sábado, outubro 22, 2011

Why Europe Dithers


German voters don't want to bail out French banks and the French government can't afford to.

'All political lives, unless they are cut off in midstream at a happy juncture, end in failure." That morbid thought, voiced by a British politician named Enoch Powell in the 1970s, is now playing out in the careers of Angela Merkel and Nicolas Sarkozy. Neither leader has an incentive to sacrifice what have become vital and divergent interests to produce a credible bailout plan for Europe. To simplify, German voters don't want to bail out French banks, and the French government can't afford to bail out French banks, when and if the long-awaited Greek default is allowed to happen.

Thus Mr. Sarkozy's re-election hopes are going down the drain, but not as quickly as they would if he acceded to the Merkel plan to let each government rescue its own banks.

Ms. Merkel's hopes for a third term are being eroded in regional election after regional election, though not as quickly as they would if she agreed to put German taxpayers on the hook for France's troubled banking sector.

There is another savior in the wings, of course, the European Central Bank. But the ECB has no incentive to betray in advance its willingness to get France and Germany off the hook by printing money to keep Europe's heavily indebted governments afloat. Yet all know this is the outcome politicians are stalling for. This is the outcome markets are relying on, and why they haven't crashed.

All are waiting for some market ruction hairy enough that the central bank will cast aside every political and legal restraint in order to save the euro.

In doing so, of course, the bank will be acting far above its pay grade, and far outside the law, to make momentous decisions for all of Europe. Which countries will be saved via the bank's willingness to print unlimited euros and buy unlimited assets to keep them out of default?

Which countries will be allowed to default and (if they so choose) drop out of the euro altogether?

These choices the bank understands perfectly well it would be making in lieu of politicians who are unwilling to make such decisions, though not unwilling that such decisions be made. In their non-rescue of Greece last July, Europe's leaders proposed a 21% "voluntary" haircut to Greek debt held by banks, and now scuttlebutt has raised the politically acceptable haircut to 60%.

Though the central bank has been adamantly against a Greek default (because it owns a lot of Greek debt), this means it will surely read its mandate as permission to let Greece default.

The central bank has already stepped up, to wide applause, to keep Spain and Italy afloat when demand for their debt began to evaporate. Italy and Spain are "core" countries that the bank understands the politicians view as too big to fail. And France will likely get a temporary pass from the markets to run up its national debt in order to recapitalize its banks because, obviously, if the ECB won't let Italy and Spain sink, it won't let France sink.

That leaves Portugal and Ireland. Let's just guess that the ECB, aware of how far beyond the pale it has wandered, will act conservatively and prop them up too.

And then the crisis will be over? Not by a long shot.

All these "solvent" countries and their banks will be dependent on the ECB to keep them "solvent," a reality that can only lead to entrenched inflation across the European economy. That is, unless these governments undertake heroic reforms quickly to restore themselves to the good graces of the global bond market so they can stand up again without the ECB's visible help.

It's just conceivable that this might happen—that countries on the ECB life-support might put their nose to the grindstone to make good on their debts, held by ECB and others. Or they might just resume the game of chicken with German taxpayers, albeit in a new form, implicitly demanding that Germany bail out the ECB before the bank is forced thoroughly to debauch the continent's common currency, the euro.

At most the endgame might be extended for a couple of years, but the native pessimists among us will have a hard time believing the single currency can survive. Those countries that consider themselves solvent and disciplined will face a relentlessly growing temptation to get out, led by Germany.

As you will recall, one argument for the euro was that, lacking their own currencies to debauch, countries would have to get a handle on welfare bloat and the disincentives they pile up on workers and entrepreneurs. But a funny thing happened on the way to a "United States of Europe." Only one major country made an effort to reform itself, Germany—the one country whose political culture would never have allowed it to opt for D-mark debauchery in the first place.

We noted as much in a column in 2003, and wondered: "If Germany overhauls itself, will other European states follow suit? Or will their commitment to the euro and a single market wilt in the face of domestic opponents who paint reform as a surrender to the Germans?"

No, this is not a paean to the "unchangeability" of national culture. But some things change slowly and national culture is one of them. It was never likely the rest of Europe would choose to become more like Germany, or Germany choose to become more like rest of Europe, on a schedule that would allow the euro to work. And that's what we're finding out.

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