Yves here. It’s astonishing to see Germany take active steps to wreck the Eurozone.
By Thomas Fazi. Originally published at Social Europe
In recent weeks, Germany has put forward two proposals for the ‘future viability’ of the EMU that, if approved, would radically alter the nature of the currency union. For the worse.
The first proposal, already at the centre of high-level intergovernmental discussions, comes from the German Council of Economic Experts, the country’s most influential economic advisory group (sometimes referred to as the ‘five wise men’). It has the backing of the Bundesbank, of the German finance minister Wolfgang Schäuble and, it would appear, even of Mario Draghi.
Ostensibly aimed at ‘severing the link between banks and government’ (just like the banking union) and ‘ensuring long-term debt sustainability’, it calls for: (i) removing the exemption from risk-weighting for sovereign exposures, which essentially means that government bonds would longer be considered a risk-free asset for banks (as they are now under Basel rules), but would be ‘weighted’ according to the ‘sovereign default risk’ of the country in question (as determined by the fraud-prone rating agencies depicted in The Big Short); (ii) putting a cap on the overall risk-weighted sovereign exposure of banks; and (iii) introducing an automatic ‘sovereign insolvency mechanism’ that would essentially extend to sovereigns the bail-in rule introduced for banks by the banking union, meaning that if a country requires financial assistance from the European Stability Mechanism (ESM), for whichever reason, it will have to lengthen sovereign bond maturities (reducing the market value of those bonds and causing severe losses for all bondholders) and, if necessary, impose a nominal ‘haircut’ on private creditors.
The second proposal, initially put forward by Schäuble and fellow high-ranking member of the CDU party Karl Lamers and revived in recent weeks by the governors of the German and French central banks, Jens Weidmann (Bundesbank) and François Villeroy de Galhau (Banque de France), calls for the creation of a ‘eurozone finance ministry’, in connection with an ‘independent fiscal council’.
At first, both proposals might appear reasonable – even progressive! Isn’t an EU- or EMU-level sovereign debt restructuring mechanism and fiscal authority precisely what many progressives have been advocating for years? As always, the devil is in the detail.
As for the proposed ‘sovereign bail-in’ scheme, it’s not hard to see why it would result in the exact opposite of its stated aims. The first effect of it coming into force would be to open up huge holes in the balance sheets of the banks of the ‘riskier’ countries (at the time of writing, all periphery countries except Ireland have an S&P rating of BBB+ or less), since banks tend to hold a large percentage of their country’s public debt; in the case of a country like Italy, where the banks own around 400 billion euros of government debt and are already severely undercapitalised, the effects on the banking system would be catastrophic.
We know for fact – despite the feeble reassurances of the eurozone’s finance ministers – that the banking union’s bail-in rule – for reasons that I have explained at length here – is already causing a slow-motion bank run on periphery banks, with periphery countries experiencing massive capital flight towards core countries (almost on par with 2012 levels), as bondholders and depositors flee the banks of the weaker countries in fear of looming bail-ins, confiscations, capital controls and bank failures of the kind that we have seen in Greece and Cyprus. Extending that same rule also to sovereigns would simply mean doubling down on a measure that is already exacerbating core-periphery imbalances and increasing (rather than reducing) the risk of banking crises. The risk is not limited just to periphery countries, of course, as the recent panic over Deutsche Bank testifies.
Moreover, the proposed measure, far from ‘severing the link between banks and government’, would almost certainly ignite a new European bond crisis – of which are already witnessing the first signs – as banks rush to offload their holdings of ‘risky’ government debt in favour of ‘safer’ bonds, such as German ones (as the German Council of Economic Experts report acknowledges, ‘as a result of the risk-adjusted large exposure limit, there is more leeway for holding high-quality government bonds than with a fixed limit’). The report estimates that banks will have to divest around 600 billion euros of government debt. As Carlo Bastasin of the Brookings Institution writes:
Sovereign bonds have a unique and pivotal role for the financial systems of the euro-area. So, once sovereign bonds in some euro-area countries become more risky, the whole financial system might turn frail, affecting growth and economic stability. Ultimately, rather than exerting sound discipline on some member states, the new regime could widen bond rate differentials and make debt convergence simply unattainable, increasing the probability of a euro-area break-up.
As noted by the German economist Peter Bofinger, the only member of the German Council of Economic Experts to vote against the sovereign bail-in plan, this would almost certainly ignite a 2012-style self-fulfilling sovereign debt crisis, as periphery countries’ bond yields would quickly rise to unsustainable levels, making it increasingly hard for governments to roll over maturing debt at reasonable prices and eventually forcing them to turn to the ESM for help, which would entail even heavier losses for their banks and an even heavier dose of austerity (which is the main reason that periphery banks are in such a terrible state in the first place).
