Stalemete within the Eurozone

16 September 2013. “People never lie so much as after a hunt, during a war, or before an election,” said Otto von Bismarck. Replacing the word “lie” with “stall” and this captures perfectly the effect the forthcoming federal election in Germany has had on policymaking towards the beleaguered southern states of the Eurozone during the past year. This election has been very convenient for the German political establishment as it has discouraged open discussions in Brussels, at the IMF, and elsewhere of any option that might be unpalatable to German voters.

Election and economic reform
The realisation that some patients don’t want Germany’s medicine for restoring competitiveness to the Eurozone, and in others that doubts that the medicine will work fast enough before fellow EU governments are thrown out by their voters, leaves many German policymakers in a bind. As the longest-serving head of government a Eurozone government once said of economic reform “We all know what to do, we just don’t know how to get re-elected after we’ve done it.” Meanwhile, having convinced themselves that long holidays, generous welfare states, and rigid rules on firing employees are the causes of other nations’ woes, the German people appear unwilling to countenance further support for Eurozone partners.

German policymakers – many of whom are amongst the most pro-European on the continent – have had to resort to double-talk and hard-to-spot technocratic initiatives to support struggling European partners. Earlier in the year, The Economist magazine reported that Germany had begun quietly writing off its loans to Greece, essentially turning those loans into the very transfers that upset German voters. Looking forward, the interesting question is what to expect after the election? After Germans have voted, can their government be more generous than in the past year? Or, will other means be found to limit fresh German contributions to the Eurozone? Probably the latter, for the reasons given below.

Optimistic forecasts by leading international bodies
Of course, one advantage of stalling is to put off awkward decisions that may not be needed if circumstances change. In the present Eurozone, this amounts to hoping that something – anything – leads to a recovery in Greek, Spanish, Portuguese, Irish, and Italian growth. Such hopes were fed by excessively optimistic forecasts by leading international bodies, including the IMF, the OECD, and the European Commission. The world economy has not obliged, however. Until recently, slow American economic growth held back the world economy. Now growth is slowing in the BRICs while the US economy is picking up.

For crisis-hit European economies, while their trade deficits have fallen a lot, exports haven’t risen fast enough to restore their economies to growth. That the reform medicine isn’t working – or at least isn’t working fast enough – can no longer be denied and its consequences will generate headaches in Berlin after the election. Greek, Portuguese, and Irish government spending has been cut sharply, but the adverse impact on their national incomes has resulted in less taxes being collected and government deficits have remained stubbornly high. The only way that austerity programmes can be said to have “worked” is that they have created so much additional unemployment that wage growth has fallen behind productivity increases cutting unit labour costs, at least for a while. Now the IMF concedes that it underestimated the adverse impact of the latest austerity package that was imposed on Greece.

Fate of a creditor nation
What will bring these matters to a head in the next 12 months is that sizeable government deficits that remain need to be financed and the private sector will be reluctant to provide more funds. Moreover, it is increasingly accepted that public debts in Greece, Portugal, and Ireland are now so high (that is, relative to the taxes their governments could feasibly collect) that debt restructuring will become necessary. For example, the hole in Greece’s public finances over and above the deficit anticipated when its last bailout was drawn up, is expected by the IMF to be 4.4 billion euros in 2014 and 6.5 billion euros in 2015.

The trigger will be the IMF’s rules, which forbid the release of more funds unless a country’s fiscal plans for the coming year are fully financed. If Greece and others don’t receive additional financial support from other Eurozone governments, then defaults loom and the financial market instability will return. Since cutting government spending produces such nasty side effects, all that is left is to cancel the repayment of some debt or limit interest paid on that debt. As the private sector now owns little Greek debt, then the IMF will insist that governments that lent money to Greece in the past accept losses on those loans or lower interest payments. In plain terms, either Germany contributes to more bailouts or it suffers losses on its previous loans. Such is the fate of a creditor nation.

Shifting the blame on to weaker Eurozone states
Surely there is an alternative? The one deal that Germany has long espoused – financial support in return for fundamental fiscal policy and supply side reform – isn’t a bargain many other Eurozone members want to sign up for, including France and Italy. Faced with this reality, German policymakers will try to cut their losses and will continue to offer the least possible support necessary to avert collateral damage to its interests. There will be plenty of smoke and mirrors to obscure the inevitable conversion of previous German loans into transfers to the Eurozone periphery. That’s why this election was so convenient – it was an effective delaying tactic and it won’t be the last tactic that Germany deploys.

Shifting the blame on to weaker Eurozone states will continue, in the hope that no one asks the following difficult question: How can Germany expect to run large trade surpluses – which it prides itself on – if trading partners cannot run deficits? One counterpart to the debt build up in the Eurozone periphery were revenues on the balance sheets of German companies. One way to weaken the link between the latter and the former is to shift German exports away from the Eurozone to countries Germany will be less likely to be asked to bailout in the future.

European recipe for stalemate
So expect more talk about reorienting German exports towards fast growing emerging markets and the USA. In this manner, Germany sustains its export machine while limiting the contingent liabilities it accumulates within the Eurozone. Policy won’t change fundamentally as Germany is as addicted to its trade surpluses as the periphery countries are to their welfare states and labour market policies. A paradox follows: Germany’s politicians will continue to parade their pro-European credentials while German business looks elsewhere for new orders.

In sum, don’t expect this election to be followed a shift in German policies towards the Eurozone. What Germany wants for the Eurozone the deficit countries reject and visa versa. This is a recipe for stalemate, which has been obscured in the run up to this convenient election. No doubt means will be found to mask this fundamental divide on economic policy. Otto von Bismarck also said “Politics is the art of the possible, the attainable – the art of the next best,” and in this case, the next best is more of the same.

Bild: Photocase / kallejipp