labelling of Britain as a "vassal" of the United States, despite Theresa May's heroic attempts to get President Trump to commit to back NATO 100%, signaled that the Eurozone will pursue its own more narrowly defined national security agenda if he becomes French President.

(Source: Bloomberg)

President Trump's team's attack, on this German centre of EU gravity, will either break the Eurozone or unite it in opposition to his new global agenda. The last report noted that President Trump had singled out the German centre of gravity that is assuming greater control of the EU executive for specific attack. This attack continued with his trade adviser Peter Navarro who opined that: "A big obstacle to viewing TTIP (Transatlantic Trade and Investment Partnership) as a bilateral deal is Germany, which continues to exploit other countries in the EU as well as the US with an 'implicit Deutsche Mark' that is grossly undervalued." The recent blowout German trade data will only have inflamed matters and supported Navarro's view. Navarro's attack was choreographed with an OECD report which identified the Euro as the most undervalued G10 currency. Faced with this evidence and also the fact that Germany runs a trade surplus with America, Finance Minister Wolfgang Schaeuble had to concede to Navarro. By conceding, however, he has used Navarro's attack for his own ulterior motive of pressuring the ECB to retract its loose monetary policy that is weakening the Euro.

Bundesbank chief Jens Weidmann's rejection was less conciliatory. Weidmann blamed the euphoria surrounding President Trump's election for the recent spike in the US dollar. He was, however, less enlightening about the causes of the strong US dollar trend that preceded the election and was contemporaneous with an expansion of ECB monetary policy. In relation to ECB policy, he guardedly accepted that it must remain loose for now, but stated that it should tighten as soon as the inflation target is hit regardless of the impact on the Eurozone's most indebted nations. This compares with Mario Draghi's rebuttal of the American accusation for the opposite purpose of persevering with the monetary policy that is anathema to Schaeuble and Weidmann.

(Source: Seeking Alpha)

This American attack on the free trade deal with Europe, should not, however, be viewed as simply an attack on free trade. Rather it should be viewed as an attack on a trade deal that America believes unfairly benefits German interest. The superpower status of the Eurozone was illustrated in an earlier report. By default, this implies that Germany enjoys this superpower status. Europe's attempt to maintain this status quo, with monetary and fiscal policy that undermines the value of the Euro, has thus become a problem for all its trade partners. Clearly, President Trump's solution to this problem is to take the Eurozone down a peg or two…. or perhaps even more. Ted Malloch the potential Ambassador to the EU has told the BBC that he thinks that the Euro could collapse this year. A collapse in the Euro would be seen as very bullish for the US dollar, so Malloch's commentary seems at first dissonant with Navarro's; until one understands that the target is the breakup of the Eurozone in order to enforce unitary trade deals with each nation. If Germany then elects to keep the Euro after Eurozone breakup, America will try to enforce a US dollar devaluation against it. Any other new Eurozone currencies will also be encouraged to float lower against the German Euro in line with the dollar. Free trade deals with these European nations outside the Eurozone and America on terms no worse than the current ones should be no trade barrier in practice.

The overt American support for European populism is yet another tactic in this grand strategy of what has been termed "regime change" in this series of reports. Indeed, Malloch's specific commentary about his new job description leaves nothing to the imagination when it comes to the subject. As he told Aunty Beeb: "I had in a previous career a diplomatic post where I helped bring down the Soviet Union. So maybe there's another union that needs a little taming." The EU's attempts to get him barred as persona non grata certainly appears to signal that they are taking his threats seriously.

The last report suggested that Angela Merkel's party may have an innate preference for the kind of European solidarity supported by French presidential candidate Francois Fillon. As part of the recent German/CDU coup process at the EU level, Fillon who is conservative represents a natural ally. Consequently, Germany's recent cautious embrace was extended to Fillon in order to see how he fits into Merkel's grand European strategy. A consummate political animal, Fillon himself was careful to balance his pro-European credentials with President Trump's new European agenda. Whilst condemning President Trump's undermining of the European Project and calling for it to be strengthened, Fillon made it clear that this can only be done in his opinion by bringing Russia into the European broad church. President Putin is playing the Europeans off against each other and against America with consummate skill and ease.

Unfortunately for Fillon, his campaign has recently become handicapped by a strategically timed investigation of corruption involving his wife just as he is emerging as a favorite. Le Pen and Emmanuel Macron seem set to profit from this fortuitous coincidence. The French Left is nowhere, because it has several potential candidates who are diluting the vote. On balance, Le Pen comes out slightly ahead since the backlash from workers against perceived elitism disproportionately favours her over the populist-elitism of Emmanuel Macron.

