Did Germany Just Blink?

By Don Quijones, Spain & Mexico, editor at Wolf Street. Originally published at Wolf Street

A most unusual thing happened in Europe this week. In a rare climb down, Angela Merkel’s government decided not to push the European Commission to impose a punitive fine on Portugal and Spain for their persistent failure to comply with their budget deficit targets, leading one Eurogroup minister to declare that the euro zone’s Stability Pact is “dead.”

Of Europe’s 27 commissioners, only four voted in favor of applying the fines; the other 23 voted against. According to El País, the deciding factor in the decision was an impromptu phone call from German finance minister Wolfgang Schäuble to some of the more conservative commissioners, giving them the green light to forego the fine.

The U-turn offers Spanish and Portuguese taxpayers a brief but welcome respite from Troika-enforced fauxterity. As we previously pointed out, if the Commission had imposed the fine, it would not have been paid by the politicians who failed to play by the rules agreed upon in Brussels; it would have been paid by the citizenry who are already suffering the consequences of the recession that helped cause the deficits.

But does this rare act of benevolence from Germany represent a genuine shift in policy toward the Eurozone’s Club Med members or is it merely an act of political expedience?

Naturally, Schäuble and Juncker would much prefer Mariano Rajoy, a man cut from pretty much the same ideological cloth as themselves, to stay in power. Spain has been an important ally of Germany under Rajoy’s charge and the support of his party was essential in propelling Juncker into the European Commission’s top spot. What’s more, if Rajoy does eventually form a government, a new round of pre-ordained fauxterity will quickly kick in.

But there are also signs that Germany may be beginning to marginally soften its stance on austerity, prompting rating agency Fitch to lament Europe’s abandonment, once again, of fiscal discipline and economic reforms.

Merkel’s government seems to have realized that for the European project to have any kind of future in a post-Brexit world, it will have to offer a little more carrot and a little less stick. If it doesn’t, the single currency that enables German manufacturers to export at a discount rate all over the world will eventually crumble under the weight of its own contradictions.

“The problem is this,” warns U.S. rating agency Standard & Poor. “The EU, as it is currently constructed and operates, doesn’t embody a coherent ‘pooling’ of the various dimensions of nation-state sovereignty, and therefore it’s unsustainable in its current form.”

Put simply, the EU is a half-way house with too much democracy and nothing in the way of transfer union.

“There are too many moving parts in the electoral politics of 28 nation states, and too many conceivable random-like events that could push political and economic developments in one direction or another, with impossible-to-predict consequences and timelines,” the agency added.

The perfect case in point is Italy’s banking crisis. If the country’s struggling banks are not saved with a combination of public and private money — a process that, to all intents and purposes, began on Friday with the announcement of Monte dei Paschi’s suspension of the ECB’s stress test as well as a €5 billion capital expansion later this year — the resulting carnage could unleash not only a tsunami of financial contagion but also an unstoppable groundswell of political opposition to the EU.

For a taste of just how disastrous the political fallout would be for Italy’s embattled premier, Matteo Renzi, here’s an excerpt from a furious tirade given by Italian financial journalist Paolo Barnard on prime-time TV, addressing Renzi directly:

“You went to meet Mrs. Merkel to ask for a minor public funded bail-out of Italian banks and you got a sharp NO. But did anyone tell you that Germany from 2009 onwards bailed out its failing banks with public money?

“Banks, that is, with holes in their balance sheets visible from the Moon. Germany bailed them out to the tune of 704 billion euros. It was all paid for by European taxpayers’ money, public funds that is.

“It was done through the EU Commission of Mr Barroso and by Mr Mario Draghi at the ECB. Didn’t you know that Mr Renzi? Couldn’t you have barked this right into Ms Merkel’s face?”

Barnard rounded off his rant with a rallying call for Italians to follow the UK’s example and demand an exit from the EU — a prospect that should be taken very seriously given that one of the manifesto pledges of Italy’s rising opposition party, the 5-Star Movement, is to call a referendum on Italy’s membership of the euro.

Such a vote would be impossible since the Italian constitution expressly forbids referendums on international treaties such as those that hold the EU together. But as Reuters reports, Matteo Salvini, the leader of the right-wing Northern League, a member of the opposition center-right, and Beppe Grillo, founder of the 5-Star Movement, have vowed to pursue a legislative change to allow an ad-hoc exception to the Italian constitution.

