Berlin blinks

July 31, 2016


The leaders of the EU know they are skating on thin ice. The eurozone is mired in a deep and prolonged economic stagnation that has caused the worse mass unemployment in the periphery of Europe since the Depression. Of the big economic member states only Germany is doing remotely well (if you consider a growth rate of 1-2% doing well) as the current currency system ensures German manufacturers can continue to export at a discount rate all over the world. The eurozone banking system is in a very fragile state and systemically important parts of it will need to be recapitalised (i.e pumped full of public money) to prevent a disastrous financial crisis. Numerous eurozone countries, including big nations like France, Spain and Italy, are persistently breaking the eurozone fiscal rules on government deficits. The migrant flows into Europe are quite likely to accelerate if Aleppo falls and Assad wins, and the Turkish turn towards authoritarianism intensifies. Across the EU radical populist parties of the left and the right are growing in support, and many of them want a radical rethink of the entire European project. Some even want to dismantle it. The entire European project seems now to be stuck in an impossible place, where it cannot go back to a pre-Euro federation, and it cannot move forwards to a new pan-European democratic polity, so none of its deep structural defects can be rectified. And Brexit, which if mismanaged could easily deliver an economic blow to the weakened europzone economy, has shown there is an exit door.

So things are little fragile. Perhaps its time for some pragmatism from the Ordoliberals in Berlin. And that’s what we seemed to have got in the last week when the German government decided not to push the European Commission to impose a punitive fine on Portugal and Spain for their persistent failure to comply with their budget deficit targets, leading one Eurogroup minister to declare that the euro zone’s Stability Pact is “dead.”

Of Europe’s 27 commissioners, only four voted in favour of applying the fines; the other 23 voted against. According to El País, the deciding factor in the decision was an impromptu phone call from German finance minister Wolfgang Schäuble to some of the more conservative commissioners, giving them the green light to forego the fine.

The U-turn offers Spanish and Portuguese taxpayers a brief but welcome respite from even deeper Troika-enforced austerity. If the Commission had imposed the fines it would have meant that Madrid and Lisbon, both trying to govern countries with massive unemployment and very large government debt levels, would have had to transfer up to 2% of their national GDP to Brussels. Only in the bonkers world of the ordoliberal rule based machine that is the single currency would that ever have been on the table.

If this soft line on deficits contuinues, combined with permissions to eurozone governments to breach the new banking and state aid regulations by bailing out their banks, it will be the triumph of political expediency over ideology and over the treaty agreed regulatory frameworks. It will probably only be temporary because the political pressures driving this new found pragmatism will ease over the next eighteen months. What is focussing the minds of the German led bloc is the political situation and electoral timetable in several large and crucial eurozone countries.

In Spain two elections in six months have failed to deliver a working coalition government majority. Schäuble and Juncker would much prefer Mariano Rajoy, a man with almost identical ideological beliefs as themselves, to stay in power. Spain has been an important ally of Germany under Rajoy’s charge and the support of his party was essential in propelling Juncker into the European Commission’s top spot. If Rajoy does eventually form a reasonably stable government, a new round of austerity will eventually be inevitable.

In Portugal a left of centre coalition is in power and is resisting further austerity. Their resistance will continue so long as Brussels and Berlin are mired in political problems, but at some point soon the new government in Lisbon must either break with austerity or break its promises to the electorate with unknown political consequences.

In Italy the the political and financial situation remains very unstable. If the country’s struggling banks are not saved with a combination of public and private money — a process that, to all intents and purposes, began on Friday with the announcement of Monte dei Paschi’s suspension of the ECB’s stress test as well as a €5 billion capital expansion later this year — the resulting wave of defaults could unleash not only a tidal wave of financial contagion but also an unstoppable groundswell of political opposition to the EU.

For a taste of just how disastrous the political fallout would be for Italy’s embattled premier, Matteo Renzi, here’s an excerpt from a furious tirade given by Italian financial journalist Paolo Barnard on prime-time TV, addressing Renzi directly in a blistering attack, in which he blasts the euro bloc as a German-led monster:

“You went to meet Mrs. Merkel to ask for a minor public funded bail-out of Italian banks and you got a sharp NO. But did anyone tell you that Germany from 2009 onwards bailed out its failing banks with public money?

“Banks, that is, with holes in their balance sheets visible from the Moon. Germany bailed them out to the tune of 704 billion euros. It was all paid for by European taxpayers’ money, public funds that is.

“It was done through the EU Commission of Mr Barroso and by Mr Mario Draghi at the ECB. Didn’t you know that Mr Renzi? Couldn’t you have barked this right into Ms Merkel’s face?”

Barnard rounded off his rant with a rallying call for Italians to follow the UK’s example and demand an exit from the EU — a prospect that should be taken very seriously given that one of the manifesto pledges of Italy’s rising opposition party, the 5-Star Movement, is to call a referendum on Italy’s membership of the euro.

Everything in Italy now hinges on the October referendum on constitutional reform. Renzi has pledged to resign if he loses so it is now a de facto confidence vote, and if he loses there will almost certainly be an election. The anti-euro 5-Star Movement is ahead in some polls.

There are also elections in France and the Netherlands next year and anti-euro, and even anti-EU, parties are riding high in the polls. If there are further deadly terrorist attacks in France then a National Front victory is a real possibility.

So there is an awful lot at stake politically in the coming year, hence the shift to a more flexible and pragmatic approach by the Germans. However the EU’s fundamental problem will not go away, which is that it is trapped in an unworkable limbo. It seemingly cannot go back and dismantle the single currency (an option I would support even with the enormous risks involved) and it cannot go forward to a real political union because the people of Europe simply do not want any more union. The Germans certainly don’t want further integration as they know it would mean they would have to bankroll the whole of Europe for ever more, and they are keen to retain and stabilise the current status quo, and that’s because they are doing the best out of current arrangements.

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