It would essentially amount to a return to the pre-2012 status quo, with governments once again subject to the supposed ‘discipline’ of the markets (what Merkel calls ‘market-conforming democracy’), as if the 2011-12 sovereign debt crisis hadn’t made clear that financial markets are just as incapable of efficiently assessing and managing the public finances of countries as they are of disciplining or correcting themselves (which, of course, is why Draghi was ultimately forced to intervene with his bond-buying program). ‘We can’t allow a regime where markets are masters of governments… It [would be] the fastest way to break up the eurozone’, says Bofinger.
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Could this be like the First Class passengers first evacuation of the Titanic? I am sure the southern Europeans will be happy with their fate in steerage. There aren’t enough life boats for more than the northern Europeans.
Isn’t this the thing AEP was going about a few weeks back, which most people ignored because there was “no confirmation in German press”?
Yes.
Seemingly intelligent people will do incredibly stupid things in defense of their entrenched beliefs in fairy tales of markets and morality. The Germans rulers really love market discipline. They seem to just love discipline for the sake of discipline.
I would say they love the discipline narrative. They use this narrative to impose their own interest.
The weird thing is that objectively it is not in their interests but they are so blind, frightened, and unsure of themselves (despite public bluster) that they adopt these idiotic policies anyway. Germany was sustained by growth in China and southern Europe, and now that growth is gone. They are now desperately trying to extract monies from the rest of Europe to bolster their overextended banks and cushion the inevitable fall in exports. It is a desperation play and won’t work. But Merkel and the whole Team Deutschland can’t imagine any thing else, no less muster the will to enact other policies. They are like the US foreign policy establishment–insular, clueless, and dangerous.
Unfortunately, insular, clueless, and dangerous accurately describes the entire Western project of the post-industrial, financialist (ie., neofeudal) states. Woe is us.
yes, I’m worried that finally they are just trying to save Deutche Bank, TBTF et too big to save, without the capitals coming from distressed euro countries
but maybe,I just have a forked tongue…
It sounds to me as though the banks want to control the governments by manipulating the risk ratings. Remember when S&P decided to downgrade US Bonds because the Obama Administration didn’t give in to the Republicans?
If the ratings agencies obtain this power in the EuroZone, they’d be able to exert considerable political control simply by downgrading the bonds of any government defying the banks’ orders.
I think is is a very good idea to have no “risk free” assets, except (perhaps) cash.
I agree that it is a very bad idea to outsource asset ratings to rating agencies because the entire model is corrupt – due to the incentive structure and because there is simply too much money to be made from running bets on rating changes, ratings are free speech, so, how can a rating agency ever be corrupt – even when it is?
And Why?
Sovereign bonds trade in the regulated markets. The effective yield contains the most current information on how “good” the bond is; higher yield, more risk, more volatile, riskier; the less volume, the more risk. This is normal asset-management stuff, banks are (mostly) capable of it. Those who aren’t should die anyway.
The real reason to bring in rating agencies is because someone wants banks to over-leverage on assets they really should not hold too many off and to allow banks to book various “bond-like” OTC-crap that is never traded in an open marked as “assets”.
Wait – you believe that Sovereign bonds accurately reflect their risks? Really? With Central Banks monetizing such debt to the tune of trillions of Dollars?
I find myself thinking this article is both right & wrong. The author’s logic is right – introducing that differentiation as they describe now would probably bring in a crisis. But the core idea is pretty reasonable. Supposed my local bank goes off and buys, say, 30 year Ukrainian debt. Should it hold capital against that? Of course it should! As a depositor I’d be appalled if it didn’t. Now Ukrainian debt isn’t really relevant here, but it shows the principle seems a good one.
It may also remove some of the incentives for bad faith from countries. Both France’s & Germany’s actions in Greece were at least partially driven by the need to protect their domestic banks who had indulged in an income boosting trade of holding Greek debt that worked because no capital was required. If a capital requirement had been in place then those banks would have held less, or no, Greek debt and their parent countries’ actions may have been different, and better for Greece. There may be the issue of who would have bought the debt instead, to which I’m not sure there is a simple answer.
I think the rating agency issue is a red-herring in this case. Deeply flawed as they are, it doesn’t remove the fact the some government debt is inherently risky.
The issue would then become how do we transition from a system that is flawed to one that is better? Or maybe it is when? It would seem this is another indication that overall the European banking system remains fragile. Do we wait for a better time? Which may mean never… It seems to me that the current rule is more of a problem than the proposed one, but finding a reasonable path from one to the other is pretty hard. And we are still wrestling with this in banking for other issues too.