(Source: Bloomberg)

As the Eurozone political governing bodies and affiliated national policy makers talk up the "crisis," economic conditions and sentiment portray the contrary opinion, much to the frustration and alarm of policy makers and the ECB. The latest employment data out of Germany showed that unemployment has fallen to an all-time low of 5.9%. New data on Eurozone consumer prices shows that they have risen to the highest level since 2013. Consumer confidence across the Eurozone is now the highest in six years. PMIs for the beginning of the year registered continued growth; however, German industrial sentiment registered the biggest warning to the "crisis" status quo position of the ECB. A recent report from the Cologne Institute of Economic Research found that over 90% of German businesses surveyed admitted to feeling positive about Brexit. On balance, Brexit is actually viewed as an opportunity by them to take market share from their English competitors on the continent. For those observers who have seen Germany's CDU taking control at the EU executive level, the aligned vision of Germany Inc will come as no surprise.

This positive feeling is also to be found in neighboring Holland. The Dutch central bank recently provided a glowing report on the recovery in economic growth and employment, although it should be noted that this was presented by way of some window dressing going into national elections later this year. The central bank was also careful to add the usual disclaimer about regional and global uncertainty.

(Source: Bloomberg)

These flourishing green Northern European shoots have been enough to motivate ECB Executive Board member Sabine Lautenschlaeger to begin nudging her colleagues towards considering tapering sooner rather than later. Bundesbank chief Jens Weidmann lent his support and rhetoric to Luatenschlaeger's call, noting that the growth and inflation data all point in this direction. Francois Villeroy de Galhau immediately shot back that the oil price driven temporary inflation spike rules out any immediate action. Dutch central banker Klaas Knot also opined that the declining tail risk of inflation is now making exit from monetary policy expansion more probable. Bundesbanker Andreas Dombret will not be nudged so easily by his Northern European colleagues however. Taking a longer-term view, he was able to take the recent oil price inspired inflation uptick well within his stride. He still sees interest rates remaining low for some further time, until inflation develops momentum that is not just driven by the recent spike in oil prices. Dombret's perspective is also held by Executive Board member Yves Mersch, who still sees some more room for inflation to converge upon target before the normalization process begins. Bank of Italy Governor Ignazio Visco also believes that deflation risk has not yet been averted, and thus sees no need to retract the current stimulus. The pressure on the ECB has become so great, that Governing Council member Ewald Nowotny has been forced to concede that a consideration of ending the current stimulus will be made in the summer. A recent survey by the European Commission found that German consumers are in fact not greatly alarmed by the uptick in inflation. This suggests that there is room being created by policy makers for the ECB to avoid removing the current monetary stimulus.

The interjection of a prime minister into the debate over interest rates, signaled just how fraught the "crisis" conditions have become to justify direct political involvement in the monetary policy debate. Spanish Prime Minister Rajoy's expression of concern over an immediate tightening of monetary policy shows that the populists have forced the incumbents to adopt populist measures themselves, such as political control of monetary policy.

The picture of German business optimism may however be an isolated occurrence that does not translate across the Eurozone, especially at the all-important consumer level where the ECB's major focus will be. A recent study by ING had some frightening observations about the state of financial health of the Eurozone consumer. European consumers have not availed themselves of the opportunities to refinance their debts at low interest rates as their sovereigns have been doing. Neither have they cleared their debts. According to the survey, only 11 percent of those consumers who have opted to save less due to low rates have used that spare cash to clear a loan, and only 8 percent paid off part of their mortgage. The Eurozone consumer is still dangerously indebted and over-leveraged, and is therefore incapable of taking on the burden of economic heavy lifting.

By implication the Eurozone banking sector, which is exposed to said over-leveraged consumer, is in bad shape. Banks that advertise their consumer loan asset book as evidence of health, with subjective stress test models of default rates to game the weak bank capital adequacy rules are lying. This risk to the consumer must also be added to the banks' exposure to their own sovereigns. Since consumers are over-burdened, they are also incapable of paying the taxes required to improve the fiscal position of their sovereigns. Faced with this bleak economic landscape, it is hard to see how the ECB can do anything else other than continue to provide access for all to its balance sheet. The Eurozone debt bulge is still well and truly stuck in the belly of the python, and the ECB is helping the python to digest it. The moot question is whether the ECB is actually enabling the debt bulge to make Eurozone sovereigns and their consumers into Zombies, so that the bulge just gets bigger and never gets egested.

The European Commission recently signaled that the banking sector is deeply in "crisis" as a result of the attrition from consumers. The Commission announced that it will be studying the upper limit on all cash transactions within the Eurozone. This "war on cash" is intended to get the cash back into the banks, which it has become absent from since the ECB has pursued negative interest rates. Consumers being in debt, long cash and short deposits have effectively done a run on the banking system. This position has been unwittingly enabled by the ECB with its ZIRP/NIRP. The systemic risk is now so great that the EU has to devise ways of getting the cash back into the banking system, using the fake news of terrorist financing, organised crime and the black economy as convenient excuses.