Whether or not a referendum on the euro takes place, one thing that’s clear is that a post-Renzi Italy will be a much more difficult, unpredictable force to deal with than the current Renzi-governed Italy. And if Italy ever did decide to leave the Union, whether in an orderly or disorderly fashion, it would be the end of the road for the European project.

For that reason alone, the Commission and Germany will almost certainly end up granting further concessions to Italy and its Southern European neighbors, including a taxpayer-funded rescue of MPS. It may even include a bail-out top-up for Portugal’s crumbling financial system, which was left out of last week’s stress tests.

The challenge for Merkel and other leaders of core euro zone nations will be trying to persuade their already disgruntled voters of the need for increased solidarity with their struggling neighbors to the South. That may well be a bridge too far. By Don Quijones, Raging Bull-Shit.

There’s a pervasive sense of inevitability to Italy’s banking crisis. Read…  Contagion from Italy’s Bank Meltdown Spreads

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  1. Steve H.

    Quick thoughts:

    1. Betteridge Law violation. Lookin’ more like a guideline…

    2. “The problem is this,” warns U.S. rating agency Standard & Poor. “The EU, as it is currently constructed and operates, doesn’t embody a coherent ‘pooling’ of the various dimensions of nation-state sovereignty, and therefore it’s unsustainable in its current form.””
    This ‘actually’ makes me happy. Perhaps S&P isn’t just an algorithm with a rubber-stamp robot at the end.

    3. Austerity coming for Germany. 10% fewer flavors of sausage!
    Acknowledging unknown knowables, does this mean that in the US, Federal taxation allows some pain to be spread throughout the union? The NBA has revenue sharing, which means small-market teams can still make a profit. (It also has perverse consequences like Philly tanking for a half a generation…) I’m thinking, this allows the EU to devolve more easily into ‘us & them’ than the US, and the US mostly doesn’t have language differences to overcome.

  2. I Have Strange Dreams

    A possible referendum on Italy leaving the Euro zone? Ooh. Don’t they know that the Gordian Knot is impossible to unravel? Apparently, Alexander did not use his sword, but a bit of lateral thinking:

    “Aristobulus says that he undid it very easily, by simply taking out the so‑called “hestor,” or pin, of the waggon-pole, by which the yoke-fastening was held together, and then drawing away the yoke.”

    I think too many people are bamboozled by the knot’s complexity; pull the pin out and the knot will unravel itself.

  3. DJG

    As Yves Smith often writes: Sign. Sospiri. Typical of the 5Star Movement: “But as Reuters reports, 5 Star’s party leader Matteo Salvini and the party’s founder, Beppe Grillo, have vowed to pursue a legislative change to allow an ad-hoc exception to the Italian constitution.”

    5Star is a minority party. They haven’t been all that effective, and sometimes, they are just downright weird. No one even yet understands what happened when they went AWOL on the civil-unions bill. An ad-hoc referendum? Imagine an ad-hoc referendum on the Second Amendment happening in the U S of A.

    The Italians have to insist to the Troika That Is that the banks’ bad loans be put into a bank for bad loans Monte dei Paschi di Siena has to be reorganized or shut down. Renzi, for once, had the right idea. The EU / ECB / IMF idea that the taxpayers should magically pick up the tab isn’t going to work, just as it hasn’t worked in Greece.

    1. a.matthey

      “The EU / ECB / IMF idea that the taxpayers should magically pick up the tab isn’t going to work, just as it hasn’t worked in Greece.”

      What are you talking about ?
      The entire point of the EU Bank Recovery and Resolution Directive of which we speak is to protect the taxpayer by insisting on a bail-in before a bail-out .

      1. DJG

        The last few articles that I read indicated that a bail-in wasn’t in the offing. One article indicated that a couple of big Italian banks that did well in the stress test, Unicredit and Intesa San Paolo, were being pressured to take on debt from Monte dei Paschi di Siena.

        So if you have other sources, please post. But the scenario as is looks a lot like Greece.

      1. OpenThePodBayDoorsHAL

        When you read the accounts of the early Maastricht negotiations it was Helmut Kohl who was leading the charge against very significant internal German opposition… but he convinced them that the budgetary constraints would bring the Euro nations into German-style “fiscal discipline”. Oops.

