July 27, 2015 6:21 pm

The rupture the EU needs to avoid is with Germany

Marcel Fratzscher

European reforms must address Germany’s fears, writes Marcel Fratzscher

The German national flag is seen in front of the Reichstag building housing the German parliament Bundestag on December 16, 2013 on the eve of the swearing-in ceremony of the German chancellor and the new cabinet. Merkel, whose conservative party CDU triumphed in the September 22, 2013 general election but fell short of an absolute majority, is to be sworn in for a third term, launching a "grand coalition" government with her traditional rivals the Social Democrats (SPD). AFP PHOTO / JOHN MACDOUGALL (Photo credit should read JOHN MACDOUGALL/AFP/Getty Images)©AFP
The Bundestag in Berlin
The Greek crisis has put Europe in a trap. The conflict over how to solve it has eroded trust and accelerated the renationalisation of policymaking all over Europe. It has distracted politicians from the challenge of reforming Europe’s architecture and making it fit for the longer term. Meanwhile, Germany has started disengaging from the European project. Many Germans feel victimised by international criticism.
European reforms will fail if they do not address Berlin’s deepest fears. The rest of the EU must take such concerns much more seriously — starting now.

Germany’s biggest fear is that the eurozone is becoming a transfer union, with Berlin as the paymaster. Remember that Germany is the main contributor to the latest Greek bailout and has €240bn outstanding in official loans or guarantees to Greece. Demands by France and others for debt mutualisation have deepened those suspicions.
Germany’s second fear is that common European rules are circumvented all too often — as is the case with the stability and growth pact and the fiscal compact, intended to ensure debt sustainability among all members. Although Berlin itself broke the pact last decade, a strong German consensus reigns that compliance should not be a matter of discretion.

Germans reacted with disbelief when Manuel Valls, France’s prime minister, refused last year to comply with common fiscal rules, declaring: “France must be respected, it is a big country . . . We are the ones who decide on our budget.”
Germany’s third fear is that national sovereignty is being eroded without Europe delivering more stability and prosperity. Today Europe cannot credibly enforce common rules, but all members are jointly responsible for bailing out individual member states when their policies fail.

The creation of a proper fiscal union is the most urgent reform and a rare opportunity for Europe to get Germany back on board. A fiscal union should include a eurozone finance minister — an idea long favoured by Wolfgang Schäuble, Germany’s finance minister. Such a person would be accountable to a strengthened European Parliament with a new chamber for euro area issues. He or she could have the right to intervene in national budgets if these violate European law, such as the fiscal compact, and have a budget financed through a European tax as an add-on to either the value added tax or the corporate tax of euro area member states. The minister could have the ability to issue some jointly guaranteed debt within narrow limits. This ability to tax and borrow could be limited to two purposes: to provide unemployment insurance and to support investment.
A European finance minister would address all three of Germany’s fears. The EU’s boosted fiscal capacity would explicitly avoid serving as a transfer union, but operate instead a fair insurance mechanism. Member states would receive net payments in bad times — the only circumstances when debt would accumulate — but make net contributions in good times. The minister’s right to intervene in national budgets would strengthen common rules without eroding national sovereignty.
Such a post would deliver concrete benefits to EU citizens and strengthen European identity while making it harder for national politicians to blame Europe for their own failures.

The Greek crisis shows that Europe urgently needs deeper integration. Stronger solidarity should be accompanied by more shared sovereignty, as exercised by a eurozone finance minister. This would provide a mechanism to protect against recessions and crises, foster productive investment and support European workers. It would address Berlin’s deepest fears and could be common ground for France and Germany to lead Europe jointly once again.