Klaus Regling the head of the European Stability Mechanism (ESM) provided another signal of the level of the "crisis" within the Eurozone banking sector with his latest comments. His signal came in response to the bad bank model recently proposed by the European Banking Authority (EBA) in order to avoid the shareholder bail-in followed by sovereign bailout of the banks. According to the EBA, a Eurozone bad bank should be set up to warehouse at least 1 Trillion Euros of bad debt on bank balance sheets. Regling thinks that this is a splendid idea. His affirmation signals just how large and festering the problem remains. He was not specific on where the funding for such a venture should come from, but the obvious place to look would be the beleaguered taxpayers of the stronger Eurozone nations. The problem is that they are voting this year and populism is now in favor.

The strongest signal of the level of "crisis" in the banking sector was provided by the ECB itself. Ironically the ECB may have been trying to send a reassuring message, but its timing and choice of worst-case scenario analysis language to frame its message only served to draw attention to the systemic problem. According to the ECB's latest private study, if the Eurozone banks had a Lehman Moment this would not become a global Lehman Moment. Allegedly, creditors and shareholders in the banks would get bailed in smoothly with no greater disruption to the global capital markets. The stress test involved various scenarios wiping out between one and twelve percent of the banks' assets. The suspicion is that the ECB was in fact trying to provide evidence in support of the Eurozone banking sector keeping its own bank capital adequacy regime rather than applying the tighter one prescribed by the BIS. The only reason to cling to a looser parochial Eurozone regime is because applying the global regime would uncover a global problem created by the Eurozone banks.

As the ECB published its stress test findings, which allegedly showed no cause for concern, Vice President Vitor Constancio unwittingly framed them as a crisis signal with some ill-conceived statement that was supposed to compliment and endorse the study. Constancio openly supported the creation of a bad bank suggested by the EBA. If everything is fine in the banking sector, why is there any need for a bad bank solution at this point in time with European elections on peoples' minds?

The new official institutional position adopted by the IMF in relation to the Eurozone is worth noting. In the past, the IMF has indulged the Eurozone in its fiscally irresponsible approach to keeping the European Project alive. The managing director was allowed to be a European, despite much consternation from the emerging nations. Christine Lagarde was allowed to give Greece the kind of soft deal that many emerging nations would dream about when the Greek debt crisis first blew up. There are signs that this Europhile laissez fair attitude is now changing, despite the fact that its leader Christine Lagarde got off lightly on the recent legal issue her own fiscal infractions when she was a French minister. The IMF has taken up a harder line in relation to the ongoing Greek bailout saga. It recently opined that Greece's public finances are "fundamentally inefficient, unfair, and ultimately socially unsustainable," creating doubt that it will remain engaged in the bailout and restructuring process. This would be a game changer.

Greece is now being used as a tool for America to advance the cause of populism and the potential breakup of the Eurozone. Following up on his recent inflammatory remarks about the lifespan of the Eurozone, as yet unconfirmed Ambassador Ted Malloch speculated over the duration of Greece's membership of the doomed single currency zone. Working on the assumption that the IMF will not participate in the next bailout, he focused attention on what will happen next. If the Eurozone nations fail to bail out Greece, then it must by logic leave the Eurozone according to his logic. As noted above, Mario Draghi has outlined how this process may work. Should Greece then fail to settle its tab for leaving, then the perfect accounting symmetry and sustainability of the Eurozone's Target 2 system would then fail. All those fiscal and current account surpluses that the German's are so positive about making even larger would then bite the dust.

The IMF institution has also opined that it takes a very dim view of the Eurozone's adoption of a fiscal stimulus strategy across the bloc. Eurogroup president Dijsselbloem's recent comments on the EU's attitude to the Italian state bailout of its banking sector suggests that conflict with the IMF may develop here also. Dijsselbloem signaled that the EU will not call the Italian government to order or to account for its breaking of deficit rules in order to bailout its banking sector. The IMF is therefore likely to call out Italy and hence move the game on from Greece to closer to home.

It would seem that the IMF is getting with the new programme of its major shareholder in Washington by taking a tougher line with Europe. This change has clearly been observed by the Chinese, because its Premier has recently been in Europe asking Germany to partner with China in bringing economic stability to global capital markets. Evidently there is a split between Europe and America within the IMF that China seeks to exploit.

Confirming that something has changed at the IMF since President Trump has taken office, the Southern European nations reacted to this global change. A recent meeting of the Southern European nations plus France concluded that deeper fiscal and political integration was required within this bloc as a reaction to President Trump. More tellingly the strategy to convert the European Stability Mechanism (ESM) into a European Monetary Fund (EMF) was mooted. The EMF would thus replace the IMF's meddling in European affairs, and would adopt a pro-fiscal expansion plan rather than a strict regime of fiscal control. Southern Europe sees a way to wriggle free of the constraints of the Stability Pact by capitalizing on the challenge presented by President Trump.

The Bank for International Settlements (BIS) also appears to have pivoted along with the IMF. Incoming managing director AugustinCarstens recently opined to a German audience that it is now time for central banks to begin gradually unwinding their accommodative stimulus. Whilst the headlines tend to focus on President Trump in isolation against the global economy, the facts show that the Eurozone is becoming isolated from the American created global architecture that the President now controls.

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