Europe is not ready to deliver

The most choreographed move in recent Europe economics finally occurred overnight with Spain requesting a €100bn bailout of its banking system:

Spain formally requested on Monday European aid of up to 100 billion euros for its banks, the Economy Ministry said in a statement.

Spain’s Economy Minister Luis De Guindos said in the letter to Eurogroup chairman Jean-Claude Juncker that the final amount of the financial assistance would be set at a later stage but should be enough to cover all banks’ needs plus an additional security buffer.

He also confirmed his intention to sign a Memorandum of Understanding for the package, which would include full details, by July 9.

As I mentioned in early June, any use of the EFSF or ESM comes with conditions and the wording of the MoU will be very important. Although Mariano Rajoy has attempted to convince his fellow Spaniards that the money will come without conditions I suspect the reality will be quite different. For his part, however, Mr Rajoy is keeping up appearances:

The Spanish government will soon take new measures aimed at stimulating economic growth and creating jobs, Prime Minister Mariano Rajoy said on Monday in a speech to business leaders.

“Soon there will be new economic measures with no objective other than (economic) growth and creating employment,” Rajoy said. He gave no details, but also said Spain was fully committed to cutting its public deficit.

He also said that European leaders, at a summit later this week, should set out a precise calendar for achieving further economic and fiscal integration in the euro zone.

On the back of a rapidly deflating housing bubble, and in the absence of a current account surplus, the Spanish economy continues to deflate. Promising  to spur economic growth and employment while promising cuts to government deficits in this environment appears to be a pile of wishful thinking, not that this is new for the Spanish.

This bailout adds another €100bn to the debt of the Spanish sovereign which is already facing €550bn in funding over the next 3 years.  Unsurprisingly Spanish yields were up overnight.

Spain was not alone, however, with Cyprus also indicating that it too will need assistance:

Cyprus has told the European authorities that it intends to apply for financial assistance, the fifth eurozone member to do so. It said it needs help to shore up its banks, which are heavily exposed to the Greek economy.

Which brings us back to exactly what crisis resolution we are going to see from this week’s summit.
I stated a few weeks ago my feeling is that, at this stage, Germany is talking the talk but will in no way genuinely commit to anything of importance until either their own economy is under threat or other nations of Europe are legally bound to enact fiscal changes. As I said:

I am sceptical anything will change in the German camp until the weaker economies of Europe are shackled to the fiscal compact, one way or another.

A recent interview from Spiegel with German Finance Minister, Woflgang Schauble, appears to give support for those ideas:

Schäuble: The most important thing is that we create a fiscal union, one in which the nation states give up their jurisdiction in terms of fiscal policy. In addition, the problems of the Spanish financial institutions reveal, once again, that Europe would be better off with a bank union. We need a European supervisory authority, at least over the major lenders, which can then influence the banks directly. Then we can also save them with joint funds.

SPIEGEL: For months, Germany has been under pressure to agree to joint government bonds, the so-called euro bonds. It would certainly be seen as a confidence-building measure if you complied with the wishes of the other European countries.

Schäuble: As long as we don’t have a fiscal union, we cannot assume joint liability for debts.

SPIEGEL: Why are you so uncompromising on this issue?

Schäuble: Because you can’t separate the responsibility for decisions and the liability. This applies to almost all areas, but especially to money. Someone who has the ability to spend money at someone else’s expense will do so. You do it, and so do I. The markets know that. And that’s why they too would not find euro bonds convincing in the end.

In that regard it has been my understanding that Germany was using the crisis to its advantage. If other Eurozone nations were unwilling, or unable, to meet their obligations under the fiscal compact then Germany could simply wait for their economies to weaken to a point were they requested a bailout which would then bind them to similar terms. From that point on, as we now see with Spain, the willingness to give up national sovereignty in return for economic help makes the shift of power to Brussels all that more easy:

SPIEGEL: With all due respect to your vision, is there truly more willingness today among EU member states to give up sovereignty than there was in the 1990s?

Schäuble: The recognition that this is necessary, and the willingness to do so, has certainly grown due to the crisis, and not just in Germany. I would much prefer that we not have so many crises, and particularly not such severe ones. But every crisis also includes the opportunity to recognize what is necessary. That’s what led to the fiscal pact, in which 25 EU countries pledged to improve their fiscal discipline. And that’s also how the new Europe will come about.

