Monday, May 28, 2012

Europe crisis - the view from Germany

Merkel Strikes Back Against Hollande

Tyler Durden's picture

Some thought that German chancellor Angela Merkel would quietly take the abuse heaped on her, and her program of "austerity" (or deleveraging as we call it, but that just does not have quite the negative connotations of a word that has become symbolic for all that is wrong with a massively overlevered world) by the new French president and Germany's increasingly more insolvent "partners", without much of a fuss.

That changed over the weekend, following a Spiegel article titled "Merkel prepares to strike back against Hollande." Now, as Bloomberg reports, the German retaliation is picking up speed, following a thinly veiled threat from the former German finance minister, who basically said that French bonds are unlikely to continue seeing the flight to safety bid they have been enjoying recently, once the rating agencies cut France even more from its one vaunted AAA rating, where Moody's and Fitch still have the country (following the S&P downgrade toAA+ in January), but likely not for long now that Germany has spoken.
From Bloomberg:
Former German Finance Minister Peer Steinbrueck said French President FrancoisHollande’s proposals may have an impact on the country’s credit rating, Bild newspaper reported, citing an interview to be published tomorrow.
Investors and rating companies will naturally take a close look at the course France sets,” Bild quoted Steinbrueck as saying in response to a question about French proposals to lower the retirement age and tax top earners at a higher rate. “That can have consequences for France’s credit rating.”
No need for blustery rhetoric or pompous oratory: two sentences and the French ego balloon just got popped.
What is more important than whether or not France gets an official downgrade warning, is that Germany refuses to pursue some form of Nash equilibrium, so critical for Europe attaining a conciliatory middle ground, and instead continues to defect at every opportunity.
And now, with Hollande presumably silenced, it is Mario Monti's turn.


