The irresponsibility of a German chancellor

By: Wolfgang Münchau

“They will not allow it to happen.” This is what a German colleague told me a little over a year ago back after I hyperventilated about a possible break-up of the euro. The euro, he said, is politically too important for the EU. There will be crises, but in the end they will do whatever it takes to save the euro area. I recall those words very well: Whatever it takes.

That was then. On Thursday, the spread between Greek and German bond yields peak at 25%. Mathematically, it implies an approximate 50% probability of a 50% loss (or a 100% chance of a 25% loss). With money market interest rates well below 1%, and not likely to rise fast within the next two years, such a valuation can only mean that the capital markets are certain of default.

Portuguese yields have not quite reached those dizzy heights, but they were also rising sharply. There are investors out there who are putting serious money on a default of the southern European hemisphere, and on a break-up of the euro.

While the south of the euro area is now becoming subject to a generalised speculative attack, the Northern part procrastinates. Until Thursday, when the heads of the IMF and the ECB pointed out the seriousness of the situation, Angela Merkel has been invoking the principle of due process. Her plan had been the merely political promise of aid would calm the market, and thus obviate the need to deliver on the promise. The markets have called her bluff.

Are her advisers stupid, a correspondent asked me? Perhaps, or perhaps not. The more important point is that this is about the supremacy of domestic politics. She had hoped to avoid a decision taken before an important state election on May 9. To her, and  Germany’s political class, the state elections in North-Rhine Westphalia are infinitely more important than the future of the eurozone. The opinion polls seem to support this attitude. Greek aid is unbelievably unpopular, with 86 per cent opposed according to a poll published last Sunday. Come to think of it, there are not many issues in a democracy on which 86 per cent of the people agree on.

Perhaps this is because Angela Merkel never went on television to explain why such aid may be necessary, and why its disbursement may be in Germany’s national interest. She is not leading, but following public opinion on this issue. In this leadership vacuum, a new and dangerous consensus has been building up among constitutional lawyers, macroeconomists, and senior members inside her own coalition – that the only way out of this mess is for Greece to leave the euro. The Greeks will, of course, not comply, so the situation has turned into a standoff. In the meantime, the bond markets are melting down, and the crisis is spreading throughout southern Europe, having reached Italy now.

So much for: “Whatever it takes.” While it is one thing to criticise a political process as being too slow or otherwise inadequate, Mrs Merkel’s response to this crisis has been irresponsible. While the Greek crisis was caused by irresponsible Greek policy, it was turned into a wider political and economic crisis by her procrastination. The promises of two consecutive European Councils have proved hollow. The financial markets now consider EU leaders, and Mrs Merkel in particular, as liars.

After Wednesday’s scare, and the downgrade of Spain, Merkel went from complacency straight into panic. But even now it is not clear whether the Bundestag is going to vote in favour of the aid – which is going to be much, much large than previously reported, about $120bn for three year, without restructuring. There is still at least a week of uncertainty ahead. A week is a long time in politics, a famous English political adage goes, but it is an eternity during a financial market meltdown.

The EU needs to take some urgent decisions to resolve this crisis. The universe of options consists of: default; unconditional bailout; conditional bailout; the latter two with or without debt restructuring/rescheduling; creation of a single European bond; creation of a minimally sufficient political and fiscal union, allowing the eurozone to break up. If the EU chooses the conditional bailout, it is essential to remove most of the uncertainty of the process. Neither the conditions, nor the bailout should ever be in doubt.

Uncertainty and indecision are pushing us fast into the first option, the default option. I am sticking to my previous forecast that Greece will eventually default.

The more worrying development is the resurgence of German nationalism and euroscepticism, a trend Merkel tried to exploit for her own political benefit. This has not yet fully caught on in other parts of the union. If and when it does, I wonder whether politicians and economists in those parts begin to question the wisdom of a monetary union with Germany under such circumstances.

munchau@eurointelligence.com

 

 

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