The writer is president of DIW Berlin, a think-tank

The Lethal Deferral of Greek Debt Restructuring

Yanis Varoufakis

JUL 28, 2015

Alexis Tsipras and Euclid Tsakalotos

ATHENS – The point of restructuring debt is to reduce the volume of new loans needed to salvage an insolvent entity. Creditors offer debt relief to get more value back and to extend as little new finance to the insolvent entity as possible.
Remarkably, Greece’s creditors seem unable to appreciate this sound financial principle. Where Greek debt is concerned, a clear pattern has emerged over the past five years. It remains unbroken to this day.
In 2010, Europe and the International Monetary Fund extended loans to the insolvent Greek state equal to 44% of the country’s GDP. The very mention of debt restructuring was considered inadmissible and a cause for ridiculing those of us who dared suggest its inevitability.
In 2012, as the debt-to-GDP ratio skyrocketed, Greece’s private creditors were given a significant 34% haircut. At the same time, however, new loans worth 63% of GDP were added to Greece’s national debt. A few months later, in November, the Eurogroup (comprising eurozone members’ finance ministers) indicated that debt relief would be finalized by December 2014, once the 2012 program was “successfully” completed and the Greek government’s budget had attained a primary surplus (which excludes interest payments).
In 2015, however, with the primary surplus achieved, Greece’s creditors refused even to discuss debt relief. For five months, negotiations remained at an impasse, culminating in the July 5 referendum in Greece, in which voters overwhelmingly rejected further austerity, and the Greek government’s subsequent surrender, formalized in the July 12 Euro Summit agreement. That agreement, which is now the blueprint for Greece’s relationship with the eurozone, perpetuates the five-year-long pattern of placing debt restructuring at the end of a sorry sequence of fiscal tightening, economic contraction, and program failure.
Indeed, the sequence of the new “bailout” envisaged in the July 12 agreement predictably begins with the adoption – before the end of the month – of harsh tax measures and medium-term fiscal targets equivalent to another bout of stringent austerity. Then comes a mid-summer negotiation of another large loan, equivalent to 48% of GDP (the debt-to-GDP ratio is already above 180%). Finally, in November, at the earliest, and after the first review of the new program is completed, “the Eurogroup stands ready to consider, if necessary, possible additional measures… aiming at ensuring that gross financing needs remain at a sustainable level.”
During the negotiations to which I was a party, from January 25 to July 5, I repeatedly suggested to our creditors a series of smart debt swaps. The aim was to minimize the amount of new funding required from the European Stability Mechanism and the IMF to refinance Greek debt, and to ensure that Greece would become eligible within 2015 for the European Central Bank’s asset-purchase program (quantitative easing), effectively restoring Greece’s access to capital markets. We estimated that no more than €30 billion ($33 billion, or 17% of GDP) of new, ESM-sourced financing would be required, none of which would be needed for the Greek state’s primary budget.
Our proposals were not rejected. Although we had it on good authority that they were technically rigorous and legally sound, they simply were never discussed. The political will of the Eurogroup was to ignore our proposals, let the negotiations fail, impose an indefinite bank holiday, and force the Greek government to acquiesce on everything – including a massive new loan that is almost triple the size we had proposed. Once again, Greece’s creditors put the cart before the horse, by insisting that the new loan be agreed before any discussion of debt relief. As a result, the new loan deemed necessary grew inexorably, as in 2010 and 2012.
Unsustainable debt is, sooner or later, written down. But the precise timing and nature of that write-down makes an enormous difference for a country’s economic prospects. And Greece is in the throes of a humanitarian crisis today because the inevitable restructuring of its debt has been used as an excuse for postponing that restructuring ad infinitum. As a high-ranking European Commission official once asked me: “Your debt will be cut come hell or high water, so why are you expending precious political capital to insist that we deliver the restructuring now?”
The answer ought to have been obvious. An ex ante debt restructuring that reduces the size of any new loans and renders the debt sustainable before any reforms are implemented stands a good chance of crowding in investment, stabilizing incomes, and setting the stage for recovery.
In sharp contrast, a debt write-down like Greece’s in 2012, which resulted from a program’s failure, only contributes to maintaining the downward spiral.
Why do Greece’s creditors refuse to move on debt restructuring before any new loans are negotiated? And why do they prefer a much larger new loan package than necessary?
The answers to these questions cannot be found by discussing sound finance, public or private, for they reside firmly in the realm of power politics. Debt is creditor power; and, as Greece has learned the hard way, unsustainable debt turns the creditor into Leviathan. Life under it is becoming nasty, brutish and, for many of my compatriots, short.

Quantum Geopolitics

By Reva Bhalla

July 28, 2015 | 08:00 GMT

Forecasting the shape the world will take in several years or decades is an audacious undertaking. There are no images to observe or precise data points to anchor us. We can only create a picture, and a fuzzy one at best. This is, after all, our basic human empirical instinct: to draw effortlessly from the vivid imagery of our present world and past experiences while we squint and hesitate before faint, blobby images of the future.

