Munchau: ‘we are moving closer towards an involuntary break-up’

I just want to highlight three things here from Wolfgang Munchau on the euro zone because he reaches conclusions I have reached.

In an FT article with the pro-European title of “Eurobonds and fiscal union are the only way out”, Munchau writes about a Greek default:

In Berlin, there is now a consensus among senior policymakers that Greece is very likely to default inside the eurozone, but not right away. By the time it happens, the European financial stability facility will be empowered to protect European banks directly. Those who advocate this approach clearly hope that the improved institutional set-up will be sufficient to deal with contagion.

That’s exactly right. There is no stomach for a full fiscal union. That’s not going to happen. Moreover, Germany is preparing for Greek bankruptcy. The markets see this as a near certainty, so it makes sense to get out in front of the event. What Germany wants is an ‘orderly’ bankruptcy, whatever that means. It’s not clear any default will be orderly, but at a minimum the Germans want to be well-prepared and that means extend and pretend.

Munchau also writes about Italian solvency:

The EFSF and its successor, the European Stability Mechanism, have been set up to handle small countries. They are not big enough to handle large countries. Besides, Italy does not have a short-term funding gap, but a long-term solvency problem. With debt of 120 per cent of gross domestic product, a potential real economic growth rate of around 1 per cent, and a long-term interest rate of 5-6 per cent, Italy’s debt sustainability is in doubt. A monetary union, which solves crises through a combination of default and backstops for the financial sector, would hardly solve Italy’s problem.

Yes, the European Sovereign Debt Crisis is a solvency crisis. My version of what Munchau writes is this:

Is it debatable whether Italy is solvent longer-term? Sure. That’s why Italy is under attack. But the right way to deal with this is to stop the panic and address the issues that could lead to longer-term insolvency. Remember, Italy has a primary surplus. It is high debt and interest costs plus slow growth which are Italy’s problems.

Bottom line: without growth or fiscal surpluses, Italy’s debt to GDP grows. That’s how the numbers work. Miraculous growth is not going to happen for demographic reasons (Italy is old). So you have to see cuts to get the debt levels down.

Finally, there’s the money quote. Munchau writes about the dissolution of the euro zone:

The ruling of the German constitutional court has raised legislative hurdles, while political hostility is rising. We are moving away from what I consider the only effective solution to the crisis. This means, by extension, that we are moving closer towards an involuntary break-up.

My version of why a breakup of the euro zone is likely:

This ruling by the German Constitutional Court does allow the EFSF to operate as planned. Most commentators have focused on this. However, the language of the decision means there can be no eurobonds and no “supra-national” fiscal agent because these are in violation of the German constitution.

[…]

In my view, eurobonds and a “supra-national” fiscal agent are almost the only mechanisms which make the euro zone viable. Therefore, with these options now excluded, the euro zone is almost doomed to failure. The euro zone double dip is almost here and I think that spells bailout fatigue, austerity fatigue, default, and political unrest which will break the euro zone apart.

Does anyone have a different view? If so, please post it in the comments.

Source: Eurobonds and fiscal union are the only way out – Wolfgang Munchau, FT

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty five years of business experience. He has also been a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College.

11 Comments

  1. Coldcall says:

    The Germans wont pay for fiscal union, so end of. The problem is that the majority of Germans probably dont understand just what a break it was for her manufacturers to join a currency peg with the likes of Greece, Spain, Italy, Portugal etc…

    The euro has been more benficial to Germany than any other european country. She could never have exported expensive technology to the GIIPS when they had their own currencies, and could devalue when they needed to gain competivity.

    The more i think of whats really happened the more i think Germany is really out of order because she was happy to reap the benefits of EMU, but doesnt want to help economies she certainly played a role in semi destroying.

    However its consecutive GIIPS governments of right and left all pro-euro, all went along with the gravy train and more or less sold out their national constituents over the euro. A disgrace, and a stain on so-called european democracy.

  2. Dave Holden says:

    Thanks for the analysis Edward.

    “By the time it happens, the European financial stability facility will be empowered to protect European banks directly.”

    and

    “What Germany wants is an ‘orderly’ bankruptcy, whatever that means. It’s not clear any default will be orderly, but at a minimum the Germans want to be well-prepared and that means extend and pretend.”

    This in particular is the first insight I’ve read that would indicate there is at least some thinking and rationale behind the current can kicking.

    Extend and pretend for a purpose is a whole lot better than just extend and pretend.

  3. David Lazarus says:

    I do not think that Greece can last long enough for there to be an orderly default. I suspect that German politicians prefer extend and pretend over Greek bailouts anyway. Though the electorate might not like that either. Fiscal union is dead not just because of Germany but Finland as well. Exit seems likely but when is another matter.

  4. ErnestJack says:

    I think when thinking through the paths for Europe, I am seeing more arguments on the macroeconomic effects or the countries after any event (restructuring, default or leaving the eurozone). What I fail to find anywhere is HOW these paths will play out in reality.

    1) Restructing or Debt swap is totally a viable way. The only issue is of course the haircut. But this way we can see a way for Greece to effectively restructure its debt and not cause a hard default. With debt restructured, the hard part will be a couple of bad years…like Ireland, but it can be done.