    2. samhill

      5Star is a minority party. They haven’t been all that effective, and sometimes, they are just downright weird. No one even yet understands what happened when they went AWOL on the civil-unions bill. An ad-hoc referendum? Imagine an ad-hoc referendum on the Second Amendment happening in the U S of A.

      Actually, they are Italy’s single biggest party in terms of voting percentage w/ ~25% in the last election. PD & PDL are coalition parties, I don’t believe any of the single parties under those umbrellas pulled 25%. Please correct me if I’m wrong.

      Funny, as for M5S being flawed, any slight contradiction or confusion is touted as sign of incapable adhoc amateurs but for the traditional center left or right parties PD & PDL who infight at a quantum level beyond m5S and daily stab each other in the back before the morning caffe’ it’s expected and sign that all is working as it should, even a sign of professionalism or some sort of twisted Italian statesmanship.

    3. Kurt Sperry

      DJG, any particular reason you changed:

      “But as Reuters reports, Matteo Salvini, the leader of the right-wing Northern League, a member of the opposition center-right, and Beppe Grillo, founder of the 5-Star Movement, have vowed to pursue a legislative change to allow an ad-hoc exception to the Italian constitution.”


      “But as Reuters reports, 5 Star’s party leader Matteo Salvini and the party’s founder, Beppe Grillo, have vowed to pursue a legislative change to allow an ad-hoc exception to the Italian constitution.”

      Because nobody with even the most cursory knowledge of Italian politics would make that error.

      I’ve seen repeated attempts made here to falsely paint M5S as a right wing party, I’ve corrected it when I’ve seen it and it’s getting old. It’s becoming a boilerplate smear and it really needs to stop.

      1. DJG

        Kurt Sperry: That was a cut-and-paste error. I must have blanked out on the Northern League, which is indeed a rather odious bunch of people who would like to take their imaginary Padania and turn it into a suburb of Austria.

        No, I don’t believe that M5S is a right-wing party. It is populist centrist. I read the interviews and party program in Repubblica a few years back when they made their first big showing. But I also don’t believe that the M5S has decided to be an effective political party.

        That written, and I hope to have explained my mistake, on the Italian political spectrum, I am somewhere around Nichi Vendola and SEL.

      2. samhill

        I think the original article had it that way. I think I copy passed from the article and not DJG’s reply. Did the article get corrected? My short term memory’s gone?

        1. DJG

          samhill: I can’t tell. I think that something misfired when I copied the paragraph.

          In any case, I perceive M5S as center-populist-left. But it is typical of Grillo, who did Italy a service in getting rid of Berlusconi, to try out something that won’t work in his favor: Teaming up with the Northern League to demand an ad hoc and non-binding referendum.

          Matteo Renzi, who is sort of a more pleasant version of Tony Blair, then outflanks Grillo. And that Rottamatore business is mainly that fake Disruption that Lambert brings to our collective attention often.

          On the third hand, Italy is remarkable in Europe these days for having two very large lefty/centery parties, with the right in disrepute and collapse. By U.S. standards, about 60 percent of the Italian electorate is flaming commies.

  4. a different chris

    I do believe that the German* plan is to continue to play tough guy on Britain but give other countries the type of breaks that are much needed and underlay (yeah I keep hearing about racism but it’s never a problem when the working class is doing well – don’t confuse symptoms with causes) the British discontent.

    *Funny, I was intending to type “EU” but it came out “German”. Wonder why? :)

  5. ChrisAtRU

    All of this is so mind numbingly sad to someone on the heterodox (#MMT/#PK) side of econ’ fence like me.
    The 3% target is irrational. The assumption that every country in the zone is capable of internal devaluation in pursuit of “competitiveness” is absurd. Germany does not need to “blink” per se, but #BrExit is definitely going to bring one uncomfortable circumstance to bear: a nation is going to leave the EU, and everyone will be looking to see how well it does — the GIIPS in particular. My belief is that the greatest fear of EU leadership is a country successfully leaving the union, not the failure of any state within it.

  6. Badtux

    It appears that the Brexit vote is having consequences well beyond Britain’s borders… the once-unthinkable has become very thinkable, and if all of Germany’s biggest export markets leave the EU, well.

  7. EuroFreeTradeZone

    The UK did very well not joining the Euro. 2nd best GDP growth in the last 10 years after Germany. I don’t see why they won’t be successful after leaving the EU. Counties outside the EU should create a simple free trade zone in competition with EU so countries can leave EU and join a free trade zone which is what the UK thought they were signing up in the first place.