Merkel Prepares to Strike Back Against Hollande

Photo Gallery: Reconciling Growth and Austerity in Europe
France's new president, François Hollande, has put the German chancellor on the defensive with his growth agenda. Now Angela Merkel is planning to strike back. She is calling for structural reforms to save the euro with a six-point plan aimed at harmonizing austerity and growth in Europe once again.
The more European leaders talked at a dinner last Wednesday, the grimmer Angela Merkel looked. One after another, they spoke out in favor of the joint assumption of debt and against the strict austerity course Berlin is calling for. The chancellor stared silently at the man who was responsible for this change of mood -- France's new president, François Hollande, who noted with satisfaction that there was "an outlook for euro bonds in Europe."
Merkel disagreed, saying that euro bonds are not the right tool, but to no avail. Only a minority stood behind the German leader. Even European Council President Herman Van Rompuy said, at the end of the dinner, that there should be "no taboos," and that he would examine the idea of euro bonds. "Herman," Merkel blurted out, "you should at least say that some at this table are of a different opinion."
Merkel's world had been turned upside down. For the first time in years, the chancellordid not set the tone at an EU summit, nor did she and the French president agree on joint positions in a backroom before the meeting.
Much depends on whether Merkel and Hollande will be able to find common ground in the fight over Europe's common currency. They have been arguing for weeks over whether more austerity or more spending can save the euro. Now the dispute has reached a new level of escalation. After Hollande's statements on Wednesday, Merkel is now presenting her opposing concept. In a six-point plan, she calls for deep-seated structural reforms for Europe. Under the plan, government-owned businesses are to be sold off, protections against wrongful dismissal relaxed and obstructive regulations for companies removed. There is also talk of special economic zones and privatization agencies based on the model of Germany's Treuhand trust, created at the time of reunification to sell off most of former East Germany's state-owned enterprises. In short, the Mediterranean region is to become more like Germany, but with better weather.
Merkel and Hollande are presenting two contrasting programs for the planned EU growth summit at the end of June. A compromise will have to be reached in the end, but there are still considerable risks. If the two leaders manage to forge a joint concept for the currency zone out of their different plans, they could go down in history as the saviors of the euro. If they fail, the process that a growing number of experts believe is unavoidable will only be accelerated: the breakup of the monetary union.
Political Equilibrium At Stake
This week, Europe seemed to move a little closer to the abyss. The financial markets speculated on a Greek withdrawal from the euro, the exchange rate for the common currency plunged to new lows and economic imbalances worsened. While Germany was able to float a two-year bond with a zero interest rate on the markets for the first time, risk premiums for Spanish and Italian sovereign debt remained at crisis levels.
The euro zone is drifting apart, and the Franco-German dispute over how to tackle the problem is partly to blame. It isn't just a question of growth programs or the fiscal pact. Europe's political equilibrium, which has shifted since Hollande came into office, is also at stake.
A president has stepped onto the stage who wants to show his citizens and the rest of Europe that he will not submit to his more powerful German counterpart, Angela Merkel, because he believes that she is wrong. He doesn't want to agree to her conditions, but in fact dictate his own terms to her -- or at least he wants it to look that way.
In recent weeks, Hollande has come across as a man who was practically bursting with self-confidence. In response a conservative politician's critical remark that he behaves as if he could walk on water, he said jokingly to journalists at the recent G-8 summit in the United States: "The chances that I will attempt this are slim."
That was the most modest thing he said at the summit. Afterwards, the president bragged that he had placed the subject of "growth" on the agenda -- even if "growth" means something a little different to everyone else. His advisors let it be known that while Hollande and Obama got along very well, Merkel has been isolated with herausterity course.
Long before the EU special summit in Brussels on May 23, the French president made the impression that he wanted a showdown with the Germans. In the election campaign, he had consistently called for a renegotiation of the fiscal pact. After coming into office, he repeated that he would not ratify the pact unless it contained a "growth component." Although he has spoken out against the so-called communitization of debt in the past, since last week he is suddenly calling for real euro bonds, not just "project bonds" to pay for European infrastructure projects.
Last weekend, French Prime Minister Jean-Marc Ayrault made an additional demand, one that contradicts everything the Germans consider sacred: that the European Central Bank (ECB) should be able to lend money directly to countries in crisis.
A Vulnerable Merkel
It appears as if the French are trying to forge an alliance against the Germans, together with representatives of the European Commission, groups like the Organization for Economic Cooperation and Development (OECD), and the representatives of smaller and southern EU countries. Hollande's advisors have noted that Italian Prime Minister Mario Monti's ideas put him closer to the French than the Germans.
Has his successful start made Hollande overly confident? Or is he trying to lead Europe away from an erroneous course? Is he merely trying to expand his negotiating position to get as much as possible in the end? Or is it all just a big show for the domestic audience, which he hopes will provide him with a majority in parliamentary elections on June 10 and 17?
For the first time since the beginning of the debt crisis Merkel, once dubbed the "Queen of Europe," no longer seems invulnerable. Hollande, who she humiliated during the campaign by unconditionally siding with his predecessor, is now paying her back.
Nicolas Sarkozy, who sought his salvation by aligning himself with the chancellor, has been followed by a president who expects to achieve a greater political success by opposing German dominance in Europe. Hollande doesn't want a German-French directorate. Instead, he wants to open up Europe once again.
The French are convinced that what has to be done in the current crisis of confidence in the common currency is what Germany has sought to prevent until now: The euro-zone countries should issue joint bonds for at least a portion of their debt. They believe that euro bonds would establish the stability for investors in the crisis-ridden countries that is so urgently needed. Besides, Hollande said on Wednesday, it is unfair that Germany pays much lower interest rates than Spain, for example. The French argument is based on the view, shared by many economists, that a monetary union without a political union and debt sharing has never worked.
Hollande's ideas are not fundamentally different from those of his predecessor Sarkozy, who consistently held similar views. Sarkozy, however, worked out his differences with Merkel in back rooms, so as to bring calm to the markets. In contrast, President Hollande highlights the differences and seems convinced that it is up to him to put Germany on the right track.
A Judo Attack
But Merkel is an experienced opponent. She knows that she is now on the defensive in Europe, and she is planning her counter-attack. She believes that euro bonds would enable the crisis-ridden countries to lower their borrowing costs, and that the necessary structural reforms would be postponed. This is why she now wants to counter Hollande's proposals with a principle familiar to judo fighters: using your opponent's momentum for your own attack.
Merkel is determined to reject both Hollande's call for euro bonds and his proposal to allow direct lending by the ECB. The monetary watchdogs, she argues, would already do everything necessary to stabilize the euro, and thus preserve their high-paying jobs in Frankfurt's Euro Tower.