I recommend you read the entire interview as it gives you an idea of what we are likely to see from the German camp at this week’s summit. It is also very much in-line with the conclusion of the latest memo from the European commission on the fiscal union:

3. The way forward

Recent years have seen an unprecedented strengthening of coordination of economic and fiscal policies at EU level. This has been accompanied by an expression of solidarity to support financially vulnerable euro area countries through the building-up of the euro area’s firepower in the form of the EFSF, and the ESM (which should be effective in July). The renewed intensification of the sovereign debt crisis demonstrates the need to build further on these achievements, and map out the main steps towards full economic union, to complement and strengthen the existing economic and monetary union, as the European Commission has advocated and implemented in the past years. A fully-fledged economic union would require more decisions taken at European level when it comes to public expenditure, revenues and borrowing, and thereby a higher degree of political integration. This should obviously entail commensurate steps that ensure democratic legitimacy and accountability.

It would appear from this week’s market tensions that a disappointing outcome from the 19th EU summit is likely to be very disruptive to the world’s financial markets. The trouble is that Europe has never been one to make bold leaps of faith as suggested by Schäuble and the EC. Although Europe’s appears to have a vision of its future the outcome is years away. I’m not sure the rest of the world is willing to wait that long.

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  1. Great post DE. Thanks.

    I read elsewhere of another reason why Germany might not give any ground at this EU Summit. Apparently the German parliament is soon to vote on the fiscal compact and the ESM. The speculation is that Merkel does not want to put these votes at risk by taking on any more commitments before then.

  2. “If other Eurozone nations were unwilling, or unable, to meet their obligations under the fiscal compact then Germany could simply wait for their economies to weaken to a point were they requested a bailout which would then bind them to similar terms. From that point on, as we now see with Spain, the willingness to give up national sovereignty in return for economic help makes the shift of power to Brussels all that more easy.”

    I think you might have nailed it with this paragraph DE. Germany is aware of the flaws in the design of the monetary union (e.g. De Grauwe’s multiple equilibria), but won’t agree to the implementation of a supra-national fiscal or monetary backstop until the moral-hazard issue is resolved (i.e. no liability without control).

    It’s shaping up to be a continual slow grind forward, with the ECB helping out when necessary via SMP or more LTROs.

    If things do start to spiral out of control, my guess is that the ECB will jump in with a monetary backstop. If that fails, Germany will probably cave in and agree to a fiscal backstop (i.e. control AFTER liability). But it will then be much harder to gain that control.

  3. It may be frustrating for the rest of the world but I agree with Merkel. Pumping (borrowed) money into the economy will let everyone of the hook, no one will ever get around to doing the required reforms and 10 years down the track everyone will be pointing at Europe again for always making this obvious mistakes.

    Germany seems intend on fixing the problem, not avoiding it… and I fully agree.

    The recession is not something which can or should be avoided. Deflation is simply letting out the air which shouldn’t have been there in the first place. So many people seem to have forgotten that.

    Yes, we have to be careful that there will not be a social collapse, but the member states each have their own responsibility in this. Pointing the finger at Germany is easy and uncalled for.

    • I think Germany could be doing more to help Spain.

      The reason Spanish 10-year bond yields are above 6% – despite Spain’s low inflation rate – is because of its (anticipated) high debt load, its low growth prospects (austerity), and its membership of a monetary union (i.e. De Grauwe’s “bad equilibrium”). Germany has already said that Spain is taking all the correct actions, but yet up until now Germany has declined to do any more to help bring these yields down to sustainable levels.

      Spain cannot bring these yields down by its own actions, nor by receiving a sovereign bailout from the EFSF/ESM.

      Perhaps after the German parliament approves the fiscal compact and the ESM, Merkel will indeed agree to do more to help Spain.

      • I think Spain, Ireland and Portugal have all shown willingness and the competency to reform. Spain for example knows pretty well what is wrong and thus what needs to be targeted. There’s no harm in enforcing/stimulating that willingness.

        However, there still needs to be a stick behind the door to keep member states making the tough decisions. Once that stick is gone no way they will be able to resist the general tendency to think about election results rather than long-term sustainability.

        • I have no problem with what you’ve said. It brings to mind Merkel’s phrase: “liability and control belong together”.

          However, a key problem at the moment is that Spain can’t get it’s bond yields back down to sustainable levels without external help. If the bank bailout does not achieve this then Spain will need a sovereign bailout, which may stretch the EFSF/ESM to its limit, and may still not achieve this.