Needed: A Franco-German concordat

Franco-German discord

Needed: A Franco-German concordat

Written by Charles Grant, 27 June 2012

Like many other EU summits over the past two years, the European Council meeting in Brussels on June 28th and 29th has been billed as a ‘last chance’ to save the euro. With the situation in Greece, Spain and Italy causing alarm, EU leaders should present a credible plan to convince financial markets that they are serious about saving the euro. They are unlikely to do so. Although there will probably be other last chances, time is starting to run out. Unless France and Germany can soon agree on a grand bargain, disaster may loom.

Not only France but also Italy, Spain, the European Commission, the IMF and the Obama administration are urging Germany to accept ‘eurobonds’ (collective eurozone borrowing), bigger bail-out funds that can intervene in sovereign bond markets and a ‘banking union’ that would include common deposit insurance and bank recapitalisation schemes. For now, however, Chancellor Angela Merkel is not budging.

According to one EU official who has worked closely with Merkel, she reacts badly when other governments ‘gang up’ against her: recent public criticism from François Hollande, the French president, and Mario Monti, the Italian prime minister, has only made her more stubborn. But the official points out that since the euro crisis began she has carried out several U-turns (for example, by agreeing to set up bail-out funds). She has also told fellow EU leaders in private that the euro is in Germany’s national interest and that if, in a crisis, new measures are required, she will take them. What she will not do is spell out in public the steps she is prepared to take, lest that encourage other governments to relax their efforts to curb budget deficits and enact reforms.

When Merkel says that she will do whatever it takes to save the euro she is presumably sincere. But in a crisis would she be able to move quickly enough? She faces severe domestic political constraints. Many Bundestag members oppose greater generosity to southern Europe. In that they reflect German public opinion, which is becoming more hostile to bail-outs. Furthermore, Germany’s constitutional court could block further transfers of power to the European Union. Most of the eurobond schemes that have been mooted would be incompatible with Germany’s current constitution. The German constitution can be changed if two thirds of Bundestag members vote for an amendment. However, if Merkel required the votes of the opposition Social Democratic Party (SPD) to change the constitution, her coalition government would probably collapse.

Not unreasonably, most Germans are reluctant to support schemes such as eurobonds unless other eurozone countries are willing to submit their economic policies to more control by EU institutions. Otherwise the southern Europeans could borrow cheaply via eurobonds and then spend freely. Monti and Mariano Rajoy, the Spanish prime minister, are willing to accept more EU control. But Hollande has not yet indicated that he is willing to do so. Many senior figures in French politics, including the foreign minister, Laurent Fabius, oppose transferring more powers to the European Commission.

Hollande’s current policies are making it hard for Germany to change its stance on the euro. He appears allergic to the kinds of structural economic reform that would boost France’s waning competitiveness, such as deregulating labour markets (he is lowering the pension age while other European governments are raising it). He says he is committed to a budget deficit of 3 per cent next year – which would mean a restrictive fiscal policy – but has so far announced no spending cuts and several spending increases. State spending is 56 per cent of GDP (the highest in the EU after Denmark) and growing. A swathe of new taxes on business is likely to discourage investment and thus stunt economic growth. For the time being, Hollande appears no more willing than Nicolas Sarkozy was to give the EU a bigger say over French budgetary policy.

The story of the euro, like that of the EU itself, is one of Franco-German bargaining. The current disconnect between Paris and Berlin is destabilising the euro. In the long run the euro is not sustainable without a grand bargain between France and Germany. Germany will need to accept the principle of eurobonds, some sort of banking union, softer budgetary targets for the countries in difficulty, and the writing off of more of those countries’ debts. In return France and the other euro countries will have to swallow both structural reforms that would enhance productivity, and greater EU sway over budgets and other economic policies.

At the moment such a grand bargain is impossible, and not only because Paris and Berlin are far apart on policy. Merkel and Hollande do not trust each other. The history of Franco-German relations suggests that even when two leaders initially get on badly (think of Jacques Chirac and Gerhard Schröder, or Nicolas Sarkozy and Angela Merkel) they eventually find a way of working together.

However, the financial markets may not wait. The next eurozone crisis could be imminent, perhaps provoked by a bank run in Spain or Italy, or those countries having to pay so much to borrow that they are effectively frozen out of the bond markets. Those who wish the euro well must hope that in an emergency, Merkel and Holland will overcome their differences, act decisively and bring along the other leaders with them.