I think the key point is that sovereign debt in ever larger amounts with increasingly inaccurate risk ratings is a structural consequence of the eurozone as it’s currently set up. It’s simply not possible for every country to run a trade surplus at the same time (whatever Germany might think). Absent a floating exchange rate or surplus recycling mechanism, that means ever increasing and unsustainable amounts of sovereign debt. No amount of market discipline will change that. Until that problem is resolved, measures like this are trying to achieve the impossible – which means that in practice it’s simply a list of harsher punishments.
Current account deficits don’t necessitate sovereign debt. Socializing private sector losses is what does that.
Confusing private debt and public debt is one of the Big Lies of the whole fascist neoliberal order.
As long as the European ruling class wants there to be a Euro zone, there will be a Euro zone. Period. Nothing else matters.
Freebie: Zero percent chance Britain leaves the EU. Literally, zero. Greece isn’t going anywhere either.
This is what the rulers want. If they didn’t, it would have changed already. The left still can’t figure out basic class analysis.
I don’t think the ruling class wanted what WW I turned out to be, either. But it happened from their choices.
I don’t think W and Chaney really hoped for the rise of Isis, either. But that also happened as a result of their actions.
Looks like a combination of ideology, overconfidence and hubris. Schauble would likely argue that he wants a strong EA, that a strong EA requires strong member countries and strong member countries require low government debt. He after all tried to get Greece kicked out last year. This also could be a scheme to pre-empt attempts to loosen up EA fiscal policy, where Renzi has played a frontal role. but it is v scary indeed.
You characterize it as Schauble kicking the Greeks out. Why the negative tone to that?
You can’t say that fixed exchange rates are bad (the EMU project) and say that helping Greece float their own national currency is also bad. There are only two options for countries like Greece, Italy, and Portugal. Either they peg their currency to the mark (the euro) like the original French vision back in the 1970s, or they break the peg and return to national currencies floating freely against the mark.
Those are the only two options. Free floating or fixed exchange rates.
Kicking someone out into a snowstorm in their underwear is not the same as helping them to wrap up warmly before venturing out fully prepared.
In both cases they’re going to suffer the cold but the first would prove fatal.
The German Elite cares, only and always, for the German Elite.
A warm coat, some supplies, and a map was pretty much exactly what the Germans were willing to offer if the Greeks asked. It was us (the Americans) that didn’t want Germany providing technical assistance to the Greeks for an orderly withdrawal from EMU and reintroduction of a new Greek drachma.
Plus, that analogy assumes the house is a good, warm, dry place to be, which is incompatible with also claiming that EMU is a terrible, evil ploy for German domination. And at anyrate, the notion that this is like a snowstorm is rather a stretch. Financial fraud and bankster bailouts are a multi-decade long issue, the exact opposite of a temporary emergency like a blizzard.
I sympathize with the author’s concerns; this is why allowing fraud and malinvestment in the first place is so wrong. But at this juncture, what is the alternative? The author wants us to clap for Tinkerbell, wishing for a world where there weren’t massive losses from fraud and malinvestment.
Seriously, what does the author propose? Should a special tax be levied on residents of Munich to bail out oligarchs in Athens?
This is a real stretch, but ponder this. Bismark told Kaiser Willhelm to cool it when he was getting all pissy about having tremendous power, armies, industries, etc… and wanted to start making more of Germany’s advantages and might, by using them. When the balance of power shifted too far in Europe to the French or to whomever else, Bismark lectured the young Kaiser that Britain would weigh in to restore the balance. Sticking to the pound may be the key to allow Britan to tell Germany and the EU where to get off and restoring from Germanic hegemony the economic balance of power in Europe.
Why would balance of power necessarily restore to that particular time period, though? That I think is the interesting question here.
Going back further, the story of continental Europe after Rome decayed and the Vikings and Caliphates were pushed back was basically Frankish (Google Charles Martel Battle of Tours and all that). USUK realpolitik works when Paris and Berlin are at odds with one another, but it’s not really a factor when they are cooperating.
I’m not sure of the first question. Bismark was saying there was a balance of power, Wilhelm, so don’t mess up all my good work to get it to this point. It was a plea to preserve, not restore. As for today, if you subscribe to the BOP premise, England will put Germany in check if they get too bossy and powerful with the EU.
That’s why I find Balance of Power irrelevant, at least from that perspective of London balancing Paris, Berlin, Moscow, etc. How does a small island nation of 65 million people put Germany, France, and the Benelux nations in check? They have something like 175 million residents and a lot more farmland.
