Even the illusion of political unity in Europe appears to be dissolving before our eyes. This, of course, should come as no surprise to anyone watching the European crisis unfold. The key problem always was the internal imbalances, a problem for which European policymakers have never offered a credible solution. They simply don't have such a solution in the context of a system of fixed exchange rates. I believe that currency devaluation is the only option that will change relative competitiveness in any reasonable timeframe and restore internal balance. But that option is unavailable for Euro members.
Lacking currency devaluation as a tool to resolve imbalances, European policymakers turned to fiscal austerity. That plan has failed, pushing nation after nation into ever deepening recession. With Greece going on its fifth year of recession, I imagine by now that Portugal, Spain, and even Italy now see the writing on the wall for themselves. Sadly, however, the alternative is exiting the Euro, which almost certainly means financial chaos for the Continent as a whole.
The Eurozone is like a roach motel. You can get in, but you can't get out.
Still, peripheral nations can only accept so much pain before the costs of being in the Euro outweigh the costs of leaving. And Italy is now sending Berlin a clear warning that such an endgame is approaching. Via the Financial Times:
Italy’s prime minister has pleaded for Germany and other creditor countries to do more to help lower his country’s borrowing costs, warning there would be a “powerful backlash” among voters in the eurozone’s struggling periphery if they did not...
..Rome would push the German government to realise it was in “its own enlightened self-interest” to lend more of its fiscal weight to lowering borrowing costs of Italy and other highly indebted governments. The single currency had brought “huge benefits …and maybe [to] Germany even more than others,” he said....
...The stance could put Mr Monti, whose appointment to replace Silvio Berlusconi was cheered by German chancellor Angela Merkel, on a collision course with Berlin.
What can Germany do? Germany could do lots of things to help - running a massive budget deficit to drive consumption and inflation higher comes to mind. Monti, however, is looking for something a little more reasonable, real help on interest rates via Eurobonds and a German commitment to a larger rescue fund. Arguably small concessions given the magnitude of the problem, but Germany resists. He also holds out hope for additional ECB aid:
But he said he believed the ECB should feel more secure to move once a new fiscal discipline treaty is agreed at an Brussels summit at the end of the month.
Perhaps he hopes for too much: A deep rift between politicians and the ECB looks to be growing. A stunning development, again via the Financial Times:
The European Central Bank has harshly criticised negotiators working on a new treaty to enshrine fiscal discipline in the eurozone, saying that recent revisions to the draft amounted to “a substantial watering down” of the pact’s strictures intended to force down debt levels within the single currency.
Jörg Asmussen, a member of the ECB’s executive board, wrote to negotiators that new provisions in the treaty that would allow highly indebted eurozone countries to breach budget deficit limits “in periods of severe economic downturn” amounted to an “escape clause” that could lead to “easy circumvention of the rule”.
“These revisions in my view clearly run against the spirit of the initial general agreement on an ambitious fiscal compact,” Mr Asmussen wrote in a letter on the ECB’s behalf, dated Thursday.
The original compact would of course be watered down - it was never credible to begin with, as it called for a level of fiscal austerity across the Eurozone compatible only with Depression. The ECB is looking for just such an outcome:
In proposed treaty language accompanying the letter, Mr Asmussen suggested that eurozone countries should only be allowed to breach the deficit limit – which is defined in the text as 0.5 per cent of economic output – in times of “natural catastrophes and serious emergency situations outside the control” of eurozone governments.
How far with the ECB push the issue? Will they back away from further bond purchases? Edward Harrison and Martin Feldstein have more here and here. I would add that it pays to remember the ECB plays for keeps, and is not above outright extortion to get what it wants.
Meanwhile, via Naked Capitalism, Wolf Richter informs us of another rift growing in the Eurozone rescue efforts, this time in the disaster that is Greece:
But now the Troika itself is in disarray. It surfaced today at an IMF press briefing in Washington: the IMF no longer supports austerity as a guiding principle. Athens News quoted a senior IMF source, who was speaking on condition of anonymity. Frustration was practically palpable:
Horizontal austerity measures are constantly being adopted that are leading nowhere, whilst further wage and pension cuts are unjustified because the only way to improve competitiveness is through growth-creating market liberalization, the opening of closed professions, and productive investments.
The three Troika inspectors—Poul Thomsen from the IMF, Mathias Morse from the EU, and Klaus Mazouch from the ECB—are supposed to head to Greece next week to inspect its books; the budget deficit is once again higher than the revised limit that Greece had vowed to abide by. And they’re supposed to negotiate additional “structural reforms.” But there probably won’t be three inspectors, according to senior IMF sources. Missing: Poul Thomsen. The IMF has had enough.
Finally, note that last week's S&P downgrade came down especially hard on Portugal. That bailout is headed toward another round of private sector involvement. Only a matter of time.
Bottom Line: In Europe, the unstoppable force of austerity is colliding with the immovable object that is reality. Expect fireworks.
