The Threat of German Amnesia

Joschka Fischer

25 May 2012

BERLINEurope’s situation is seriousvery serious. Who would have thought that British Prime Minister David Cameron would call on eurozone governments to muster the courage to create a fiscal union (with a common budget and tax policy and jointly guaranteed public debt)? And Cameron also argues that deeper political integration is the only way to stop the breakup of the euro.
A conservative British prime minister! The European house is ablaze, and Downing Street is calling for a rational and resolute response by the fire brigade.

Unfortunately, the fire brigade is being led by Germany, and its chief is Chancellor Angela Merkel. As a result, Europe continues to try to quench the fire with gasolineGerman-enforced austerity – with the consequence that, in a mere three years, the eurozone’s financial crisis has become a European existential crisis.

Let’s not delude ourselves: if the euro falls apart, so will the European Union (the world’s largest economy), triggering a global economic crisis on a scale that most people alive today have never experienced. Europe is on the edge of an abyss, and will surely tumble into it unless Germany – and Francealters course.

The recent elections in France and Greece, together with local elections in Italy and continuing unrest in Spain and Ireland, have shown that the public has lost faith in the strict austerity forced upon them by Germany. Merkel’s kill-to-cure remedy has run up against reality – and democracy.

We are once again learning the hard way that this kind of austerity, when applied in the teeth of a major financial crisis, leads only to depression. This insight should have been common knowledge; it was, after all, a major lesson of the austerity policies of President Herbert Hoover in the United States and Chancellor Heinrich Brüning in Weimar Germany in the early 1930’s. Unfortunately, Germany, of all countries, seems to have forgotten it.

As a consequence, chaos looms in Greece, as does the prospect of subsequent bank runs in Spain, Italy, and France – and thus a financial avalanche that would bury Europe. And then? Should we write off what more than two generations of Europeans have created – a massive investment in institution-building that has led to the longest period of peace and prosperity in the history of the continent?

One thing is certain: a breakup of the euro and the EU would entail Europe’s exit from the world stage. Germany’s current policy is all the more absurd in view of the bitter political and economic consequences that it would face.

It is up to Germany and France, Merkel and President François Hollande, to decide the future of our continent. Europe’s salvation now depends on a fundamental change in Germany’s economic-policy stance, and in France’s position on political integration and structural reforms.

France will have to say yes to a political union: a common government with common parliamentary control for the eurozone. The eurozone’s national governments already are acting in unison as a de facto government to address the crisis. What is becoming increasingly true in practice should be carried forward and formalized.

Germany, for its part, will have to opt for a fiscal union. Ultimately, that means guaranteeing the eurozone’s survival with Germany’s economic might and assets: unlimited acquisition of the crisis countries’ government bonds by the European Central Bank, Europeanization of national debts via Eurobonds, and growth programs to avoid a eurozone depression and boost recovery.

One can easily imagine the ranting in Germany about this kind of program: still more debt! Loss of control over our assets! Inflation! It just doesn’t work!

But it does work: Germany’s export-led growth is based on just such programs in the emerging countries and the US. If China and America had not pumped partly debt-financed money into their economies beginning in 2009, the German economy would have taken a serious hit. Germans must now ask themselves whether they, who have profited the most from European integration, are willing to pay the price for it or would prefer to let it fail.

Beyond political and fiscal unification and short-term growth policies, Europeans urgently need structural reforms aimed at restoring Europe’s competitiveness. Each of these pillars is needed if Europe is to overcome its existential crisis.

Do we Germans understand our pan-European responsibility? It certainly does not look that way. Indeed, rarely has Germany been as isolated as it is now. Hardly anyone understands our dogmatic austerity policy, which goes against all experience, and we are considered largely off-course, if not heading into oncoming traffic. It is still not too late to change direction, but now we have only days and weeks, perhaps months, rather than years.

Germany destroyed itself – and the European ordertwice in the twentieth century, and then convinced the West that it had drawn the right conclusions. Only in this manner – reflected most vividly in its embrace of the European projectdid Germany win consent for its reunification. It would be both tragic and ironic if a restored Germany, by peaceful means and with the best of intentions, brought about the ruin of the European order a third time.

Joschka Fischer was German Foreign Minister and Vice Chancellor from 1998-2005, a term marked by his strong defense of Germany’s participation in NATO’s intervention in Kosovo in 1999, followed by his strong opposition to the war in Iraq. Fischer entered electoral politics after participating in the anti-establishment protests of the 1960’s and 1970’s, and played a key role in the establishment of the German Green Party, which he led for nearly two decades.

How to stop Greece’s “bank jog”
Mohamed El-Erian
May 28, 2012

Bank runs are not supposed to happen in a modern advanced economy. Yet, newspapers reported last week that Greek depositors were stepping up their withdrawal of savings held in local banks. Understanding why this is happening – and what we can do about it – is key to assessing the threat to European and global growth, jobs and financial stability.