    1. Yves Smith Post author

      First, a deal like that would take decades and the UK has gutted its Foreign Department as a result of Thatcherism, so it doesn’t even have the bureaucrats to lead it. And they created a ton of opponents with their conduct in the EU, so they would not be seen as good partners.

      Second, as we’ve and others have written, the transition costs of a Brexit will be extremely large. The UK will face higher import costs, due to the sterling falling. It will certainly lose some of the City’s business. And it will lose some of its biggest other export industry, transport, since all of the foreign manufacturers have a lot of production there not to sell to the UK but to the EU, and they’ll move that out over time. And other exporters to the EU will also suffer.

      So tell me how the UK does better in the face of the items above? I have yet to see a single government official or pundit set forth a single concrete idea as to how the UK will make up for the exports goods and services it will lose, much the less how it comes out ahead.

      1. JTMcPhee

        I don’t know the answer, I am just asking: does The City actually add any value to the real economy of the U.K.? It seems they don’t pay taxes, import a lot of talent, bleed wealth out of the area, inflate one bubble after anothe, and somehow feel entitled to continue the game. Their businesses are very portable, like Wall Street, and their wealth is ex-country. Other than oooooh noooo GDP numbers, how does movement out of City players hurt, and whom?

        I am struggling with my limited understanding to figure out why the sense the City has a grip on the UKs short hairs.

        1. Yves Smith Post author

          It’s the result of the success of the Thatcher program to kill manufacturing. London dominates the UK economy and financial services are its biggest export.

          Mind you, I’m a believer in more national sovereignity…but in this case, the people who were pushing it want to escape EU labor and environmental rules. So while a Brexit could in theory be used to help the working man and woman, the people in charge of that effort want the opposite to happen.

          1. aab

            Is there any real possibility that if through some extraordinary circumstance a snap election got called soon and Corbyn took over, he could make Brexit work for the people of Britain/England (no idea what happens with Scotland in this case).

            I’ve been trying to follow along, and if I understand things reasonably well, the best course with Brexit would be to drop helicopter money on the population for years while slowly rebuilding the manufacturing and agricultural sectors. Is that correct? I realize this is very unlikely to happen, but my question here is, a) is that, indeed, the best path to making Brexit work and b) could it actually work?

        2. vlade

          actually, City pays quite a bit of taxes – although arguably less than it could/should. London contributes about 25% of all UK taxes, of which a lot of it is generated by well paid (although admitedly maybe not top paid) City generated middle/upper middle class jobs.

          So while your millions-making hedge may skip the tax, there are tens of thousands of jobs that pay mutliples of average UK salary (I’d say that the average salary in these jobs in the City would be around 60k+, which is about 2.5 times average UK salary). These are actually the jobs that Amsterdam and others are salivating over, not the top hedgies jobs.

  8. Will Richardson

    How can these be concessions if it simply gives them broadly similar treatment to France and Germany?

    The Instability and Stagnation pact was mutually assured econocide…dead in the water…it’s only a matter of time.

    As for too much democracy as they say in W1A “I don’t mean to be funny but…” you’re ‘avin’ a larf! Too little EU transfer flow solidarity more’s the truth.

  9. sunny129

    ‘ But did anyone tell you that Germany from 2009 onwards bailed out its failing banks with public money?’

    Why doesn’t the CITIZENS of other EU Countries fail to see this ‘HYPOCRISY”?

    Are they that DENS or have Zombie brains?

    Simply Amazing!

  10. samhill

    5 Star’s party leader Matteo Salvini and the party’s founder, Beppe Grillo


    Salvini heads The Nothern League a right wing anti immigrant anti-tax ‘nationalist party’ in as much as they are anti-euro/eu but also entertain a separatist faction and are anti-centralized power from Rome and for keeping their taxes away from the southern half of the country, every last penny if it were up to them. Grillo and Salvini would be unhappy in a room together, maybe akin to Marie LePen and the head of France’s “Up All Night” movement.

    IMO a M5S ref on italexit would be a BIG mistake. England sees/imagines itself as a locomotive that can leave the burning train behind, but Italians see themselves as the caboose, and cutting loose the caboose doesn’t bode well.

