Germany loses its grip

And so we roll on…

One of the things that amazes me about the European “crisis” is how symptoms of the underlying problems of the macro-economic system that is the Eurozone get confused with the actual problem. Let’s take the current situation in Greece for example:

So as of yesterday, the EU finance ministers , the EC and the IMF joined forces to demand that the Greek creditors take a larger hit on the countries debt forgiveness. The Institute of International Finance, that represents the creditors, said that its last offer is a 4% coupon on new bonds issued after the deal. The EU wants a better deal because the target is to get Greece down to 120% debt to GDP by 2020 and a lower rate is supposedly required to make that happen. The main reason there is so much argy-bargy about the rate is because every time someone looks at the state of the Greek economy it is worse. So basically, the EU is demanding more from creditors because their own policies have failed to turn the economy around. What makes this particular situation most interesting is that Europe has spent 2 years and literally hundreds of billions of dollars trying to avoid a Greek default, yet now they are making demands that have the potential to push the country in exactly that direction.

If a new deal cannot be struck that both sides can agree on then Greece may have no choice but pursue collective action clauses on outstanding bonds written under Greek law to force private creditors to take a deal. Talks are on-going.

However, although this particular problem is now the focus, it is just one symptom of the actual problem. That problem was highlighted overnight with the European flash PMI’s. Germany once again outperformed the rest of Europe, France treaded water, admittedly with its head held a little higher, while the periphery of Europe slowly drifts away. The latest Euro PMI was a little better than expected, in some part due to the ECB’s actions over the last month or so no doubt, put the forward looking indicators suggest more weakness to come and I expect the divide to grow as Europe slows further. As I have stated previously that the German data is a double edged sword because, although it is good for Germany that its economy is powering, it is a big negative for the rest of Europe because one of the major issues that brought on the crisis in the first place was the competitiveness imbalance of nations under the single currency.

What we are now seeing in Greece, and will continue to, is a symptom of this underlying problem. But Greece is not alone,  it is becoming obvious that Portugal has got itself into a similar position:

The cost of insuring Portugal’s debt against default was at record highs Tuesday and its bond yields remained at elevated levels amid concerns that a possible second bailout for the country in 2013 would include a Greek-model haircut for private-sector bondholders.

Worries have mounted among experts that Portugal won’t be able to return to markets for funding next year, forcing it to request a second bailout package.

Portugal’s five-year credit-default swap—a derivative that functions like a default insurance contract for debt—pushed above its record closing level in the continuation of the trend that started last week after the Standard & Poor’s Corp. downgrade to “junk” status.

So now even if Greece manages a deal to write-off some of its debt the markets will quickly turn their eyes to Portugal who will no doubt require a second bail out, but increasingly a debt restructure as well.

With Spain also struggling and Italy under increasing pressure, the continuation of contagion appears to be taking its toll on the politics of Europe with Germany’s ability to control the situation diminishing. As Spiegel reports:

Berlin has been unflinching it its efforts to both increase fiscal discipline in the euro zone and to avoid throwing more money at the European debt crisis. Increasingly, though, Germany’s EU partners are unwilling to play along. Chancellor Merkel now finds herself confronted with powerful opponents


A large alliance of the finance ministers, heads of government and central bankers from almost all of the 17 euro-zone member states has been calling for the European Stability Mechanism (ESM) to be enlarged — significantly. The permanent euro backstop fund, which will go into effect this year and will ultimately replace the temporary European Financial Stability Facility (EFSF), needs to encompass fully €1 trillion ($1.3 billion) instead of the planned €500 billion, Italian government officials have told their German counterparts.

At the same time, widespread resistance in Brussels to German plans for a new system of financial regulation within the EU is becoming more assertive. Merkel’s proposal for all EU member states to pass balanced budget initiatives — known in Germany as a “debt brake” — has been torpedoed as has the idea to allow the European Commission to bring countries that stubbornly violate deficit rules before the European Court of Justice.

Indeed, the balance of power in Europe has shifted. As long as Italy was ruled by a clown like Silvio Berlusconi, it hardly had any voice in efforts to save the euro. But ever since Monti, a respected financial expert, took over, the front of Merkel opponents is stronger than ever, all the more so because quite a few experts endorse Monti’s position.