There is something to this. The ECB has signaled internally that, if it becomes necessary (if Greece withdraws from the euro, for example), it will buy up the bonds of other ailing countries once again. With a view toward Hollande's calls for more growth incentives, the Germans, for their part, are trying to seem more conciliatory. They are prepared to increase the capital of the European Investment Bank (EIB) to €10 billion, which would bring Germany's share to €1.6 billion.
They also want to yield to the French drive to use the money in the European Structural Funds in a more growth-friendly manner and float so-called project bonds. This would involve the EU countries and private investors raising funds together to pay for things like cross-border infrastructure projects. Merkel isn't hostile to the idea.
In Strasbourg, a day before the beginning of the EU special summit in Brussels last week, the European Parliament and European governments decided to try out such bonds, which was good news for Hollande. According to an internal European Commission priority list that SPIEGEL has obtained, some of the projects directly involve France. They include construction of the TGV high-speed rail line between Lyon and Turin, the Seine-Northern Europe canal in the corridor between Amsterdam and Marseilles and the expansion of travel routes between Dublin and Brussels.
When it comes to energy projects, the European Commission places special emphasis on projects such as connecting the wind farms in the North Sea and the cross-border power and gas lines among the Baltic countries, between Northern and Southern Europe and to North Africa. It also wants to promote international natural gas pipelines like Nabucco and expanding efficient internet connections. While Germany and France agree on the importance of these projects, their differences lie elsewhere. To stimulate growth throughout Europe, Merkel's advisors don't just want to implement measures that cost money. The Germans are convinced that growth can also be generated less expensively, using structural reforms that require nothing more than living with hardships.
Six-Point Plan
According to an internal document making the rounds at the Chancellery, German government experts have developed a six-point plan that is reminiscent of former Chancellor Gerhard Schröder's Agenda 2010 economic reforms, and seeks to harmonize austerity and growth in Europe once again. The document defines the position with which Merkel intends to enter into negotiations with Hollande and the other EU partners.
In the plan, the Germans focus primarily on measures that have been successful in Germany in the past, and that placed the country in the role of Europe's engine for growth. Accordingly, Merkel wants to launch Europe-wide programs to promote start-ups and small and mid-sized business, like the programs offered by the KfW development bank in Germany. Under the German programs, government agencies have to approve investments within a fixed time period, and the applications are considered automatically approved if they are not denied within that time period.
Merkel also wants EU countries with high unemployment to use Germany as a model in reforming their labor markets. This would mean relaxing protections against wrongful dismissal and introducing more limited employment circumstances, called "mini-jobs" in Germany, with lower tax and contribution burdens. And like Germany, these countries would also be expected to develop a dual education system, which combines a standardized practical education at a vocational school with an apprenticeship in the same field at a company in order to combat high youth unemployment.
Merkel's advisors have also noticed that southern EU countries still own many companies that enjoy special protections. Under their plan, privatization agencies or special funds would be established in these countries to privatize the state-owned businesses. Foreign investors could be attracted with tax benefits and less stringent regulations.
The advisors also recommend the establishment of so-called special economic zones, like the ones that once ushered in China's economic ascent. Finally, the Germans want Europe's southern countries to invest more in renewable energy, reduce tax barriers and promote worker mobility. All of this, they reason, strengthens Europe's competitiveness.
Hope in Hollande
Growth programs versus structural reforms: This is the conflict Europe is about to face, and for which Merkel and Hollande are now seeking allies. The French president has awakened the hope, especially in the southern European countries, that the German chancellor's austerity course could be softened. He already portrayed himself as something of a messiah for the southern countries during the campaign. "So many people in Europe long for our success! I don't want a Europe of austerity, where nations are forced on their knees," he told his supporters.
With remarks like that, Hollande became a shining light in Greece. In his resistance to Merkel's austerity policy, Alexis Tsipras, the leader of the leftist alliance Syriza, invokes a "new era" and says that the French socialist is "clearly a great white hope for us."
In Italy, where Prime Minister Monti's government of technocrats has not produced any growth so far, despite having implemented a few reforms, commentators maliciously referred to the G-8 summit as "Merkel's defeat" and raved about the "birth of a new alliance" between Monti and Hollande.
The former Berlusconi activist newspaper Il Giornale wrote that Germany, and not Greece, is Europe's real problem, "because it is bursting with health and, as a result, is also causing its neighbors to burst. Germany has to adjust to the rest of Europe, not the other way around."
So far, Merkel has shown little interest in publicly rebuking Hollande. At the EU special summit in Brussels, she merely noted pointedly: "Euro bonds do not create growth." She knows that she has to wait until after the parliamentary election in mid-June to begin dealing with a president who is no longer involved in an election campaign. What she doesn't yet know is whether he will be less adamant after that.
Uncertain Outcome
Although Merkel has lost allies, she is not completely isolated, not even in southern Europe. Portuguese Prime Minister Passos Coelho is competing with his Spanish counterpart Mariano Rajoy for the distinction of being Merkel's model student. Since the Spanish conservative came into power last December, hardly a week has passed in which he has not imposed a new austerity measure.
The Spanish media and the socialist opposition had hoped that Rajoy, in Hollande's wake, could apply more pressure to the German chancellor to spend more on growth measures. But the first upset happened even before Hollande and Rajoy met. Hollande said that it ought to be possible to recapitalize the Spanish banks from the European bailout fund. But this remark came at a very inconvenient time for Rajoy. "Hollande doesn't know what condition the Spanish banks are in," he said, rebuffing the French president's suggestion.
Instead, Rajoy cozied up to the chancellor during a group boat ride on the Chicago River after the NATO summit. He too takes no stock in a debate over euro bonds. "They're not the most important thing now," he repeated on Wednesday after meeting with Hollande in Paris. However, Rajoy agrees with Hollande's proposal to allow the ECB to actively buy government bonds, thus helping to lower interest rates.
Europe finds itself in the middle of a conflict with an uncertain outcome. The dispute over the growth pact could exacerbate the fiscal crisis if Hollande and Merkel block each other's proposals. But it could also turn out to be liberating if it leads to a workable consensus. The Germans have to accept that even more money has to flow from the north to the south, while all the Mediterranean countries must accept that they need additional reforms.
The fight has only just begun, and so it comes as no surprise that the roar of battle is drowning out everything else at the moment. But there are also signs of rapprochement. During his first official visit to Berlin, Pierre Moscovici, the new French minister of economics and finance, revealed some sympathy for the German line. He confirmed the new French government's intention to reduce the national deficit in the coming year to below the upper limit of 3 percent of GDP, and to eliminate all new borrowing starting in 2017. He also underscored how important healthy budgets are for growth and employment. Those who have too much debt become impoverished, he said. And those who are poor, he added, cannot invest.


