The pattern is becoming despairingly familiar. The embattled periphery countries, led by Italy and Spain but also endorsed by France, propose more fiscal integration in the form of mutual debt pooling and shared financial liability. Such reforms are met with resounding rejections from Germany who instead point to the long run benefits of austerity in terms of promoting a sustainable economy. Similar responses are also reserved for Greece who is seeking to renegotiate elements of its bailout agreement following a recent general election which resulted in the formation of an awkward coalition government.
The focal point of this resistance is Germany’s Chancellor Angela Merkel who, supported by its Central Bank’s President Jens Wiedmann, is adamant that the focus for the Eurozone should be implementing the necessary fiscal reforms rather than loosening conditions. This position, generally supported by the ‘northern core’ countries, highlights the almost daily division between the creditor and debtor nations in the single currency bloc. The current official line from Germany is that ‘More Europe’ is the solution to the crisis however without a clear prescription as to what that definition entails, uncertainty will remain.
As the crisis intensifies, hopes are low that a two day summit starting Thursday will produce agreement on the best course forward. Since the election in Greece, investors have dumped Spanish bonds leading to higher funding costs which in turn have led to a bailout request from Spain to deal with the funding problems being experienced by its banks. Details of the bailout are thin on the ground but the proposed bailout fund, the European Stability Mechanism which is yet to be ratified, has been structured to rank creditor repayments ahead of those of private bondholders – something which has unnerved investors. Such uncertainty has spread to Italy who, struggling to implement the required reforms, is attempting to stave off the bond vigilantes which threaten to drive the country towards a bailout that would undoubtedly collapse the Eurozone.
Facing the abyss of terrible economic data releases and on-going political division, senior Eurozone officials in Brussels are scrambling to propose measures to stop the rot. Such proposals, including a banking union, joint euro debt issuance and a central European treasury, have raised tensions in Berlin where Angela Merkel today firmly reiterated that there will be “no total EU debt liability” in her life. Such rhetoric is likely to increase uncertainty on the markets that increasingly look to statements from German political leaders for direction in the crisis. Supposed negative statements from key figures, including Merkel and Wiedmann, only serve to compound the dire news from the real economy and push the Eurozone further into demise.
What’s clear is that the current game of chicken being played is close to its finale. At some point soon Germany will have to relax its austerity demands, risking a political bloodbath at home for Merkel, or allow the collapse of the Eurozone which would be triggered by a funding crisis for Italy. As always, when this will happen is unclear but such a move either way will be caused by an adverse market response rather than decisive political leadership. It’s unlikely that Merkel can say “Nein” forever.