  11. Sound of the Suburbs

    Germany must blink before the Euro-zone is destroyed, fiscal policy is the only way out.

    The EU is the real world embodiment of an ideology where technocrat elites are in control and power is removed from nation states.

    Unfortunately, this ideology was fatally flawed in having neoclassical economics at its heart.

    The raw capitalism of neoclassical economics was in place in the 1920s and it didn’t work then either, it led to massive inequality, the Wall Street Crash of 1929 and the Great depression.

    It’s resurrection for the globalisation project has led to massive inequality, the Wall Street Crash of 2008 and a global recession.

    Its mistaken belief that capitalism itself reaches stable equilibriums lies behind the Euro-zone which we can watch polarising further and further in lock step with the rise of inequality within nations.

    The Euro was conceived as a way of removing economic control from Governments with the ECB taking over this role.

    The putative “father of the Euro”, economist Robert Mundell is reported to have explained to one of his university of Chicago students, Greg Palast: “the Euro is the easy way in which Congresses and Parliaments can be stripped of all power over monetary and fiscal policy. Bothersome democracy is removed from the economic system” Michael Hudson “Killing the Host”

    Many years ago when Alan Greenspan first proposed using monetary policy to control economies, the critics said this was far too broad a brush.

    After the dot.com crash Alan Greenspan loosened monetary policy to get the economy going again. The broad brush effect stoked a housing boom.

    When he tightened interest rates, to cool down the economy, the broad brush effect burst the housing bubble. The teaser rate mortgages unfortunately introduced enough of a delay so that cause and effect were too far apart to see the consequences of interest rate rises as they were occurring. The end result 2008.

    With the Euro-zone, the Germans were the first ones to go bubble crazy over the dot.com boom and their version of the NASDAQ collapsed by 97% in the bust.

    To help Germany, the ECB lowered interest rates and blew bubbles in the Club-Med nations that burst when the Euro-zone crisis hit.

    The Euro started going wrong after a couple of years when the first bubble burst, it’s been on the way out ever since.

    The evidence seems over-whelming that monetary policy is far too broad a brush to control economies, but who are we to learn from past mistakes?

    Ideas that raw capitalism reaches stable equilibriums that provide the best outcome for the majority prove themselves wrong again and again, but who are we to learn from past mistakes?

    The EU desperately needs to abandon its current ideology before it destroys itself, but who are they to learn from past mistakes?

    1. Sound of the Suburbs

      For those having trouble seeing the broad brush effects of monetary policy, check out housing markets throughout the West where low interest rates have blown bubbles everywhere apart from Germany.

      The German’s have always been very cautious after their hyper-inflation of the 1920s. They have succumbed to one bout of irrational exuberance since, over their dot.com boom, and have been in a state of acute embarrassment ever since.

      These bubbles have burst in the US, Ireland, Greece and Spain so far and we know what damage has been done to their economies.

      Neoclassical economists never learnt anything from the Wall Street Crash of 1929, but others did.

      Irving Fisher looked at the debt inflated asset bubble after the 1929 crash when ideas that markets reached stable equilibriums were beyond a joke.

      Fisher developed a theory of economic crises called debt-deflation, which attributed the crises to the bursting of a credit bubble.

      Hyman Minsky came up with “financial instability hypothesis” in 1974 and Steve Keen carries on with this work today.

      Steve Keen saw the debt bubble inflating in 2005, three years before 2008.

      “Minsky Moments”

      1929 – US (margin lending into US stocks)
      1989 – Japan (real estate)
      2008 – US (real estate bubble leveraged up with derivatives for global contagion)
      2010 – Ireland (real estate)
      2012 – Spain (real estate)
      2015 – China (margin lending into Chinese stocks)

  12. No one in particular

    The German’s blinked, or better Angie did, a long time ago: when they allowed Target to be misused to finance the Spanish, Italian and French deficit’s; the May 2010 weekend the first Greek (French and German Bank) bailout was conceived; and so forth.

    No more blinking necessary – the transfer of unpaid and unpayable liabilities to the responsibility of the German taxpayer is almost complete. Time is up once the creditor’s make up the sums and figure out that even Germany cannot repay them all…..

    If the Spanish or Portugese would have had to pay a fine, it would have been perceived as Germany taking the punch bowl away, triggering “contagion” aka a market tantrum…. money is slowly leaving Italy, Spain and else for month, witness Target balances, woefully under reported….

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