The temple of Parthenon is silhouetted against a cloudy sunset


Calling bluffs in the eurozone crisis

In mid-June, Greece will have renewed elections. If opponents of austerity win, a Greek exit from the eurozone seems more likely. The consequences would be fatal for Greece and uncertain for the EU.
For many in Europe, there are unsettling numbers coming out of Greece: Polls show that the Coalition of the Radical Left (Syriza) could win 30 percent during a fresh round of voting on June 17, making Syriza the strongest force in parliament. That would have clear consequences, party head Alexis Tsipras has said. Greece would reject its austerity course.Paradoxically, more than half of Greece sees things differently, though, says Janis Emmanouilidis of the European Policy Center (EPC), a think tank in Brussels.

"The most probable scenario is that a government will be formed that is led by the conservative Nea Dimokratia," he said.

If so, the conservatives would likely continue along with the austerity course demanded by the EU.

Years of reform necessary
Greece's Left Coalition party leader Alexis Tsipras
Alexis Tsipras could lead the charge against the EU's austerity measures
One explanation for the differing poll results could be that voters do not want to say openly that they would vote for the same parties that have supported austerity policies that have led to misery for many. Voters may also be looking for ways to maintain pressure on both the campaigning parties and on Europe.

Regardless of the make-up of the new government, it will have to enter negotiations with the troika consisting of the European Union, the European Central Bank (ECB) and the International Monetary Fund (IMF). And if the country wants to make it out of the crisis, it cannot avoid reform, noted Janis Emmanouilidis. Those reforms will likely take years and will encompass new approaches to economics, politics and society.

"Greece has to reform itself radically, otherwise it will never make it out of this crisis," Emmanouilidis said.

Most argue that Greece will have to stay in the eurozone to maneuver its way out of the crisis, and more than 80 percent of Greeks say that is what they want to do. However, around two thirds of the country also opposes the austerity package. That represents another paradoxical polling result, at least from the EU's perspective.The country is in a recession with a fourth of all of those capable of working unemployed. Greece cannot and will not support an austerity package without a parallel program to promote economic growth. In that regard, left-wing populist Alexis Tsipras' statement that the EU is just bluffing with pushing Greece out of the eurozone does not fall on deaf ears.

'Both sides are bluffing'
Interim government head Panagiotis Pikrammeno
Interim government head Panagiotis Pikrammenos. New elections are in June.
"Both sides are bluffing - it's really a tough game of negotiating," observed Janis Emmanouilidis.

The EU argues that it could survive the withdrawal of a country from the currency union. And that has led banks, companies and politicians to run through and prepare for the scenario of a Greek withdrawal from the currency zone.

"It's self-evident that we have to prepare ourselves for all possible outcomes, otherwise we would not be doing our jobs," said the Euro Group President Jean Claude Juncker at an EU special summit on Wednesday (March 23).

