Bill Jamieson Nearer to the endgame

COMMENT

BILLJAMIESON | Executive Editor of The Scotsman

Nearer to the endgame

The euro crisis now strikes at Germany, the heart of the currency union.

AS 2012 has progressed, the sovereign debt crisis in the eurozone has conformed to a familiar, and deeply disturbing, pattern. Fears of default trigger sharp falls in equity markets, government bond yields rise to crisis levels and deposits flee from vulnerable banks.

Eurozone leaders hold another ‘crisis summit’. A tortuous communique is hailed as a resolution of the crisis. But after a short interval, confidence resumes its downward plunge.

Such has been the pattern since 2010, and this year is proving no exception. Barely three weeks after eurozone leaders proclaimed progress on a ‘roadmap’ for future integration and barely three days after finance ministers had approved the terms of a €100 billion loan to Spain than yields on Spanish government debt soared well above the seven per cent level widely regarded as unsustainable.

We are back where we started – or not quite. A Spanish bail-out would dwarf that required for Greece. That is why this latest development is by far the most dangerous escalation yet and may exhaust both the patience and the resources of the International Monetary Fund and eurozone institutions. Given this background it is well-nigh impossible for business to muster the confidence that is the pre-requisite for investment, expansion and new employment. All the exhortations for business to invest and all the measures in the UK to coax banks to lend to businesses have little prospect of making headway while the eurozone crisis continues and the economies of the eurozone are mired in recession. Hopes of an export-led recovery rest almost entirely on continuing growth in non-eurozone economies, Asia Pacific in particular. But for thousands of UK firms it is a recovery in key continental markets on which their hopes critically rest. And on current forecasts from HSBC, eurozone economies are set to contract in aggregate by 0.6 per cent this year.

The austerity route of yet more cutbacks in government spending now looks closed. Social tensions are increasingly evident. It now looks likely that the European Central Bank will be urged to resort to further substantial monetary easing. But even conceding that this can be little more than a cosmetic solution to a fundamental loss of competitiveness over the past 20 years, there are growing obstacles to the relentless resort to money-flooding.

Germany may still be able to avoid outright recession. But it is facing a period of prolonged low growth – an environment that will cause many voters to question further support for chronically indebted economies.

German uncertainties

That roadmap to fiscal integration is set to prove rocky. In Germany, whose support for further emergency funding is critical, there are formidable obstacles. A 2013 general election is drawing closer as the potential liabilities of Germany to the European rescue mechanisms have risen inexorably. Running parallel to this is an evident slowdown in economic confidence indicators. Germany may still be able to avoid outright recession. But it is facing a period of prolonged low growth – an environment that will cause many voters to question further support for chronically indebted economies.

German support is also conditional on the sanction of the country’s Constitutional Court. It is currently considering whether the Bundestag has the authority to approve additional contributions to enlarged eurozone rescue funds and has now deferred a decision until well into September. According to Jurgen Michels, European economist at Citigroup, the potential liabilities of the German sovereign to the European Rescue Mechanisms have increased substantially to about €400 billion. On top of this, the Bundesbank has an exposure of about €290 billion to Greece, Ireland, Italy, Portugal, Spain and Cyprus “if the Euro does not completely break up or Germany leaves the monetary union.” A 50 per cent write-down of these peripheral country debts could cost German banks about €76 billion, triggering in some cases additional capital support from the German government. Add to this contagion effects in other countries and losses could be far greater.

The current coalition failed to get sufficient support from its 330 MPs to get a majority in parliament in the recent decisions on rescue measures, while comments from senior opposition SPD sources suggest the party may push for much stricter conditions for giving the ESM the ability to lend directly to banks than the currently required establishment of an ‘effective single supervisory mechanism’.

As for the views of voters, an opinion poll in early July found that 55 per cent of those surveyed believe Germany should have kept the D-Mark and that only 10 per cent are in favour of introducing joint and several guarantees for euro area sovereign debt.

This is therefore not a crisis of Spain or Greece or Italy alone but one that strikes at the heart of the euro project and the commitment of its largest paymaster. And it is set to strike whatever the state of public opinion in Germany. Were this a crisis of Greece, or even Spain alone, Europe and the Western economies could look beyond to a contained resolution. But it is not so contained. Either the ‘roadmap’ to fiscal integration is urgently forced through or exits from the single currency zone will come to look less a matter of ‘if’ but ‘when’. n