The Telegraph, London
Sunday, May 9, 2010
Great caution is in order. German Chancellor Angela Merkel has so far said little. The descriptions of the deal agreed by EU leaders in the early hours of Saturday are coming from the French bloc and EU bureaucrats. How many times during the Greek saga of the last four months have we heard claims from Brussels that turned out to be a distortion of what Germany had actually agreed, causing each relief rally to falter within days? They had better get it right this time.
But if the early reports are near true, the accord profoundly alters the character of the European Union. The walls of fiscal and economic sovereignty are being breached. The creation of an EU rescue mechanism with powers to issue bonds with Europe's AAA rating to help eurozone states in trouble -- apparently €60bn, with a separate facility that may be able to lever up to €600bn -- is to go far beyond the Lisbon Treaty. This new agency is an EU Treasury in all but name, managing an EU fiscal union where liabilities become shared. A European state is being created before our eyes.
No EMU country will be allowed to default, whatever the moral hazard. Mrs Merkel seems to have bowed to extreme pressure as contagion spread to Portugal, Ireland, and -- the two clinchers -- Spain and Italy. "We have a serious situation, not just in one country but in several," she said.
The euro's founding fathers have for now won their strategic bet that monetary union would one day force EU states to create the machinery needed to make it work, or put another way that Germany would go along rather than squander its half-century investment in Europe's power-war order.
Whether the German nation will acquiesce for long is another matter. Popular fury over the Greek rescue has already cost Mrs Merkel control over North Rhine-Westphalia and with it the Bundesrat, dooming her reform agenda. The result was a rout.Events are getting out of hand, and not just on the streets of Athens.
For now, the world has avoided a financial cataclysm that would have been as serious and far-reaching as the collapse of Lehman Brothers, AIG, Fannie and Freddie in September 2008, and perhaps worse given the already depleted capital ratios of banks and the growing aversion to sovereign debt
Bond risk on European banks as measured by the iTraxx financial index reached even higher levels late last week than in the worst moments of the Lehman crisis. The safe-haven flight into two-year German Schatz was flashing the most extreme stress warnings since the instruments where created forty years ago."We're seeing herd behavior in the markets that are really wolfpack behavior," said Anders Borg, Sweden's Finance Minister.
Credit specialists in Frankfurt, London, and New York feared a blow-up by Thursday afternoon, when ECB president Jean-Claude Trichet said the bank's council had not even discussed the `nuclear option' of buying Club Med bonds. The ECB seemed to be on another planet.
It was the fall-out from that press conference -- at a moment when markets were losing all confidence in EU leadership -- that had much to do with the DOW's 1000 point drop in New York hours later. This is not to blame Mr Trichet. He did not have a mandate to go further at that stage. The Bundesbank had blocked him, knowing full-well that ECB purchases of bonds is the end of monetary discipline and the start of a Primrose Path to Hell. As they say in Frankfurt, a central bank should be like pudding: "the more you beat it, the harder it gets".
It is pointless to fault either camp is this clash of Latin and Teutonic mores. The euro was never an "optimal currency area", which is to say it was never an "optimal legal and cultural area". It was a late 20th Century version of the same Hegelian reflex of imposing ideas from above -- making facts fit the theory -- that has so cursed Europe. Schopenhauer said Hegel had "completely disorganized and ruined the minds of a whole generation". Little did he know how long the spell would last.
But I digress. There is a difference between quantitative easing by the US Federal Reserve and the Bank of England for liquidity purposes, and use of this policy to soak up the debt of governments dependent on external finance to cover structural deficits. The lines are of course blurred. One purpose can leak into the other.
But whatever the objections of the Bundesbank, it seems that Europe's elected leaders pulled rank this weekend -- and high time too says the French Left. The reaction in Germany already been fierce. "The ECB is going crank up the printing presses," said Anton Börner, head of Germany's export federation. "In five to ten yeas we will have a weak currency, with rising inflation and higher rates of inflation that will act as a break on growth."
I don't agree with Mr Börner. The M3 money supply is contracting in the eurozone, pointing to the risk of a Japan-style slide into deflationary perma-slump, although the panic response to that down the road may well be to call in the printers. But there is no doubt that Mr Börner represents German opinion.
The EU is invoking the "exceptional circumstances" clause of Article 122 of the Lisbon Treaty, arguing that the euro is subject to an "organized worldwide attack". This is a legal minefield. A group of professors has already filed a case at Germany's Constitutional Court, claiming that the Greek bail-out is illegal and that the EMU is degenerating into a zone of monetary disorder.