    2) Hard Default, this seems to be on the table if Greece is backed into a corner. If they dont get a deep enough haircut, they know this is an inevitability as they will not sell their natural assets to pay an unsustainable debt. (By the way, when is Europe going to lend money at Zero rates to hardup countries like the US does to its banks? Even mildly high interest rates is fatal to anyone over indepted.)

    3) Leaving the Euro and Euro Breakup. This path is not currently possible. Maybe, 5 years from now they can start a 5 years phase out of some member, but certainly this cant even be discussed now. Anyone who advocates Greece leaving the Euro, or thinks the Euro will breakup is not spending 30 minutes of thinking about what the damage would be, to everyone. How can you change Euro contracts, debt, deposits, trade, etc…values in many mnay multiples of the GDP of the countries back into local ccy? Anyone care to explain it? How do swaps in Euro between banks in France and Germany going to be unwound? How about corporations in swaps? Trade contracts in Euros? All 17 countries have been doing business in euros for over a decade. How can that be unwound without very very heavy and indescriminate pain to persons, corporations, banks, and govts worldwide?

    Please, can someone explain this? How does one exit the Euro in terms of its consequences domestically and intraeurope?

  5. SunZU says:

    All involved are extending and pretending till the EFSF is setup to recap all the big banks, once setup, they will allow the PIIGS to begin defaulting like dominos. Greece goes first, then the runs intensify then all other PIIGS. It’s coming in 2012.

    • David Lazarus says:

      I agree with the idea, but disagree over the economics. I doubt that the banks are making anywhere near enough profits to boost capital to be in a position to take the losses. If there is another credit squeeze, as a result of a greek default then even the UK with minimal exposure to Greece will be severely impacted because of its exposure to countries with higher greek liabilities. If the French banks collapse as a result of the defaults then they would probably wipe out the UK banks. The UK banks have been paying out so much in bonuses that they have not improved their balance sheet sufficiently.

  6. I am afraid a genuine fiscal union is not feasible within the given conditions. Time is against European leaders anyway and a fiscal union will definitely require years of bargaining. In the meantime the euro architecture will fall apart and thus the discussion will become meaningless.

    Only measures/mechanisms that do not require extra treaty changes and all the bureaucracy Europe is notorious of, can provide any solution to the systemic crisis of the euro. In the long-term a fiscal union is the only viable and stable option nonetheless(accompanied by further political integration).

    As we currently speak European leaders are faced with three straightforward options that will determine the future of the euro and consequently the fate of its constituent states. Namely those are (1) the continuation of the same failing policies, (2) the creation of a plan that will envisage an orderly Greek default within the context of the euro and will provide means of containing the resulting shock wave, (3) an overall change in approach vis a vis the crisis that will address the crisis as a systemic issue and not as a series of individual cases of “debt crisis”.

    I expand in detail on the topic in the latest article I wrote on my (euro)blog. Feel free to examine it.
    http://protes-stavrou.blogspot.com/2011/09/greek-default-optimal-and-suboptimal.html

    Thank you and keep up the good work. Oh and the euro will certainly collapse if things stay as they are.

  7. ErnestJack says:

    FT today has run an article EXACTLY laying out why Greece cant simply leave the Euro and how absolutely catastrophic the event would be for Greece, the PIIGS, the rest of Europe, USA and many more….

    http://www.ft.com/intl/cms/s/0/f2133a2e-e2e0-11e0-903d-00144feabdc0.html

    Please read as this is my point and shows those arguing Euro exit are simply thinking outloud and not thinking in ernest.

    • ErnestJack, I understand your point and have also said that Greece’s departure would be catastrophic if done now. However, you overplay this in making a categorical statement. If planned over a period of time in conjunction with the liquidity to aid that transition, a eurozone exit is 100% doable.

      • ErnestJack says:

        HI Edward,

        Thank you for addressing my statement. To be fair in my previous comment i say that in 5 years time they could consider it. So i dont rule it out categorically, but i do say that until the crisis of banks in Europe and sovgn defaults is set to rest in the PIIGS is put to rest, it is, for all intents and purposes a nonstarter as a way for Greece in the short-to medium term (contrary to the media’s attempt to amplified the comments by Roubini, et al,).

        It can be done, but it complicated and a very long way away from the current crisis at hand.

        Many thanks for your time.

  8. Riikka Söyring says:

    Greetings from Finland.

    What I have noticed is that when discussing about euro and the continuos crisis we´ve faced almost nobody ever mentions that the problems lay inside the system; meaning fractual reserve-banking and that money equals as debt.

    So consequently we are offered as “solutions” more debt to go over the crisis which fundamentally spring of us having too much debt.
    It does not make any sense.

    I also read what it says in the ESM- and EFSF-contracts and which content I find extremely suspicious and dangerous!
    I cannot think anybody on their right mind to agree to give immense amounts of money to a corp. that has been freed from all accountability what so ever, taxes and auditing.

    Then I was informed about the IMF operative plans to form a “global money” of IMF´s SDR. http://www.imf.org/external/np/pp/eng/2010/041310.pdf
    page 4 – and I began to wonder whether ESM and EFSF are used to drive things to such a catastrophic phase so that everyone will be ever so happy to accept the offered “solution” ie. IMF´s SDR.

    It would match ever so nicely with the UN´s Agenda 21-plans of only 10 regions worldwide, digitalized “global money” and energy-plans and all the other not-so-nice things the Agenda 21 has included in it.