In the world of intelligence and military planning, it is far less taxing to base speculations on the familiar — to simulate a war game that pivots on an Iranian nuclear threat, a seemingly unstoppable jihadist force like the Islamic State and the military adventurism of Russia in Eastern Europe — than it is to imagine a world in which Russia is weak and internally fragmented, the jihadist menace is contained by its own fractiousness and Iran is allied with the United States against a rising Sunni threat. In the business world, it is much simpler to base trades and strategies on a familiar environment of low oil prices and high interest rates.

Strategists in many domains are guilty of taking excessive comfort in the present and extrapolating present-day assumptions to describe the future, only to find themselves unequipped when the next big crisis hits. As a U.S. four-star general once told me in frustration, "We always have the wrong maps and the wrong languages when we go to war."

So how do we break out of this mental trap and develop the confidence to sketch out plausible sets and sequences of unknowns? The four-dimensional world of quantum mechanics may offer some guidance or, at the very least, a philosophical approach to strategic forecasting. Brilliant physicists such as Albert Einstein, Louis de Broglie and Erwin Schrodinger have obsessed over the complex relationship between space and time. The debate persists among scientists over how atomic and subatomic particles behave in different dimensions, but there are certain underlying principles in the collection of quantum theories that should resonate with anyone endowed with the responsibility of forecasting world events.

Quantum Principles and Political Entities

Einstein described space-time as a smooth fabric distorted by objects in the universe. For him, the separation between past, present and future was merely a "stubbornly persistent illusion."

Building on Einstein's ideas, celebrated U.S. physicist and Nobel Laureate Richard Feynman, some of whose best ideas came from drawings he scribbled on cocktail napkins in bars and strip clubs, focused on how a particle can travel in waves from point A to point B along a number of potential paths, each with a certain probability amplitude. In other words, a particle will not travel in linear fashion; it will go up, down and around in space, skirting other particle paths and colliding into others, sometimes reinforcing or canceling out another completely.

According to Feynman's theory, the sum of all the amplitudes of the different paths would give you the "sum over histories" — the path that the particle actually follows in the end.

The behavior of communities, proto-states and nation-states (at least on our humble and familiar planet Earth) arguably follows a similar path. We have seen statelets, countries and empires rise and fall in waves along varied frequencies. The crest of one amplitude could intersect with the trough of another, resulting in the latter's destruction. One particle path can reinforce another, creating vast trading empires. Latin America, where geopolitical shifts can develop at a tortoise's pace in the modern era, tends to emit long radio-like waves compared to the gamma-like waves of what we know today as a highly volatile Middle East.

Applied Quantum Theories: Turkey

If we apply the nation-state as an organizing principle for the modern era (recognizing the prevalence of artificial boundaries and the existence of both nations without states and states without nations), the possibilities of a state's path are seemingly endless. However, a probability of a state's path can be constructed to sketch out a picture of the future.
The first step is to identify certain constants that have shaped a country's behavior over time, regardless of personality or ideology (an imperative to gain sea access, a mountainous landscape that requires a large amount of capital to transport goods from point A to point B, a fertile landscape that attracts as much competition as it provides wealth). The country's history serves as a laboratory for testing how the state has pursued those imperatives and what circumstances have charted its path.

What conditions were in place for the state to fail, to prosper, to avoid getting entangled in the collisions of bigger states, to live in relative peace? We take the known and perceived facts of the past, we enrich them with anecdotes from literature, poetry and song, and we paint a colorful image of the present textured by its past. Then comes the hard part: having the guts to stare into the future with enough discipline to see the constraints and enough imagination to see the possibilities. In this practice, extrapolation is deadly, and an unhealthy obsession with current intelligence can be blinding.

Take Turkey, for example. For years, we have heard political elites in the United States, Eastern Europe and the Middle East lament a Turkey obsessed with Islamism and unwilling or incapable of matching words with action in dealing with regional competitors like Iran and Russia. Turkey was in many ways overlooked as a regional player, too consumed by its domestic troubles and too ideologically predisposed toward Islamist groups to be considered useful to the West. But Turkey's resurgence would not follow a linear path. There have been ripples and turns along the way, distorting the perception of a country whose regional role is, in the end, profoundly shaped by its position as a land bridge between Europe and Asia and the gatekeeper between the Black and Mediterranean seas.

