Europe's Coming Meltdown
By Staff News & Analysis - March 15, 2011

Total German triumph as EU minnows subjugated … The Iron Chancellor of Germany could not have been clearer. "Whoever wants credit must fulfill our conditions". Chancellor Angela Merkel (left) has agreed to cut the interest rate on the EU share of Greece's €110bn loan but this does not restore solvency. These conditions are capitulation by three vulnerable states on core policies, and partial loss of sovereignty for the rest of the eurozone. For Greece, the terms are a fire-sale of €50bn (£43.2bn) of national assets within four years, a tenfold increase from the original €5bn that premier George Papandreou thought he signed up to a year ago. When the IMF first mooted this sum last month he told the inspectors not to "meddle in the internal matters of the country." State holdings in Hellenic Post, Hellenic Railways, Athens Public Gas, the Pireaus port authority, Athens airport, Thessaloniki water, and ATEbank, to name a few, will not fetch more €15bn. What next? – UK Telegraph

Dominant Social Theme: The Germans are being quite reasonable. Frau Angela Merkel is benevolent.

Free-Market Analysis: The just-completed deal between North and South Europe (between Germany and the PIGS, really) is apparently almost entirely one-sided and bound to inflame not diminish civil unrest as spring begins to bloom across Europe. The lines of battle are not hardening; they look to have been set in reinforced concrete. In such an environment it would seem continued clashes within the affected countries are inevitable. Have you read this elsewhere? Here's one interpretation from the European Voice:

Herman Van Rompuy, the president of the European Council, declared that the eurozone leaders had resolved their differences over economic governance in time for the EU summit at the end of the month. A pact on competitiveness – which demands greater policy convergence between the eurozone states – has been agreed. In addition there are agreements in principle on boosting the effective lending capacity of the eurozone's bail-out funds – both the temporary arrangement, the European Financial Stability Facility (EFSF), and the permanent mechanism that will come later, the European Stability Mechanism (ESM).

Van Rompuy was speaking in the early hours of Saturday morning (12 March) at the conclusion of a meeting of the heads of state and government of the eurozone. Van Rompuy said that all 17 leaders of the eurozone countries agreed that their economies needed to be more competitive and more convergent. The pact would help achieve that, he said. Eurozone governments would make their first pledges at the end of this month as to what action they were going to take at a national level to help the eurozone. "What has changed is the political commitment," he said. Nicolas Sarkozy, the French president, hailed the pact as a "decisive step forward".

Sarkozy and Von Rompuy may be satisfied, but we would suggest that some others are not, including the heads of certain besieged Southern PIGS. The current state of affairs, in fact, is entirely in keeping with what we've been predicting for the past year or so. Europe's Southern tribes put up with the EU and especially the euro so long as it provided additional prosperity; but there is no benefit to these countries now, only eroded sovereignty and punishing austerity. The social compact has been breached and we wonder how long it will be before the debt will be rendered to Europe's spendthrift Northern banks in blood and bone rather than fiat paper – no matter Brussels' happy talk.

The Europhile Financial Times – of all papers – recently carried a hard-hitting editorial on the subject by Gideon Rachman. It was entitled, "Merkel's nightmare: the voters' revenge," and to read it is to realize how far Europe has traveled from two years ago when Eurocrats were so dismissive of European pushback to the new EU Constitution that they forced the language through by treaty, even demanding the Irish vote twice to ensure the changes were adopted. Here's an excerpt from Rachman's editorial:

In the new economic and political climate inside the EU, none of the key national governments feels it has any room for manoeuvre. On both sides of the euro divide, centrist governments are worried about the rise of nationalist and extremist parties. That makes it much harder to reach EU agreements, which worsens the economic crisis, which then worsens the political crisis. Germany is the key country pushing for tough, structural economic reforms across the eurozone. Its proposals have been made with France. But the hardline strictures on debt, deficits and later retirement ages, agreed in last weekend's euro pact, are very German in inspiration …

[In the Netherlands] … the rightward drift of Dutch politics has continued. The Party of Freedom of Geert Wilders, which is strongly opposed both to Muslim immigration and to the EU, is now a major force in Dutch politics. The German chancellor knows that anger about the EU and about immigration are also potent forces in her own country. Mr Wilders has spoken to enthusiastic audiences in Germany and the thought of a German Wilders is Ms Merkel's ultimate nightmare … The trouble is, to fend off the threat of political radicalisation in Germany, Ms Merkel is demanding austerity policies in countries such as Greece that pose a long-term risk to their political stability. European leaders do not know whether to be more frightened of the bond markets or of their own voters.

One begins to question whether or not leading Eurocrats have become even further detached from reality than they already were. Every few months, now, EU leaders are gathering at a "summit" guaranteed to "reassure the markets" that the EU is "firmly behind" the euro and that Southern PIGS will not default. This latest agreement is perhaps the most disastrous as it indicates (as we have been predicting) that there is no compromise to be had.

Ambrose Evans-Pritchard of the UK Telegraph has provided us with a fairly unvarnished summation of what just occurred (see article excerpt above). The "agreement" as Evans-Pritchard points out does nothing to heal Greece's long-term economic woes. The debt load, he writes, "will approach 150pc of GDP in 2011, and debt service costs are 14.4pc of tax revenue." Meanwhile, Greece is under an affirmative obligation to privatize €50 billion in state holdings rather than €5 billion. In return, the Iron Chancellor has chopped 10 basis points from the Greek's €110bn loan package and extended the pay-back term. The deal also doubles the size of the EU bailout fund, though how the rating agencies are going to react remains to be seen.