But the intrusion of democracy could spoil the best efforts to salvage the euro. In the Netherlands, parties that oppose austerity at home as well as more money for bail-outs could win September’s general election. Monti’s government of technocrats, increasingly unpopular in Italy, could fall long before the elections that are due next spring. Within the past few days both Wolfgang Schaüble, the German finance minister, and Sigmar Gabriel, the SPD leader, have said that big changes such as eurobonds could well require a referendum in Germany.

Many things can go wrong, but if France and Germany work together the euro has a sporting chance of survival. The EU institutions can play a role in bringing them together. Ever since the euro crisis began, the Commission, in particular, has been marginalised from some of the decision-making on the most important issues. The gravity of the current situation presents an opportunity for the institutions to reclaim some intellectual leadership. The ‘four presidents' report’, published on June 25th, shows that they are trying to do so.

Written by the presidents of the Commission, European Central Bank, Eurogroup and European Council – with Herman Van Rompuy, president of the European Council, in the lead – the report sketches a way forward on banking, fiscal and economic union. It calls for common systems for banking supervision, deposit insurance and bank resolution. It also suggests more EU control over national budgets and levels of debt, alongside tentative steps towards debt mutualisation (it mentions short-term ‘eurobills’ and a ‘debt redemption fund’, kinds of eurobond that may be compatible with the German constitution).

The four presidents’ report offers EU leaders a sensible roadmap for their future work. However, Merkel’s response, expressed to law-makers in Berlin on June 26th, was to say that she did not expect to see eurobonds in her lifetime. She is, in the words of the EU official quoted at the start of this piece, “practising brinkmanship, which of course entails the risk that one falls into the abyss”.

Parts of this article are based on a piece that appeared on the Guardian website on June 25th 2012.

Charles Grant is director of the Centre for European Reform.

Comments

Added on 28 Jun 2012 at 10:40 by Leigh Phillips

Interesting. Two quibbles - French productivity easily outstrips most other countries: http://online.wsj.com/ad/article/france-productivity and lowering retirement age, while initially counterintuitive, actually makes sense: http://www.foreignpolicy.com/articles/2011/01/02/unconventional_wisdom?page=0,7

Britain outside the EU: Switzerland with nukes?

Britain outside the EU: Switzerland with nukes?

Britain outside the EU: Switzerland with nukes?

By Charles Grant, 27 June 2012
From Reuters

Link to press quote:
http://www.reuters.com/article/2012/06/27/us-britain-eu-idUSBRE85Q0Q420120627

Cameron's next European 'faux-pas'

Cameron's next European 'faux-pas' spotlight image

Cameron's next European 'faux-pas'

Written by Hugo Brady, 26 June 2012
From E!Sharp

Britain - in or out?

Britain & the EU

Britain - in or out?video icon

BBC Newsnight
By Charles Grant, 25 June 2012
From BBC Newsnight

Link to video:
http://www.bbc.co.uk/iplayer/episode/b01k9ptk/Newsnight_25_06_2012/

Germany's own goal: Why Berlin's sense of invulnerability will be its undoing

Germany’s own goal

Germany's own goal: Why Berlin's sense of invulnerability will be its undoing

Written by Simon Tilford, 22 June 2012

Countries around the world fear that Europe's handling of the eurozone crisis will cause a global slump. But in Germany, the currency union's biggest economy, there is a curious sense of invulnerability. For many Germans, including many senior policy-makers, the crisis seems to be someone else's problem. Indeed, some even believe that Germany would be better off without the euro. Merkel's obduracy is widely credited with striking a blow for Germany's national interests. The German government and media portray demands that Germany accept debt mutualisation or a banking sector union as a call for German charity or benevolence. Such reforms are rarely, if ever, seen as being in Germany's self-interest, but rather an imposition on the country. This is puzzling, because Germany is much more vulnerable than German policy-makers appear to believe. And Germany’s strategy for dealing with the crisis is maximising, not minimising, the risks to the country’s economic and political interests.


What explains this sense of invulnerability? Is the German economy really so strong that it can sail through an EU slump and a renewed global crisis? The German economy has certainly bounced back stronger than most of the rest of the Europe. Over the four years to the first quarter of 2012, the economy grew by 1 per cent. This hardly qualifies as the Wirtschaftswunder it is sometimes portrayed as in Germany (and is a worse performance than the US), but is considerably better than the EU or eurozone average. Germany's labour market has also performed strongly. Unemployment has fallen steadily, contrasting sharply with surging joblessness in France, Italy and Spain. German youth unemployment is at a 20 year low. This partly reflects demographics – the number of Germans coming of working age each year has fallen steeply due to the country’s persistently low birth-rate. But demand for labour has also held up well.

