13 Feb 2012

Endgame II: Europe’s Faustian pact

So we now have a thumping vote in favour of the EU/IMF austerity package. Mass rioting in Athens. One in seven Greek MPs thrown out of their political parties. And a snap election set for April. On Wednesday Eurozone finance ministers should sign off Greece’s new bailout, and then the “voluntary default” for Greece’s bankers can be signed off too. But will they really stick to the promises made to the Troika amid the tumult of an election campaign?

As I said in Endgame (part 1), Greece has been cauterised. The decision made by politicians now needs to be backed by the Greek people at April’s election, if Greece is to remain in the single currency. Some of the words from likely PM Samaras, suggest a plan to renegotiate the deal in April.

He even suggested that MPs should vote yes to staying in the euro, because “eurobonds are coming”, even though Chancellor Merkel is implacably opposed to pooling Europe’s debts. In November the troika forced Mr Samaras to write a letter confirming he’d stick to the negotiated plan. The combination of electioneering and a five way negotiation still sounds pretty fragile.

To understand where this is going however, you need to get to know what exactly it is that Germany and those driving the EU are trying to achieve. A senior figure in Chancellor Merkel’s CDU party referred to it as “spreading the stability culture throughout Europe”.

1. This is not just about German sado-austerity. The “fiscal compact” is an almost pointless fig leaf in policy terms. But it is a piece of marketing aimed at northern voters. The more significant policy changes are the reams of changes aimed at bringing down unit labour costs in the Mediterranean economies. Germany sees this as exporting the “stability culture”, as Germany itself has cut such costs since the euro’s creation. That is why the adjustment measure in Greece stresses things like cutting the minimum wage by 22 per cent.

In Italy, Spain, Ireland, and Portugal too, we see a host of measures meant to cut labour costs. Many economists in Germany see this as fair, given the sharp 30 per cent rise in real labour costs in many of these countries since the creation of the euro. That is one part of the Faustian pact: on average labour costs surged in these nations during the boom years. One leading former ECB figure I spoke to last year was actually offended by that trend. Now they have to come down. A type of hell, to pay for the better times.

2. This is as a direct result of the perceived success in Germany of a series of reforms started by Chancellor Schroder, which saw average real wages in Germany fall. The Hartz IV reforms help explain why unemployment has nearly halved in Germany in the past five years. It’s not just about classic labour market flexibility.

Chancellor Merkel also used billions of euros of taxpayers’ money to keep people in work during the financial crisis recession. They reaped the benefit over the past year and a half with a boom during the recovery. The rest of Europe can, and is, copying these reforms – but they fundamentally mean lower real wages.

3. The Draghi bazooka known as the LTRO, will be repeated in a fortnight, again aimed at the eurozone banking system. The ECB is effectively pursuing a variant of QE. The LTRO’s effect is almost the same as QE. But importantly it is QE that does not look like QE to an inflation/debt/money-printing averse German voter/politician. (There is a difference: banks have to post collateral for these loans, but eligibility is very wide including all sorts of mortgage binds and corporate loans).

The fact that he has done this and cut interest rates twice within weeks of arriving as the ECBs Italian boss in Frankfurt, and that he’s done this without inviting a mass German revolt, is very impressive. Will Germany rebel eventually? The popular wisdom says yes – I say no.

4. The market is beginning to discern the G from the PIIS. Greece is in a separate division. My market intelligence has many of the hedge funds closing out their shorts of the euro in the sovereign Credit Default Swap market. The risk here is that Greece’s politics become contagious, and Portugal and Ireland ask for some of the same deal that Greece gets. The ECB will find a legal way to share the burden of the Greek bond haircut.

5. As we get to the end of the year the German elections in 2013 will come into focus. Watch German politicians such as Per Steinbruck, who have been withering about Merkel’s dithering. Watch out for who the German SPD choose as candidate for chancellor. They have suggested they are far warmer on eurobonds than is commonly suggested about Germany.

All roads lead to the German elections next year.  If it is clear that Europe’s sado-austerity is not working in Portugal, and Spain as well as Greece, then expect some form of eurobond. The euro will very much still be with us until then.

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9 reader comments

  1. Anthony Martin says:

    I predict that Greece will default and rightly so. The citizens of that country are being well and truly screwed over while the wealthy elite bask in the financial gains of their speculation.
    Greece and the Greek citizens are part of our family of nations. The Banks and wealthy criminal Mafia-like cronies are their enemy.
    Greece needs to forge a country that sets an example to other nations facing the same repercussions of predatory capitalism. Go it alone and shape a system that is regulated properly by the people and not by the wealthy colluding scum.
    Greece has many talented people and much to offer the world. The Greeks, Irish, Portuguese, Spaniards, etc are all part of our collective ‘EU family’. So, to those out there spinning smear tactics on the Greeks, go drown yourself in your ill gotten loot and leave these people alone.
    Germany is not the ‘power house’ calling the shots of Europe. ALL the countries are as one, like a body functioning with differentiating organs. If the Liver goes down, they all go down.
    Globally, there needs to be a concerted effort to remove the wealthy criminal control and regulations forced in place to stop this disaster. Will it…

    1. Knut34 says:

      If Greece disappears from the EU or Eurozone it will not even move markets 5%. It is all priced in. Even German CEOs are now saying enough is enough. Kick them out.

  2. Y.S. says:

    Germany gives Greece money in one hand and takes it back as repayment in the other.

  3. Andrew Dundas says:

    Getting Greeks’ real wages down even lower will not solve its Government’s insolvency.
    Greece only managed to raise 31% of its GDP in tax revenues in 2010 – the latest OECD figures report – and that compares with over 40% for other EU states with small populations. (UK’s was 35%).
    That was a fall from the peak of 32% in 2007 and before The Crunch. Despite higher tax rates, things are getting worse.
    What taxes Greece does collect are often wasted. For example, Greece spends 2.5% of its GDP on medicines, vs. 1% of GDP in the UK. Even allowing for the greater efficiencies of the NHS, that suggests profligate waste.
    Greece needs help with its governance. Greece won’t recover quick enough without that support.

  4. pierregonzalez says:

    Let’s remember a few things :
    Spain has been the only country respecting the previous Stability Pact until 2008 and look where they are . Conclusion : Stability Pacts are not a guarantee against financial crisis !
    At the beginning to solve the Greek problem would have been costing around 100 billions ; thanks to Merkel we are now at more than 200 and running !
    Germany with their salary deflation policy are responsible for the ruin of south European economies but if they don’t pay to solve it , the boomerang effect will kill them.
    And the best for the end : The Greek opposition will not respect the deal they just agreed !
    No way they do it . Which means that Greece will leave the Euro after stilling billions from the other countries ; in any case the Eurozone countries have now a plan B to adapt to their departure . Farewell and die alone !

  5. pierregonzalez says:

    The numbers prove me right ! The last info about the German economy shows a contraction of 0,2% for the last quarter of 2011.
    The reason ? Less exports to the EU countries.
    If you push people to have less money they spend less . And if they feel that they have less money because of the Germans they will buy products from other countries.

    1. Knut34 says:

      It is better to work less and sell less than to work a lot and give money as gift to others so they can buy your stuff.

  6. Knut34 says:

    The decision on Eurobonds is not up to the German government. The supreme court has clearly said “no”.

    In order for a German government to say yes to Eurobonds, they would need to have a referendum on a new constitution.

    Success – unlikely.

    1. Andrew Dundas says:

      Thanks for your timely reminder.

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