Sarkozy is now getting the support of prominent economists from around the world. Christine Lagarde, the head of the International Monetary Fund (IWF) is calling for more money for the euro backstop fund as is Mario Draghi, the president of the European Central Bank (ECB), who has been in regular contact with his compatriot Monti. In a Monday appearance in Berlin, Lagarde said “we need a bigger firewall.”

Germany also appears to be losing support from even its strongest allies. Last week the Dutch central banker Klaas Knot gave an interview blaming Germany for the failure of the EFSF in which he stated:

“The most important obstacle lies in Germany, not in the Netherlands, we haven’t moved in the right direction and it’s also clear that measures needed are happening too slowly and are too limited in size.”

To add to that, Luxembourg’s new foreign minister gave an interview with German media yesterday in which he called the fiscal compact a ‘waste of time and energy’.

Is the failure of austerity-centric policy finally taking its toll on Germany’s ability to steer Europe’s response to the financial crisis? This would certainly explain why Mario Monti seems so sure that his country will be receiving the fiscal and monetary backstops. The outcomes from next week’s EU summit will provide more clues.

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  1. the flash PMI’s in Europe overnight were excellent. Not only is the eurozone not breaking up but they might actually also avoid recession.

  2. Is it just me or does anyone else get the feeling that German policy makers know exactly what they’re doing in forcing austerity onto the rest of their weak Euro-bretheren? The harm they have inflicted (and continue to inflict) on so many of their neighbours appears to have been good for Germany to some extent. Pushing so many others who share their common currency into permanent near-depression has placed at least some downward pressure on the value of the currency (am I wrong here?) which is not such a bad thing for an export-oriented economy like Germany. Are German policy makers deliberately cutting the throats of the weaker members in order to shore up their own export competitiveness outside the Eurozone?

    • Yes! If Germany was forced out of a currency union with the PIIGS its currency would appreciate rapidly, destroying its export “competitiveness” unless it adopted a dirty float against the US and Japan. China might not be the main problem as Germany may compete in different markets to China to some degree at this stage.

  3. I have colleagues who swear that Germany is preparing the ground for a Euro exit. The gist is in 2 parts (plus a bit extra):

    1. that Germany is a manufacturing economy first & an exporter second so a strong currency is a double-edged sword. Yes you may have “export competitiveness” issues but you also primarily have “input efficiency” gains through the same strong currency (and German products demand is fairly inelastic)

    2. The Europeans (ex-Germany) are hell bent on printing to monetise debt and that doesn’t suit a manufacturing economy one bit as the terror of inflation that stalks the Germans will destroy all or most of their efficiency gains, leave them in recession AND holding the bag for the rest of the inefficient European debts.

    How can ze Germanz at only 5% of the global economy hope to support the other 15% of global GBP that comprises the rest of the EU? If they demand the most stringent control mechanisms via fiscal brakes etc and the rest of Europe says “Nein” they can say “we tried” & leave the Euro, or if everyone caves in, then they’re in control politically & economically.


  4. Sorry DE, I was out of the loop all day yesterday and only got to read your post this morning.

    “This would certainly explain why Mario Monti seems so sure that his country will be receiving the fiscal and monetary backstops.”

    I still think that Monti is just wanting to be optimistic, rather than having any firm grounds for a belief that Italy will be given a fiscal or monetary backstop anytime soon.

    The logic still stands:
    1. Growing resistance to the “fiscal pact” is adding to the uncertainty of both the timeline and the strength of the final agreement.
    2. Merkel will require proof that Italy can’t back-slide after the next election.
    3. It is very difficult to provide such proof anytime soon (if ever).

    • I forgot to add the following:

      I think the best that Monti can realistically hope for, particularly in the near term, is an increase in the firewall (i.e. the ESM), as proposed by Lagarde in her speech on Monday. An article in the FT on Monday/Tuesday suggested that Merkel is now “conditionally” more open to the idea of combining the left over EFSF “committments” with the ESM, thus creating a firewall of about 750B euros.