Evans-Pritchard obviously believes the deal is a kind of non-starter. Greek joblessness, he points out, rose to nearly 15 percent of the work force – and given that government numbers always underestimate the reality, it is likely far more than that. Youth figures apparently are in the area of 40 percent. How about Portugal? "A descent into Hell," said a spokesperson for the "Bloco de Ezquerda" (Portugal's left wing). Portugal's pensions, welfare, and health-care are all being cut along with wages.

What has been the reaction, generally, in Portugal to "austerity?" Evans-Pritchard reports that almost 300,000 youth took to the streets of Lisbon and Oporto on Saturday – an open revolt of the "Desperate Generation." The Socialist Party itself is riven, with factions vowing not to endorse the just-completed compact. Five-year bonds have now climbed to eight percent, meaning that Portugal has to tempt investors to buy its paper by offering ever-rates.

Ireland is under continued pressure meanwhile to hike its low corporate tax rate, which is the foundation of what is left of the Irish economy, with both pharmaceutical and software companies settling in the Emerald Isle specifically because of the non-punitive fiscal environment. Ireland's repayment rates remained as they were because the new Irish leader Edna Kenny would not agree to raise the corporate rate. And well he should not, as that would be fastest way for Kenny to become a former "Taoiseach" in record time. Ireland is paying something like nearly six percent for its loan, while GDP has contracted over TWENTY percent.

Other PIGS are coming under increased scrutiny. Spain and Italy will experience increased scrutiny of pensions, wages, taxes and various additional government linked fiscal and economic policies. "Just as eurosceptics always feared," Evans-Pritchard writes, "monetary union has led to a state of affairs where – in order to 'save the euro' as Mrs. Merkel puts it – Europe's ancient states find themselves having to accept a quantum leap towards political union and a degree of subjugation that would not have been tolerated otherwise."

Under the agreement, debtor states will not be able to purchase their own bonds in the market to lower the overall debt burden, nor will the EU buy bonds of struggling PIGS as a matter of long-term policy. Meanwhile, Europe's Northern banks remain undercapitalized and likely unable to withstand any "haircuts" – though haircuts are exactly what they will get sooner or later. It is a matter of mathematics. Ireland and Portugal (and perhaps Spain and Italy) cannot pay their debts and are not receiving sufficient latitude from the EU to make debt-repayment possible.

In such an environment someone must pay somehow; even a debt jubilee repudiates SOMEONE'S debt. In this case, sooner or later it will be the banks. The North, in fact, is being a tad hypocritical in this regard by insisting on full repayment. German, British and French banks made a bad bet on Europe's Southern flank. Such misjudgments usually result sooner or later in a loss of capital. Merkel and the North are trying to alleviate economic losses via political pressure. Ultimately, the market is more powerful than politics; sooner or later that will become clear, we'd venture.

Evans-Pritchard does us the favor of revealing the souring sentiment in Greek's ruling PASOK party. "We should default and return to the Drachma to punish foreign loan sharks who have bled us dry" he quotes a recent PASOK editorial as suggesting. As for amiable cipher Enda Kenny: "[He] may ultimately have to choose between his EU club loyalties and his duties to the sovereign nation that elected him. Some within his coalition ranks already seem tempted to retaliate by pulling the plug on EU banks."

Interestingly, he makes the point that deep popular unrest usually appears three years after the initial crisis, citing the 1930's as his authority. Perhaps he is correct, though it seems to us that unrest is already occurring. And while many observers (and euro-investors) might be satisfied with the austerity now being inflicted – Southern Europe's welfare states being notoriously insupportable – this would be in our view a misreading of the situation.

Southern European countries are not Northern ones. Over and over, the ill-run governments of Southern Europe verged on insolvency and spread the pain though a devaluation. This solution is no longer available yet the problems are the same, only worse. From the perspective of many in the South, it is the government itself, the industrial and political elites that benefited from the largess of EU, while all that is left to the larger population is austerity.

We have advanced this view before. Southern Europe received millions – billions – of euros in order to "balance" its various economies in advance of joining the EU. This money was never well accounted for by design as it was seemingly a bribe to the various power centers of the PIGS to ensure the decision makers would bring their countries into the fold. The idea was that the political process would grind along, providing Europe with an ever-more perfect union no matter the difficulties along the way.

Something happened however. The logic appeared sensible but the implementation is increasingly plagued with resentments and violence. The Southern tribes of Europe are deeply aggrieved. It is not a question of logic but fairness, as they see it. No one likes to be snookered, Southern Europeans least of all. Who knows why it hasn't worked? Maybe the financial crisis was a good deal deeper than expected; maybe the Internet itself has revealed too much about elite manipulations.

But it seems to us that the pushback is far deeper than expected and EU paralysis is far more profound than might have been anticipated. Perhaps Europe and the EU will muddle through. More likely, sooner or later banks will be forced to acknowledge their imprudence and some, if not many, will go out business, deepening Europe's malaise. We would expect, sooner or later, as well, that one or more PIGS will withdraw from the union or at least the euro in order to default, as the EU is incapable of providing the necessary flexibility.

After Thoughts

Nicolas Sarkozy and others (Merkel) can maintain "rigor" in the face of what is to come, but in a few years time the EU may look somewhat different than it does today; various compromises may have to be made to keep it together at all. It will be something of a defeat for the Anglo-American power elite that has banked on the EU as a stepping stone to world government; but the Anglosphere has experienced setbacks before. They are experiencing more of them in the 21st century than the 20th.

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