Hopeful Signs for EU and Euro?
By Staff News & Analysis - February 16, 2011

Perhaps too much Rioja has gone to my head, but I no longer think it matters whether Portugal follows Greece and Ireland in needing an EU-IMF rescue. The risk of instant contagion across the Rio Guadiano – undoubtedly real a few months ago – has diminished with each passing week, while the EU bail-fund is at last taking a half-way credible form. This does not mean that EMU's yawning North-South chasm has been bridged, or that monetary union has yet proved itself workable without fiscal transfers and a debt union, or that such political union could ever be democratically healthy and accountable if achieved. – UK Telegraph

Dominant Social Theme: After some tough times the EU will triumph and the euro will rise.

Free-Market Analysis: The biggest euro-skeptic in the mainstream press has recanted (or decanted?). Ambrose Evans-Pritchard, author of the article from which the above excerpt is taken, has decided the euro is going to remain solvent after all. Perhaps, he says, too much Rioja has gone to his head. But he now believes that Spain will eke its way out of the debt crisis that Southern PIGS find themselves in.

Evans-Pritchard believes that Spain's high savings rate, high investment rate and export efficiency is going to help that country overcome the effects of the sovereign crisis. Of course, he hedges his bets mightily, but his tone is improbably upbeat for someone who has been on the forefront of EU negativity for the past several years – and who is instinctively a Euro-skeptic. It seems a quite astonishing conversion and it is hard to tell from this one article whether he is fully committed to his new position or whether he will change his mind. For now, he seems convinced, and adds the following to explain his conversion:

Anthropologically, you could say that Spain has refound its 14th Century creativity when it was the most dynamic society on earth, before Conquista gold corrupted the Iberian soul. Its chefs are sought everywhere, its sportsmen are triumphant. Even its boom-bust ordeal is the symptom of a thrusting nation in a great secular upswing, like Holland in the 1630s, or England in the 1720s. It is the declining plodders you need to worry about. Spain's current account deficit was second only to the US in absolute terms in 2007. It has since plummeted from 10pc to 4pc of GDP, in stark contrast to Portugal where the rot is structural. The trump card is Asiatic levels of savings, which makes it easier for the country to carry a public-private debt near 300pc of GDP …

Spain is not out of the woods yet. It must raise €300bn of sovereign, regional, or bank debt this year in a hostile market. Unemployment is stuck at 20pc. There is an overhang of almost 1m unsold homes on the market. A Chinese hard-landing and a US-EU relapse would vastly complicate matters, and there is always the risk of a temper tantrum in Berlin or a ruling by the German constitutional court that the EU bail-out machinery is illegal. Yet short of an external shock, Spain should pull through. Those who still thinks that Spain will trigger the break-up of the euro are barking up the wrong tree. Germany is another matter, of course, and so is France.

Evans-Pritchard has turned suddenly optimistic, but he rightly points out that difficulties remain. His reference to Germany is at least in part to the pending German court decision about the constitutionality of the "guaranteed loans to Greece." The court is scheduled to rule on the constitutionality of the European Financial Stability Mechanism and European Financial Stability Facility. These two European money pools – to which the Germans are contributing mightily – have provided Greece with some 40 billion euros; as the Germans entered the EU with express assurances that they would not end up as the regions guarantor of last resort, the trend toward just this sort of situation is creating a good deal of tension.

Nonetheless, the lawsuit is not liable to have much traction. The court is a powerful one within the German system – as an article in the Irish Times explains – but the position of the courts has generally been pro-integration. And in this case there are some specifically mitigating factors. In a fairly detailed article, the newspaper rehearses the arguments (pro-and-con) and explains what might be expected. Here's some of that analysis:

The complainants base their case on several points. Firstly, they claim that the European stability mechanisms contravene article 125, paragraph 1 of the Treaty on the Functioning of the European Union, which states that the union is not liable for the financial commitments of member state governments, and that member states are not liable for the commitments of other member states. By contributing to the bailout packages, so the argument goes, Germany is taking on liability for the commitments of other member states.