In Greece, opponents of the austerity package argue that the troika cannot begin to foresee the consequences of a withdrawal, and, as such, that it must support the country even if it does not live up to its austerity pledges. There is some truth to that, says Janis Emmanouilidis, but it does not tell the whole story.

"To think at the same time that EU partners will support Greece in the long term even if it is not sticking to its pledges is wrong," he said, calling the negotiations a dangerous game for both sides.An expensive farewell
Customers outside of a Greek bank
Greek banks are experience a slow run ahead of elections
It seems clear that leaving the EU would spell disaster for Greece, but what consequences that move would have for the EU and the eurozone generally is a topic of heated debate. Some think it could help ease the crisis, but others, like Bundesbank President Jens Weidmann warn of unforeseeable problems for Europe.

Fears of a domino effect that could draw other struggling EU member states into its path remain high. Janis Emmanouilidis also notes that leaving the eurozone - a legally unregulated and difficult to organize maneuver - would have its costs for the EU. His argument: only with well-negotiated favors in return, would a country be willing to leave the shared currency zone voluntarily.


SUNDAY, MAY 27, 2012

German taxpayers face re-denomination loss from TARGET2

As the risks of Greek exit from the EMU increased, the mainstream financial media began to pay attention to growing TARGET2 issues within the Eurosystem. A recent Bloomberg article did a good job in describing the situation. But strangely, rather than referring to it as TARGET2 - the technical term, they called it the German "bailout" (although they've written about the topic before).
Bloomberg: - Here’s how it worked. When German banks pulled money out of Greece, the other national central banks of the euro area collectively offset the outflow with loans to the Greek central bank. These loans appeared on the balance sheet of the Bundesbank, Germany’s central bank, as claims on the rest of the euro area. This mechanism, designed to keep the currency area’s accounts in balance, made it easier for the German banks to exit their positions.

Now for the tricky part: As opposed to the claims of the private banks, the Bundesbank’s claims were only partly the responsibility of Germany. If Greece reneged on its debt, the losses would be shared among all euro-area countries, according to their shareholding in the ECB. Germany’s stake would be about 28 percent. 
Let's help Bloomberg with the explanation here. To start with, this is the "tricky part" - it's actually fairly straightforward. The arrows point to the direction of claims.

And here is how the Bundesbank claims grew. Bundesbank refers to it as "BBK01.EU8148: External position of the Bundesbank since the beginning of EMU / Claims within the Eurosystem / Other claims (net)".  For those who have trouble finding it on the newly redesigned Bundesbank website, you can plot it using Bloomberg charts here (just extend the period to 5 years to see the full effect).

Bundesbank "other claims" on the Eurosystem

But Bloomberg has yet to take that extra step and describe what would actually happen with these claims should a periphery nation exit. The exit would simply result in a re-denomination of some claims and would look like this:

There is no other way to do this. As loans to Greek banks become drachma denominated, so will the claim on the Bank of Greece (BoG), with the central bank separating from the Eurosystem. The Eurosystem was never designed for an exit of a central bank, so this process would need to be cobbled together on the fly - sort of the way the Greek restructuring was done. The "exercise" may potentially set up a process for other nations exiting the EMU.

In this scenario the Eurosystem's asset (claim on the BoG) is denominated in drachma and the liability in euros. The resulting P&L from the drachma devaluation will hit the books of the ECB and will need to be shared by the remaining Eurozone partners (of which Germany is 28%). So as the Bloomberg article points out, even if Germany avoided a massive direct bailout of Greece and other periphery nations, this "backdoor bailout" exposure will sill end up on the doorstep of German (and other core nations')  taxpayers.

Bloomberg: - In short, over the last couple of years, much of the risk sitting on German banks’ balance sheets shifted to the taxpayers of the entire currency union.

It’s hard to quantify exactly how much Germany has benefited from its European bailout. One indicator would be the amount German banks pulled out of other euro-area countries since the crisis began. According to the BIS, they yanked $353 billion from December 2009 to the end of 2011 (the latest data available). Another would be the increase in the Bundesbank’s claims on other euro-area central banks. That amounts to 466 billion euros ($590 billion) from December 2009 through April 2012, though it would also reflect non-German depositors moving their money into German banks.

By comparison, Greece has received a total of about 340 billion euros in official loans to recapitalize its banks, replace fleeing capital, restructure its debts and help its government make ends meet. Only about 15 billion euros of that has come directly from Germany. The rest is all from the ECB, the EU and the International Monetary Fund.