However, Germany's export dependence remains as pronounced as ever. The country's current account surplus has fallen but not significantly so: after peaking at 7.4 per cent of GDP in 2007 it was still equal to 5.7 per cent in 2011. Over the four years to the first quarter of 2012, domestic demand rose by 2 per cent, and hence outpaced growth in overall GDP. However, this was largely down to a steep fall in exports in 2009. Since then the contribution of net exports (exports minus imports) to economic growth has been positive: growth in domestic demand has lagged that of the economy as a whole. Moreover, stripping out government consumption – which has risen relatively strongly – domestic demand increased by just 1 per cent over the last four years. And growth in government consumption has now slowed sharply.

But what of the argument that Germany is no longer so dependent on the eurozone because of growing trade with the rest of the world? The eurozone accounted for 39 per cent of German exports in 2011, down from 43 per cent in 2007; the EU's share fell from 63 per cent to 59 per cent over this period. Put another way, exports to the EU are still equivalent to over 25 per cent of German GDP. And Germany exported 10 times as much to the EU in 2011 as it did to China. What of the country's trade surplus with the rest of EU? The surpluses with the EU have fallen from the highs reached in 2007. In 2007, trade with the rest of the eurozone accounted for 60 per cent of Germany's overall trade surplus and the EU for over 80 per cent. By 2011 these proportions had fallen to 40 per cent and 55 per cent respectively.

Germany has not rebalanced decisively towards domestic demand and remains highly dependent on trade with the rest of Europe. What of Germany's foreign investments? Almost two-thirds of Germany's total foreign assets (equivalent to around 200 per cent of GDP) are denominated in euro. Two-thirds of the country's stock of foreign direct investment (FDI) is in eurozone countries. The value of these assets is already being depressed by the crisis and would fall dramatically if the currency union collapses. And then there is the Bundesbank's exposure to other eurozone central banks. As capital flight from the struggling member-states has got underway, banks in these economies have become dependent on funds from their central banks, which have turned to the Bundesbank for financing. At the end of 2006 the difference between the Bundesbank's claims on other eurozone central banks and the latter's claims on the German central bank was negligible, but by May 2012 stood at €700bn. This will not pose problems so long as the euro system holds together, but it is far from clear what would happen if it falls apart.

Record low government borrowing costs have fuelled Germany's sense of invulnerability. Investors have pulled out of struggling eurozone economies in favour of German bunds, pushing yields down to unprecedentedly low levels. But there are signs that this is now changing as Germany's burgeoning exposure to the rest of the eurozone raises fears for the country's own fiscal stability. A declining group of countries are being called upon to underwrite ever larger sums of money, eroding their own creditworthiness. For example, a full bail-out of Spain would further erode confidence in Italy which would have to underwrite 23 per cent of the funds or around €100bn (on the assumption that a Spanish bail-out totalled around €400bn). This, in turn, would increase the likelihood of Italy itself needing a bail-out. At this point, only Germany, France, the Benelux, Austria and Finland would be in a position to underwrite bail-out funds. As a result, France's share of a bail-out of Italy would be around 35 per cent of the total, and would inevitably prompt a steep rise in French borrowing costs. Indeed, there is real risk that France would not be able to underwrite its share, leaving German (and a group of small economies) back-stopping the whole edifice. With each new country forced to seek a bail-out from the EU's rescue funds, the more vulnerable Germany becomes.

The current strategy for dealing with the eurozone crisis is largely a German one. But far from limiting the risks to Germany, it is maximising them. The German economy is not immune to the economic slump enveloping a growing swath of Europe. One country after another will need bailing out, with Germany ultimately providing the back-stop. Much of this debt will not be repaid, leading to a dramatic rise in Germany's public indebtedness. Without a mutualisation of risk, the euro will collapse, with devastating implications for German exports (to EU and non-EU markets alike as a euro collapse would hit the global economy hard), the value of Germany's foreign investments, and the stability of its banking sector. These are just some of the direct economic costs; the political fall-out would be grave for Germany. Isolated and blamed for the collapse, it would be poorly placed to pursue its interests through whatever is left of the EU.