There are two critical safeguards against the start and disorderly acceleration of bank runs: national deposit insurances schemes and central bank provision of emergency liquidity. They kick in once the banking system’s first line of defence – which consists of strong capital and good assets on the balance sheet – is breached.

Many banks were caught offside by the global financial crisis and the widespread economic and financial deterioration that followed. The result was a sharp erosion – both real and perceived – in capital cushions relative to the quality and size of the assets. Moreover, given the heavy concentration of government bonds on banks’ balance sheets, the situation took a further and significant turn for the worse with the downgrading of sovereign creditworthiness in some European countries, and most prominently in Greece.

Worsening sovereign risk also served to undermine the credibility of the circuit breakers designed to minimise the probability of bank runs. After all, national deposit insurance schemes are as credible as the sovereigns that stand behind them. And with access to emergency central bank liquidity involving the pledging of assets that themselves are now under severe pressures, such funding becomes less straightforward.

These dynamics are dramatically playing out in Greece due to self-reinforcing concerns about another debt default, the imposition of capital controls, and currency denomination that would accompany a possible eurozone exit. In addition to pushing the country further to the edge, they raise legitimate worries about the risk of yet another wave of negative contagion for some other European countries – particularly through the further destabilisation of bank deposits.

Greece’sbank jogneeds to be immediately stopped if it is not to evolve into a full-fledged bank run with region-wide implications. And to do so, Greece requires even greater support from its already (and understandably) reluctant eurozone partners.

An incredibly disruptive situation could be avoided if Greek depositors were given quick access to a region-wide (as opposed to just national) deposit insurance scheme that is unambiguously supported by the fiscal authorities in the strongest eurozone countries. This would need to be coupled with even larger liquidity support from the European Central Bank, along with direct capital injection into the Greek banks from regional funds (e.g., the European Stability Mechanism, or ESM) and multilateral institutions (namely the International Monetary Fund).

Finally, agreement would be needed on how and when to impose burden sharing on banks’ equity holders and bond creditors.


Add these financial requirements to the considerable sums already committed to Greece to cover its primary budget deficit, meet interest payments, roll over maturing debt, and facilitate much needed structural reforms. Each serves to complicate an already tense and stretched relationship between Greece and the troika (ECB, EU and IMF). Together they pose a considerable and urgent challenge – and one that makes it even more difficult to reconcile simultaneously cascading financial demands, economic imperatives, conditionality design, and democratic realities.

Whichever way you look at this troubling situation, last week’s intensification of deposit flight in Greece is much more than just a new wrinkle in what has become a protracted European crisis. If the phenomenon spreads, and it will in the absence of a credible region-wide policy response, control of Greece’s destiny within the eurozone would slip even further away from politicians and policymakers and more directly into the hands of a population that is approaching the June 17 election in a mood of rejection. Already this rejection is not that far from tipping Greece into a classic funding panic and the eurozone into even greater turmoil.

France’s Broken Dream

Martin Feldstein

26 May 2012

CAMBRIDGEThe crisis in the eurozone is the result of France’s persistent pursuit of the “European project,” the goal of political unification that began after World War II when two leading French politicians, Jean Monnet and Robert Schuman, proposed the creation of a United States of Europe.

Monnet and Schuman argued that a political union similar to America’s would prevent the types of conflict that had caused three major European wars – an appealing idea, but one that overlooked America’s horrific Civil War. A European political union could also make Europe a power comparable to the United States, and thereby give France, with its sophisticated foreign service, an important role in European and world affairs.

The Monnet-Schuman dream led to the 1956 Treaty of Rome, which established a small free-trade area that was later expanded to form the European Economic Community. Establishing the EEC had favorable economic effects, but, like the North American Free Trade Area, it did not reduce national identification or create a sense of political unity.

That was the purpose of the 1992 Maastricht Treaty, which established the European Union. The influential report One market, one money,” issued in 1990 under the leadership of the former French Finance Minister Jacques Delors, called for the creation of a single currency, relying on the specious argument that the single market could not function well otherwise. More realistically, advocates of a single currency reasoned that it would cause people to identify as Europeans, and that the shift to a single European Central Bank would herald a shift of power away from national governments.

Germany resisted the euro, arguing that full political union should come first. Since there was no chance that the other countries would accept political union, Germany’s position seemed like a technical maneuver to prevent the establishment of the single currency. Germany was reluctant to give up the Deutsche Mark, a symbol of its economic power and commitment to price stability. Germany eventually agreed to the creation of the euro only when French President François Mitterrand made it a condition of France’s support for German reunification.