This interpretation is, however, based on a false understanding of what is meant by the term "liable". The purpose of article 125 was to make clear that, despite entering into a common currency, states could not be made legally liable by creditors for the financial obligations of other member states. It was important to stress this in order to define the limits of the common financial policy within the euro zone …

Article 14 of the German constitution protects property. The complainants' argument here is that a separate part of the recovery plan – purchasing the bonds of nations in crisis via the European Central Bank – will undermine the stability of the euro, allegedly injuring the complainants in their right to property and contravening article 88 of the constitution, which states that the ECB is obligated to maintain price stability. However, arguments concerning price stability have failed in the past. In the present case, it is likely the court will decide that whether or not the euro will be undermined via the ECB's bond purchases does not lie within its jurisdiction, because the court may only decide on the constitutionality of laws, and not generally on their efficacy.

The German government has decided to give the loan guarantees precisely in an attempt to maintain price stability. Only if the complainants are able to make an overwhelming case for their point of view is the court likely to consider seriously the efficacy of the government's measures. Due to the apparent weakness of the case, overwhelming legal opinion in Germany is that it is destined to fail.

Of course a court decision supporting the EU bailout will clarify some legal aspects but it likely will not assuage German anger over the country's sudden assumption of the mantle of "banker to Europe." The anger is bound to stay constant given that there are threats of further bailouts. Even if Evans-Pritchard does not now believe that Spain will prove the EU's final blow, many dangers await the EU in a post-boom world, and the Germans believe themselves correct to be worried.

One of the most high-profile German worriers was Axel Weber, a central banker often described as "rigorous," who just resigned as head of German's powerful central bank, the Bundesbank. He is expected to be replaced by Jens Weidmann, chief economic adviser to Angela Merkel, the German chancellor. Weber is said to have resigned over the issue of German bailouts to the EU and also over the issue of European quantitative easing, in which the ECB has begun to buy euro debt from failing PIGS, specifically Greece. For Weber, such behavior was tantamount to a kind of financial incest, and not to be happily tolerated.

Weber is said to have is eye on a private banking job, a state-of-affairs that has not only left Germany's Angela Merkel taken aback but has also roiled the EU itself as Weber was apparently a front-runner to take over as head of the EU central bank. Weber was a valued commodity because he was known in Germany for hawkish stances regarding either German or EU money printing; thus, Eurocrats and Merkel herself anticipated that Webber would provide the EU with additional credibility.

That credibility may still be captured but it won't be through Weber. The EU is now said to be looking South, to Italy of all places, to capture a candidate possessed of the kind of rectitude that Weber represented. Thus, once again, we see the EU powers-that-be are continually engaged in a rear-guard action to redefine the EU in ways that are expansive but still palatable. The idea is to retain a narrative of probity while creating the monetary instrumentalities necessary to salvage a sinking situation.

Perhaps, then, Evans-Pritchard's sudden optimism is warranted. Spain is on the upswing, he suggests; no EU countries have yet defaulted, a new ECB banker will be found with the requisite probity and the German constitutional challenge is probably not going to be sustained. And yet … we retain our Euro skepticism for now. Even the Telegraph article is exceptionally hedged, for good reason. Evans-Pritchard is well aware of the challenges that remain.

An inflationary crisis is sweeping China and, absent China, just what country is to create the necessary, vast demand in an increasingly lifeless global economy? America is years away from another spasm of consumerism and the rest of the BRICs – Brazil and India in particular have inflation worries that verge on China's.

What Pritchard must also be aware of is that both America and the EU have sown the seeds not just for inflation but stagflation and perhaps a very vicious case at that. As the money that central banks have poured into the world's economy begins to circulate, rates will have to rise worldwide, choking off recoveries that might be taking place in Spain and elsewhere. Meanwhile, accumulated debts continue to generate interest payments, etc. And there are simply too many shaky countries in the EU, too many countries with too much debt, in our view.

Finally, there is austerity itself. Unless the EU can immediately generate numerous good jobs (we don't see how) the mood shall remain sour and probably worsen. Between price inflation, rate increases, expanding debt and austerity violence, we tend to believe that the EU faces considerable challenges.

After Thoughts

When Evans-Pritchard wakes up from his Rioja-fueled bender, he may recall that prosperity is a monetary phenomenon. Get the money right and wealth accrues. Get it wrong and all the best industrial policies shall avail you little. We don't see that anything has changed monetarily in Europe (or in the world for that matter) and thus, absent another boom, even the best industrial efforts shall not likely overcome the chaos of the current fiat-money bust. The ramifications have by no means played out. In fact, we may be in the eye of the storm.

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