How, then, can we explain a week's worth of events in which Turkey launched airstrikes at Islamic State forces and Kurdish rebels while preparing to extend a buffer zone into northern Syria — actions that mark a sharp departure from the timid Turkey to which the world had grown accustomed? We must look at the distant past, when Alexander the Great passed through the Cilician Gates to claim a natural harbor on the eastern Mediterranean (the eponymous city of Alexandretta, contemporarily known as Iskenderun) and the ancient city of Antioch (Antakya) as an opening into the fertile Orontes River Valley and onward to Mesopotamia. We move from the point when Seljuk Turks conquered Aleppo in the 11th century all the way up to the crumbling of the Ottoman Empire in the wake of World War I, when a fledgling Turkish republic used all the diplomatic might it could muster to retake the strategic territories of Antioch and Alexandretta, which today constitute Hatay province outlining the Syrian-Turkish border. 

We must simultaneously look at the present. A contemporary map of the Syria-Turkey border looks quite odd, with the nub of Hatay province anchored to the Gulf of Iskenderun but looking as though it should extend eastward toward Aleppo, the historical trading hub of the northern Levant, and onward through Kurdish lands to northern Iraq, where the oil riches of Kiruk lie in what was formerly the Ottoman province of Mosul.   

We then take a long look out into the future. Turkey's interest in northern Syria and northern Iraq is not an abstraction triggered by a group of religious fanatics calling themselves the Islamic State; it is the bypass, intersection and reinforcement of multiple geopolitical wavelengths creating an invisible force behind Ankara to re-extend Turkey's formal and informal boundaries beyond Anatolia. To understand just how far Turkey extends and at what point it inevitably contracts again, we must examine the intersecting wavelengths emanating from Baghdad, Damascus, Moscow, Washington, Arbil and Riyadh. As long as Syria is engulfed in civil war, its wavelength will be too weak to interfere with Turkey's ambitions for northern Syria, but a rehabilitated Iran could interfere through Kurdistan and block Turkey farther to the east. The United States, intent on reducing its burdens in the Middle East and balancing against Russia, will reinforce the Turkish wavelength up to a point, while higher frequencies from other Sunni players such as Saudi Arabia will run interference against Turkey in Mesopotamia and the Levant. While Russia still has the capacity to project military power outward, Turkey's moves in Europe and the Caucasus will skirt around Russia for some time, but that dynamic will shift once Russia becomes consumed with its own domestic fissures and Turkey has more room to extend through the Black Sea region.

Thinking Beyond Limitations

This sketch of Turkey is by no means static or deterministic. It is, simply but critically, the product of putting a filter on a lens to bring the state's trajectory into clearer view. The assumptions we form must be tested every day by incoming intelligence that can lead to refinements of the forecast at hand.

A quantum interpretation of the world will tell you that nothing is deterministic, and we cannot know for sure that a certain outcome will or will not happen based on the limited information we possess.

We can only assign a probability of something happening, and that probability will evolve over time.

As Stephen Hawking said, "It seems Einstein was ... wrong when he said, 'God does not play dice.' Not only does God definitely play dice, but He sometimes confuses us by throwing them where they can't be seen."

We can apply the same process to the ebb and flow of the Far East, with a resurgent Japan responding to the reverberations of a powerful China and an artificially divided Korea sandwiched in between. Or, the push and pull between France and Germany on the European mainland as centripetal forces subsume the EU project.

Too often, we see the future as we see the past — through the distorted lens of the present. That is the flaw in our human instinct that we must try to overcome. Constraints will apply, and probabilities will be assigned. But whatever the time, direction or dimension we are operating in when forecasting geopolitical events, we must simultaneously exist in the past, present and the future to prepare for a world that we have yet to know.