Moreover, under pressure from France, the Maastricht Treaty’s requirement that countries could introduce the euro only if their national debt was less than 60% of GDP was relaxed in order to admit countries that were seen to beevolving” toward that goal. That modification allowed Greece, Spain, and Italy to be admitted.

The pro-euro politicians ignored economists’ warnings that imposing a single currency on a dozen heterogeneous countries was bound to create serious economic problems. They regarded the economic risks as unimportant relative to their agenda of political unification.

But the creation of the euro caused a sharp fall in interest rates in the peripheral countries, leading to debt-financed housing bubbles and encouraging their governments to borrow to finance increased government spending. Amazingly, global financial markets ignored the credit risks of this sovereign debt, requiring only very small differences between interest rates on German bonds and those of Greece and other peripheral countries.

That ended in 2010, after Greece admitted that it had lied about its budget deficits and debt. Financial markets responded by demanding much higher rates on the bonds of countries with high government debt ratios and banking systems weakened by excessive mortgage debt.

Three small countries (Greece, Ireland, and Portugal) have been forced to accept help from the International Monetary Fund, and to enact painful contractionary fiscal cuts. The conditions in Greece are now hopeless, and are likely to lead to further defaults and a withdrawal from the eurozone. Spain, too, is in serious trouble, owing to the budget deficits of its traditionally independent regional governments, the weakness of its banks, and its need to roll over large sovereign-debt balances each year.

It is already clear that the EU’s recently agreedfiscal compact” will not constrain budget deficits or reduce national debts. Spain was the first to insist that it could not meet the conditions to which it had just agreed, and other countries will soon follow.

French President François Hollande has proposed balancing deficit limits with growth initiatives, just as France had earlier forced the EU’s Stability Pact to become the Stability and Growth Pact. The fiscal compact is an empty gesture that may be the last attempt to pretend that EU members are moving toward political unification.

The European project has clearly failed to achieve what French political leaders have wanted from the beginning. Instead of the amity and sense of purpose of which Monnet and Schuman dreamed, there is conflict and disarray. Europe’s international role is shrinking, with the old G-5 having evolved into the G-20. And, with German Chancellor Angela Merkel setting conditions for the eurozone, France’s ambition to dominate European policy has been thwarted.

Even if most eurozone countries retain the single currency, it will be because abandoning the euro would be financially painful. Now that its weaknesses are clear, the euro will remain a source of trouble rather than a path to political power.

Note from the editor

The Chinese default mystery

By Javier Blas, Commodities Editor

Over the last two weeks, Chinese consumers of thermal coal and iron ore have been defaulting on their contracts, sending prices sharply lower.

The reason behind the cancellations is a hotly debated topic in the physical commodities market.

Analysts and traders have put forward two radically different theories – with opposite implications to global commodities markets: either Chinese buyers do not need the raw materials because weak demand and high inventories – a bearish scenario – or they need the shipments, but they are defaulting to take advantage of falling prices and they plan to rebook at a lower costs neutral to bullish.

The market has experience with both hypotheses: after the start of the global financial crisis of 2008, Chinese buyers defaulted en masse as demand vanished. But in 2010, when fears about the eurozone send prices down, Chinese customers also defaulted on their shipments, only to rebook their cargoes shortly after at much lower prices.

Commodities traders tell me that probably both theories are at play at the moment.

For sure Chinese commodities demand is lacklustre – and inventories are indeed high. The country’s electricity production, a proxy for thermal coal needs, rose only 0.7 per cent last month, a large slowdown from double digit figures in 2011 and earlier this year. Moreover, thermal coal stockpiles at Chinese utilities rose last week to the equivalent of 26 days of consumption, up 62.5 per cent from 16 days in the same period of a year ago, according to the China Coal Transport and Distribution Association.

But the wave of defaults only started after iron ore and – particularly – thermal coal prices fell about 10 per cent, breaking key resistance levels. The benchmark iron ore contract62 per cent iron contentfell last week in Singapore to $130.5 a tonne, the lowest since early November 2011. Thermal coal prices in the Australian port of Newcastle, the benchmark for Asia, fell to $93.5 a tonne, the lowest since October 2010.

The price drop left some Chinese domestic traders, who usually do not hedge the price risk of coal and iron ore, suffering big losses. That is when the chain of deferrals and defaults gained pace, with a dozen of cargoes left in the water.

Commodities traders say this week would be critical for sentiment: if Chinese buyers take the defaulted cargoes – at a lower price after negotiations. The mood could improve if the wave of defaults are a reaction to the price fall rather than a genuine fall in demand.

But if price negotiations do not reach any quick conclusions and Chinese buyers continue to say that they do not need the material, the market could take another hit. Moreover, the amount of distressed cargoes looking for an owner in the Asia-Pacific market is significant, raising the prospect of some traders executing fire-sales.