Good point, and I’ll leave to people much better informed than me to speculate on how much a Brexit would diminish German hegemonic influence. I was pointing to historical precedents for the inclination to make the attempt.
If one finds it credible that the Eurozone is as at least as corrupt, ideologically sclerotic and structurally incapable of responding to any but short-term threats/rewards as the U.S. is, then this is completely unsurprising. Besides, it’s what Varoufakis and others have predicted. Plus the timing seems designed to up the ante in response to fomentations against the powers-that-be.
Bigger is better when it comes to a trade block. The EU was conceived to promote trade surpluses but they have disappeared. Not just in the EU but everywhere. So now the EU is stuck with bigger is better debt instead. The “exchange rate” pretends to be a measure of the health of the currency when in fact the health of the currency depends entirely on the well balanced health of the economy. Exchange rates that threaten sovereignty are as draconian as the German sense of debt, forcing countries to produce surpluses to protect their currencies at the expense of their own well being, which imo, is an oxymoron. Especially now in this new century. But in a frantic attempt to force this old mercantilist idea to work, finance has devastated the whole thing with tons debt that cannot be serviced. So none of this comes together regardless of any new EZ finance ministries or Fiscal Councils because these agencies are also determined to take all power away from the sovereign whose currency is depreciating. Why don’t they dispense with exchange rates altogether? Doesn’t Merkel know that a “market-conforming democracy” is total fiction? Really these new plans are same old for the EU.
The thing about EU is Germany, France and Benelux are the economic heart and everyone else feeds off them. So long as they stick together the rest will follow.
The second proposal – the Eurozone Finance Ministry – is furthering the creation of an independent financial power centre to replace national democratic controls.
USE is coming to a continent near you.
by chance, circumstance or conspiracy, it has been a little more than a decade since the european constitution was rejected a few days before the ISDA opened up CDS trading crashability in June of 2005 (as our royal majesty pointed out in her book) and the last of the govt guaranteed german Landesbank bonds were sold in July of 2005. The Amato Group report basically laid down the frame work for the european world as we know it today…by the june 2007 meetings, the first of the burp ups with West LB reacting to the massive reduction in US mortgage banking wholesale lines and the fall of the mortgage banking industry went into full swing by basically refusing to pay up on its cross party guarantees and letters of credit for US securitized loan pools…and BNP Paribas helped make more money on its prime brokerage operations by refusing to pay off and out on some of its hedge positions in august 2007…all this while the battle for ABN Amro was causing a mess with B of A prime brokerage trying to short out Fortis and Royal Bank of Scotland along with Santander…Santander survived but the other two choked on the payback for daring to force B of A out of the deal…
frat boys peeing on each others legs…
all this leads to the Schauble Solution…make everyone else look like garbage in the Euro Area so that every institution bids down the interest rate of German Govt Bonds…no matter the demographic nightmare he is leaving behind as he will not be that much longer for this earth in his condition…maybe it is all ego…IBGYBG german style…It is a sad sign when so many European woman are not interested in having enough children to keep the economy growing…
Babylon ended up turning to dust…perhaps europe will end up being a giant detroit…the chinese are moving upstream in their industrial sales…the chinese red army will print as many IOU’s as needed to sell their products to end users to compete with the German Mittelstand…
If Schauble were smart (as against being clever), he would offer to buy the Greek Non Performing Loans and offer to refi at 1.5% for 5 years no questions asked…it would be hard for the Greek borrowers to complain at that rate and it would allow him to claw deeper into control of the greek economy without looking even more like Dr K’s eviler son(it’s only 350 km from freiburg to nuremburg/furth)…
but ego and shadenfraude seem to be the game theory the ever pure are playing against the unwashed…
will the russians do venture capital style investing with their surplus oil to claw back into the eastern europe economy and look like the heroes while helping to rebuild the old warsaw pact economically…oil and gas keep the lights on and the business growing…use oil and gas as financing vehicle for end products…look like heroes and keep market share from sauds and persians…
we are living in interesting times…maybe berlusconi would have been better off not agreeing to pay reparations to khadaffy and Libya…August 30 2008…I recall something happening soon thereafter…a shift in the force…
sometimes it seems it is just the last straw that breaks the camels back…
the biggest danger for herr schambles and his Kyffhauser dreams is the Greeks and Turks stop listening to others who say “lets you and him fight” and decide its elmer season…by “giving in” to a demilitarized “New Kurdistan” Nation, dominated (and protected) by the Turkish military, Turkey can reclaim some of its lost Ottoman Oil…and by doing a buddy road trip movie with Greece, can take Cyrenaica (for greece of course) to help solve the immigrant problem (and more oil)…at that point europe would be in trouble if it did not quickly take in Turkey…as with the remnants of old Ukraine, Egypt and Iran/Iraq, Greece, Romania and Bulgaria, Turkey would be at the center of its own 300 million plus person economic zone with its power in the Black Sea and some compromise with Greece over the Aegean…
Greece and Turkey are the two most powerful members of NATO…
if they were to stop fighting each other…
for whom the bell really tolls…every man can be his own island…
That sounds like a complex, crafty plan to bolster nationalism. Germany has shown with their manufactured immigrant crisis and subsequent censoring of their victimized populace to have no nationalism of any kind. Nor have they stemmed the tide of free-movement-of-scab Schengen destruction, what they call ‘sacred.’
