July 12, 2012
Since the summit, it's the Germans against the restPosted in Irish Independent · 192 comments ·
First off, however it happened, the Government should be applauded on keeping Irish concerns on the EU’s agenda. Clearly, the Italians and the Spanish did the heavy lifting for us. Had the Spanish and Italians not been in serious trouble, the Germans couldn’t have cared less about us. But a deal is a deal and one on debt sharing for Irish bank debt is a huge result. It might seem premature to talk of “results” but now we have a great chance to reduce our odious debt burden.
The EU — which is all over the shop right now — needs some class of victory for a set of policies that are falling apart. So it might not be so unusual that it has grafted Irish concerns onto the greater Italian and Spanish dilemmas. In addition, given the ECB’s role in bullying a bust Irish State into paying unsecured bondholders in October 2010, Mario Draghi, the new boss, might be trying to clean the slate.
So this is all good, but one thing is clear: the eurozone is in serious trouble and whether it survives is still 50/50. The Italian and Spanish governments are now being charged four times more than Germany to borrow. This can’t go on for very long. It makes a mockery of the term monetary union. It is, in fact, an exercise in monetary apartheid, where one set of economic citizens is treated totally differently to another. Quite apart from the ludicrousness of the situation, the present penal interest rates on the periphery versus the historically low rates in the core will ultimately make the recession worse all over the eurozone.
All this would be problematic enough, if it wasn’t for the fact that the rest of the world is also slowing down rapidly.
We are witnessing a rapid slowdown in China while the American recovery is fading away. This will be the background noise to the continued crisis in Europe.
Let’s look at each in turn. But let’s go to China first. The Chinese Central Bank has slashed rates twice in a month. Is this a sign of politburo panic?
Yes, it is — and the key is political legitimacy as much as economic vibrancy. The China investment boom is faltering but politically, economic growth and the Communist Party are now umbilically linked. Since it dropped the Maoist carry-on, the only legitimacy the party has is growth. “Prosperity, not equality for all” is the slogan. Recession is not an option. If they don’t deliver success, they are toast. But cutting interest rates won’t help because when the problem is too much capacity, building yet more only makes the problem worse. Chinese manufacturing has just seen its eighth successive monthly decline.
The markets are pricing this in with the continuing gold sell-off and oil is moving towards $80 a barrel for the first time in eight months.
At the same time, the US employment recovery — essential for Obama’s re-election prospects — is fading away. The US only created 80,000 jobs last month. The natural growth of the labour force each month is — or should be — 125,000.
Brookings Institution economists say that if the economy adds about 208,000 jobs per month (the average monthly rate for the best year of job creation in the 2000s), then it will take until June 2020 — or eight years — to close the jobs gap. This gap is the number of jobs that the US economy must create to return to pre-recession employment levels — while also absorbing the people who enter the labour force each month.
This is a big ask.
Even if the Federal Reserve cuts, what can cuts in nominal rates do when real rates are already negative? Recent US data is awful. Average earnings — 0.2pc, retail sales — 0.2pc, industrial production — 0.1pc, housing starts — 4.8pc, consumer confidence — 5.5pc and car sales — 4.5pc. The much-hyped recovery is evaporating
After the euphoria of the EU summit, Spanish yields are now close to 7pc again.
Following a phoney war in Europe, the real one begins. After the summit it’s Germany against the rest. Either the Germans pay for everyone, or the whole thing falls apart.
Without systematically looting German savings, Spain and Italy have no chance of financing themselves in the months ahead. Growth is close to zero while yields are at 7pc. Next year, Italy must refinance existing debts to the tune of 29pc of its GDP.
The past week has seen all sorts of dissent coming out of Germany. Think about it from the German point of view.
Even if they paid for everything now, prompting the biggest bull market in Spanish and Italian bond markets in years and a massive bear market in Germany’s bond market, it still wouldn’t solve the core of the competitiveness problem.
By backstopping Italian debts now with German money, Italy is incentivised to borrow more, not less.
The reaction in Germany to the summit has been uniformly negative. I was in Mainz, in Germany, last week and the receptionist in the hotel laughed in dismay when I mentioned the summit.
For Chancellor Merkel, looking for the receptionist vote, a new policy of putting German savers first might make her isolated in Europe, but she would be very popular at home. She is a politician who wants to be re-elected next year, so which way do you think she will jump?
France, though unaffected right now, is actually the weak link. It pretends to be a slightly shabby version of Germany, but the French banking system is very fragile. Its manufacturing recorded its biggest monthly decline last year and runs a large current account deficit. While it may throw political shapes, it is economically weak.
If French yields rise, Germany must choose: does she risk everything for France?
The average German — like the receptionist in Mainz — will say “nein danke”, but politicians and strategists deep inside the German establishment, wedded to the central pillars of EU integration, will say “oui”. The discussion will move to the compromise. German politicians will realise they can only sell the deal to save France by abandoning Italy and Spain.
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