Monday, 15 August 2011

Why Germany will not accept Eurozone bonds

There is a lot of guesswork going on in the financial press about Germany’s apparent refusal to condone the issue of Eurozone bonds. Such bonds are bonds, issued by a relevant institution of the EU, underwritten by every member state, and the proceeds of the sale of such bonds could then go to member countries that have problems borrowing money in the financial markets.

Financial journalists have a tendency to dismiss politicians as bumbling idiots because they do not do everything the markets demand. In this case, we hear that the market wants bonds issued with complete, gold-plated German guarantees.  Germany is not likely to accept that.

It is not because European politicians are incompetent. It is because the “battle to save the Euro” is played out on many levels. The upper level is where the panic has been: Something was needed to “rescue” Greece.

At a deeper level, it is about sovereignty. And about moral hazard – again. A look at history gives some important clues

Since Germany accepted the principle of a monetary union in connection with the German reunification, nothing has been more constant than the German unwillingness to underwrite moral hazard. Early on, Germany had spotted that the Monetary Union would give countries such as Italy the possibility of profiting from lower interest rates while maintaining the right to flood the market with government bonds denominated in EUR. As a result, Germany pressed hard to have a “stability pact” that would put at least some limitations on the more irresponsible governments in the Euro-zone.

As we all know now, nobody took the Stability Pact seriously, and it was never enforced. Germany’s nightmare came true.

The Stability Pact was only a second best. Germany, already familiar with a federal structure, would have preferred a Euro-zone fiscal authority. In the ‘90s this was unthinkable, as the governments jealously guarded their prerogative to collect taxes and decide government spending. It is after all one of the key elements in politicking.

Now, almost two decades later, Germany’s attitude is fundamentally the same. Germany will not underwrite Eurozone government bonds unless moral hazard is taken off the table. Germany will not bail out government after government because they have behave recklessly with their own public finances.

Under the impression of the market turmoil several countries are increasingly understanding that it is impossible to have a monetary union without adequate institutions. As a result, ECB has been permitted to expand its activities way beyond what its charted allows it to do. Some governments are ready to consider some kind of federalism in fiscal matters.

France resists any such idea. President Sarkozy has repeated what every president before him has stated. The prerogative to decide on taxes and spending lies with the French government.

In my view, France is playing with high stakes here. The French economy has not been “liberated” from the government influence and is increasingly lagging behind the German export locomotive. Nevertheless, France insists on being treated on a par with Germany. In Berlin this is accepted because membership of the Eurozone is a geopolitical imperative, and a Eurozone without France AND Germany is irrelevant. So France is playing on Germany being willing to go further in saving the Eurozone than has already been the case.

I would not bet on that happening. After all, the basic tenet of German policy towards the economic policy in the Eurozone has remained unchanged for a very long time. It makes complete sense that one country should not write blank cheques to everybody else. The financial markets may rail against German inflexibility as much as they like.

But there is no reason to expect that Germany should listen. Money talks. It is Germany holding the purse strings, and that gives a guarantee that Europe will listen.

In case anybody wants to have a short summary of Germany’s position, Finance Minister Schäuble laid it out clearly last year in Financial Times. It is worthwhile reading again.

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