It’s more likely that the German elite is the same Fredmonite vulgar free believers, watching Rome burn around them.
Most of the comments are missing one crucial reality: None of the Eurozone members have a fiat currency. All bonds from EZ countries are suspect unless that country has a balanced budget (or nearly so). Just where would extra Euros get created to fund an expanding economy? If banks create the money, they also create a debt–thus a zero-sum game.
The EZ countries are now similar to US states. They can not run deficits (or at least not for long). The USA, Britain, China, Japan can do so because they create money into existence which, for better or worse, if not taxed back out of existence will either a) cause inflation or b) fund the expansion of that economy. EZ countries can not do this because the rules of the EZ prevent a member nation from monetizing its debt.
Moral of the story: having a common currency w/o a common taxing authority CAN NOT WORK unless one wants either a stagnant or dwindling economy.
I hadn’t paid close attention to the way the Eurozone was structured until everything started going down the tubes. I was surprised that they didn’t set it up that way – analogous to the way the U.S.A. and its states or Canada and our Provinces/Territories operate with taxes, transfer payments through the federal government to balance things out, overall programs etc. When the financial crisis hit I was stunned to learn how things were actually arranged in the Eurozone. It seemed about as smart as designing an aeroplane and deciding that the wings and ailerons were wasteful frivolities – and then sending the thing off on its maiden flight with a full complement of passengers over a densely populated city.
No one would have joined the EU if that was the case. West Germany was already a tad irked by the need to pay to alter East Germany. They weren’t going to do that on a Continental level. Mitterand was do trying to preserve France’s place in a world with the U.S., Japan, Russia, China, India, Brazil, and Indonesia, and Mitterand was out to preserve France’s place in the sun. The UK has kept the pound all these years.
The U.S. predates the Constitutional Order. The U.S. was reshaped rapidly by the surrogate sons of George Washington, both veterans of the Revolutionary War too, who warned of potential problems. Madison and Hamilton weren’t just random legislators. They were bigger than the fantasy Hillary in a very real way. When they spoke, people listened especially General Washington. The Articles of Confederation government produced quite a list of accomplishments for the young country.
The last Act of Dominion was 1955ish. Canada ran as divided provinces for 100 years under the Crown next to a much larger economic power which set many of the conditions of how Canada could operate. Much of Western New England is descended from turn of the 20th century economic refugees from Canada. Why didn’t Canada just reorganize 100 years earlier? Besides the Crown taking care of many issues, Canada until World War II was in many ways six different countries with starker differences than any U.S. state besides the free-slave divide. The Founding Fathers in the U.S. spent a considerable amount of time working to create not just a government but a federal style and mass culture for the whole country outside of the South.
I wasn’t talking about the EU, just the Eurozone specifically – it never occurred to me that with the introduction of a common currency that they wouldn’t have also introduced a overriding central bank, taxation distribution authority etc. because I would have thought not having that would be catastrophic (and I seem to be right about the catastrophic part). It’s actually why I was so amazed that the Eurozone happened in the first place – thorough ignorance as to what was really happening I thought the nations involved had become a sort of large federated overall state which would have been a massive change in the way Europe works.
Sovereign debt is nominally riskless when denominated in the currency of the NATIONAL central bank that issued it; Its forex value fluctuates with fluctuations in the foreign value of the nominal amount. There is no sovereign called “EURO” which issues Euros. There is a weird hotpotch of committees, sovereigno-crats and so forth which consider which member earns more Euros in trade than it spends in services. IF the terms of trade of all members EXCEPT one are negative, that one member is the only one whose debt is riskless. Except its not since EVEN THAT MEMBER does not control the forex value of its bonds. German bonds are thus, in forex terms, as risky as the overall currency risk and that is not set by Germany but by the assembly of states in the EU.
WOT A MESS
WOT A MESS