By contrast, the reforms needed to stabilise the eurozone pose far fewer risks to Germany. Debt mutualisation need not be open-ended, so moral hazard could be limited. And it is far from clear that mutualising debt would boost Germany's borrowing costs compared to the current approach, which threatens to undermine the country's creditworthiness without doing anything to address the underlying reasons for the eurozone crisis. The arguments for a banking union are equally compelling. If the eurozone banking crisis is left to fester, banks will collapse, which in turn will hit German banks (and hence German taxpayers) very hard. In return for agreeing to mutualise debt and to introduce a eurozone back-stop to the economy's banking sector, Germany could demand a host of concessions. The political union needed to give legitimacy to these institutional reforms would be cast in Germany's image. Berlin would cement its influence over Europe's economy and its politics but in a benign and hence sustainable fashion.

Five years ago Germany was plagued by self-doubt and even self-flagellation. Now the political debate, media coverage and national mood generally are marked by hubris and self-righteousness. Germany's strength is exaggerated and its weaknesses downplayed. The German authorities are underestimating how much they have to lose from the eurozone crisis and the damage it is inflicting on the European economy as a whole. Germany should agree to big institutional reforms of the currency union, not out of charity, but as a way of containing the risks to itself. A deepening crisis, culminating in defaults, a rupturing of the eurozone and most probably the single market are all but inevitable under the current strategy. This will not only do huge economic damage to Germany but leave the country isolated and mistrusted by a region from which it derives its strength. With the German economy slowing rapidly and investors starting to question the safety of German debt, it is possible the country will change course. But at present it appears that Germany is not for turning.

Simon Tilford is chief economist at the Centre for European Reform

Comments

Added on 28 Jun 2012 at 04:25 by Peter palms PH.D

The many political, economic and social challenges facing Europe are the same as those of the entire globe. The Euro zone cannot be handled and Germany would be better off with real money. Everyone in the zone is precariously vulnerable for these reasons.
Long term price stability is possible only when the money supply is based upon the gold (or silver) supply without government interference.

For a nation to enjoy economic prosperity and political tranquility, the monetary power of its politicians must be limited solely to maintenance of honest weight and measures of precious metals.

A nation that resorts to use of fiat money has doomed itself to economic hardship and political disunity.

Fraction money will always degenerate into fiat money. It is but fiat money in transition

When men are entrusted with the power to control the money supply, they will eventually use that power to confiscate the wealth of their neighbors.

Germany can survive only if it has real currency. Those capable of fixing things won’t .. All investment in Euro will collapse, which I why Britain isn’t in it. USA dollar bailout and the further collapse for the Fed since the Cartel of Bankers was authorized by Congress in 1913, is also imminent and unavoidable. Awareness of dependency on the Euro and the inevitability of its collapse make required action apparent. All central banks except Cuba, North Korea and Iran are owned by the Rothschild group. This is a global collapse. Borrowing costs are low because what is being borrowed has low value. The Emperor has no clothes What would happen when the Euro falls apart. I can explain to you in 26 pages As a survivor Germany would be recognized sooner or later as the savior of Europe, Value of Germany’s debt will plummet if in Euros.

Britain must defend the single market

Britain must defend the single market

Britain must defend the single market

Written by Jo Johnson MP, 22 June 2012

O efeito dominó que ameaça a Espanha e a zona do euro

Spain

O efeito dominó que ameaça a Espanha e a zona do euro

Written by Simon Tilford, 19 June 2012
From Carta Maior

Continental drift adds to challenge

Continental drift adds to challenge

Continental drift adds to challenge

By Simon Tilford, 15 June 2012
From The Wall Street Journal

Link to press quote:
http://online.wsj.com/article/SB10001424052702303410404577468732449300216.html?mod=googlenews_wsj

France's new leader negotiates to keep promises

France's new leader negotiates to keep promises

France's new leader negotiates to keep promisesvideo icon

National Public Radio
By Charles Grant, 17 June 2012
From National Public Radio

Link to video:
http://www.npr.org/player/v2/mediaPlayer.html?action=1&t=1&islist=false&id=155213224&m=155213250

German leaders want 'more Europe'

German leaders want 'more Europe' spotlight image

German leaders want 'more Europe'video icon

BBC Newsnight
By Charles Grant, 13 June 2012
From BBC Newsnight

Link to video:
http://www.bbc.co.uk/iplayer/episode/b01jxx1y/Newsnight_12_06_2012/

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