...to spite your face. This should be the new, official slogan of German policymakers. It is pretty clear that financial conditions in Europe are unravelling, now putting the Euro into free-fall. European policymakers simply became far too complacent over the winter, thinking that the ECB's two LTROs had fixed the problem. And, in a sense they did - for the moment. But as it became increasingly evident that the ECB was back out of the game, everything went sour. The economic realities came back into play. Moreover, there has been precious little action taken to resolve those problems - essentially, the lack of an federal fiscal institutional structure - that would make a common currency workable.
Moreover, Germany continues to block movement in that direction. From the FT:
Germany refused to share the debt burden of stressed eurozone peers on Tuesday, ignoring two of the most influential international economic bodies which offered support for proposals championed by Paris, Rome and Brussels ahead of a summit.
Angela Merkel, Germany’s chancellor, has argued that any co-mingling of eurozone debt would remove incentives for southern economies to adopt structural reforms. The calls from the International Monetary Fund and the Organisation for Economic Co-operation and Development came on the eve of Wednesday’s EU summit.
Merkel sees a large stick as the only way to end the crisis. She is unwilling to recognize that she needs to match that stick with a large carrot. At the end of the day, rather than concede on the necessity of internal fiscal transfers to make this work, she would rather doom the entire project to failure.
And speaking of the path to failure, notice another warning sign. Germany is now selling zero coupon bonds. Again from the FT:
Germany sold €4.5bn of two-year government bonds at a record low yield of 0.07 per cent, underscoring the strong demand for safer assets amid fears that Greece could be forced out of the eurozone.
The German Bundesbank said the two-year “Schatz”, which was sold with a zero-coupon for the first time, received bids for €7.7bn, compared to a maximum sales target of €5bn.
Germany is rushing headlong on the Japanese (and arguably) US path, dragging the rest of Europe along for the ride. Of course, German policymakers see it exactly the other way, and worry about the moral hazard implications of changing course. But Europe is beyond moral hazard, which at this point is just something to talk about over a few pints at the pub. Germany needs put moral hazard concerns in the back seat and find a cooperative path, and needs to find it soon.