Op-Ed Contributor

How the Greek Deal Could Destroy the Euro


JULY 27, 2015

PARIS — The July 13 deal offering more financing for Greece has been billed as a last-minute step back from the brink, but the threat of a “temporary exit” from the euro proposed by a German coalition government has shaken the foundation of the euro in a far more fundamental way than meets the eye.
It has undermined what little Franco-German cooperation was left in economic affairs; it has made the single currency as it stands politically indefensible in France; and it has substantially increased the risk of euro exit across the monetary union. In short, the prospect of Grexit today has made a French, or even German, exit tomorrow far more likely.
These tensions are not new. Germany always thought of the euro as an improved exchange-rate mechanism built around the Deutsche mark, and France had bold but vague ambitions of a real international currency that would enhance the effectiveness of Keynesian economic policy.
These fundamental differences were papered over at the launch of the euro because both François Mitterrand and Helmut Kohl agreed that the single currency should first and foremost serve as a means toward the greater aim of European political integration.
Since 2010, both this constructive ambiguity and the ultimate goal of further political integration were more or less preserved. But during the last round of Greek negotiations both broke down, and with them the glue that has until now kept France and Germany so tightly committed to the euro and to building it together.
Indeed, the European institutions led by Germany seem to have decided that waging an ideological battle against a recalcitrant and amateurish far-left government in Greece should take precedence over 60 years of European consensus built painstakingly by leaders across the political spectrum.
By imposing a further socially regressive fiscal adjustment, the recent agreement confirmed fears on the left that the European Union could choose to impose a particular brand of neoliberal conservatism by any means necessary. In practice, it used what amounted to an economic embargo — far more brutal than the sanctions regime imposed on Russia since its annexation of Crimea — to provoke either regime change or capitulation in Greece. It has succeeded in obtaining capitulation.

The negotiations leading to the Greek agreement also destroyed the constructive ambiguity created by the Maastricht Treaty by making it absolutely clear that Germany is prepared to amputate and obliterate one of its members rather than make concessions. Germany appears to believe that the single currency ought to be a fixed exchange-rate regime or not exist at all in its current form, even if this means abandoning the underlying project of political integration that it was always meant to serve.
Finally, and perhaps most importantly, Germany signaled to France that it was prepared to go ahead alone and take a clear contradictory stand on a critical political issue.
This forceful attitude and the several taboos it broke reveal that the currency union that Germany wants is probably fundamentally incompatible with the one that the French elite can sell and the French public can subscribe to. The choice will soon be whether Germany can build the euro it wants with France or whether the common currency falls apart.
Germany could undoubtedly build a very successful monetary union with the Baltic countries, the Netherlands and a few other nations, but it must understand that it will never build an economically successful and politically stable monetary union with France and the rest of Europe on these terms.
Over the long run, France, Italy and Spain, to name just a few, would not take part in such a union, not because they can’t, but because they wouldn’t want to. The collective G.D.P. and population of these countries is twice that of Germany; eventually, a confrontation is inevitable.

This sorry state of affairs is not of Germany’s making alone. It began largely because of France’s romantic and somewhat naïve view of the monetary union; it deepened due to France’s political absence from European affairs since the beginning of the crisis; and it was compounded by the traumatic shock caused by financial stress on French banks and government bonds during the summer of 2011, which laid bare the economic enfeeblement that continues to undermine France’s self-confidence.
Meanwhile, Germany has built a politically and morally coherent narrative that obscures an economically deceptive vision based on the idea that abiding by the rules alone can create prosperity and stability for the European Union as a whole. This narrative has wide support across the German political spectrum and the clear backing of the German public.
France has still not completely overcome its inclination to put French sovereignty and decision-making first and has failed to articulate its own post-Maastricht vision of a prosperous monetary union, backed by a federal budget, governed by a real European executive power and legitimized by the European Parliament.
Despite the recent call by President François Hollande to address these issues, progress is unlikely. That’s because French elites are now unable to convince the public of the merits of the Union’s current economic policies in general — and toward Greece in particular. They are also too divided to propose a new shared vision, too disoriented to challenge the German narrative, and too afraid to start building alliances with like-minded countries such as Italy and Spain.
This unhappy marriage could last for years, but it will substantially increase the chances of anti-establishment parties coming to power across Europe, because mainstream leaders can no longer disprove the assertion that the euro as it stands has become both economically and politically destructive.
This will force all parties, including pro-European ones, to engage in a discussion about the potential merits of leaving the currency union and it will encourage political posturing, especially in France, where there is an undercurrent of Germanophobia that is easy to rekindle.
Regardless of what happens in Greece now, the July 13 agreement has made the prospect of a future euro breakup far more likely. The question is whether it will take the form of an orderly departure by Germany or a prolonged and economically more destructive exit by France and the south of Europe.
Shahin Vallée, a former adviser to the French economy minister and the president of the European Council, is a senior economist at an investment management firm.