By Ambrose Evans-Pritchard, Telegraph.co.UK | 14 May 2010
Just when you thought the EU could not go any further down the road towards authoritarian excess— it gets worse. The European Commission is calling for EU powers to vet budgets of the 27 member states before the draft laws have been presented to the House of Commons, the Tweede Kamer, the Folketing, the Bundestag, the Assemblee Nationale, or other national parliaments. It applies to Britain even though we are not in EMU.
Fonctionnaires and EU finance ministers will pass judgement on the British (or Dutch, or Danish, or French) budgets before the elected bodies of these ancient and sovereign nations have seen the proposals. Did we not we not fight the English Civil War and kill a king over such a prerogative? Yet again we are discovering the trick played on our democracies by Europe's insiders when they charged ahead with EMU, brushing aside warnings by their own staff economists that monetary union was unworkable without fiscal union.
Jacques Delors knew perfectly well that this would lead inevitably to a crisis, but it would be the "beneficial crisis" that would force sovereign parliaments to submit to demands that they would never otherwise accept. This is now playing out before our eyes. Club Med governments have built up €7 trillion sovereign debt under the cover of monetary union, which shut down the warning signals for borrowers and creditors alike. We are now near— or beyond— the point of no return.
Eurozone states must go along with this cynical entrapment, or risk economic catastrophe. The conspirators have succeeded. The €750bn shock and awe package agreed over the weekend clearly alters the character of the European Project, crossing the line towards an EU debt union and an EU Treasury. How long will it be now before the EU acquires direct tax-raising powers?
As French president Nicolas Sarkozy said: "We have a veritable economic government". I hope the excellent and proud French people realise what this means before it is too late, as it is for the Greek, Irish, Portuguese, and Spanish peoples. They are being forced by the logic of the economic machine to squeeze fiscal policy at a time when they are either in recession or trapped in a deeper perma-slump without offsetting stimulus.
A Deutsche Bank note to clients said these countries have given up all three instruments of economic control: fiscal, monetary, and exchange. They are powerless. We are under an "EU protectorate", said Spain's opposition leader Mariano Rajoy last week, though it was empty, useless rhetoric since he does not draw any of the necessary conclusions from this intolerable state of affairs. In Brussels, Mr Barroso wants EU powers to monitor current account deficits and credit growth— under pain of sanctions— in order to stop booms running out of control. "We must get to the root of the problems," he said.
Notice how one-sided this is. The entire adjustment burden falls on the people of the Club Med states— including his own nation, Portugal— though they are already trapped in debt-deflation. There is no recognition that the EMU system itself is fundamentally dysfunctional because the euro was painted on a cultural canopy that cannot possibly be deemed an "optimal currency area", nor that these countries have been grossly violated by the entirely predictable— and predicted— perversions of EMU. There is no hint that intrusive EU surveillance powers should be used to compel Germany to increase spending and tolerate higher inflation so that the EU's North-South divide can be bridged by the both camps meeting each other half way.
All responses are tilted in one direction: deflation, fiscal austerity. This is the Gold Bloc fallacy of Continental Europe from 1931 to 1936, the policy that led to Bruning's destruction of Weimar and Laval's near destruction of the Third Republic in France with his deflation decrees. It was a precursor to Laval's fateful role as the Nazi enforcer of Vichy. He was later executed by firing squad, vomitting from a botched suicide with cynanide.
The reactionary character of the EU system is astonishing to behold. Mr Barroso— a Maoist student protester on the revolutionary barricades, turned Thatcherite, turned what exactly— a Salazar, a son insu?— is becoming a serious danger to civil society and the survival of European democracy. Señor Barroso, a decent man, needs to step back and ask himself what on earth is going to be achieved by imposing a deflation death spiral on a large swathe of Europe.
Nor is there any recognition at all that the European Central Bank was itself partly responsible for the crisis that has now engulfed the South. We all forget that the ECB ran a persistently loose monetary policy during the bubble— Greenspan Lite, let us call it— and an overly tight policy after the bubble burst. A double whammy for the GIPS.
It missed its own inflation target every year, and by the end it was tolerating an 11% growth rate in the M3 money supply (against a target of 4.5%, but by then it had abandoned its Bundesbank tradition of monetarism). This was pouring petrol on the property fires of Ireland and Spain.
The ECB has since let M3 contract, doing its own part to ensure a replay of 1931, at least until Europe's politicians read the riot act on Friday and forced it to buy Greek, Portuguse, Irish, and Spanish bonds, albeit sterilized and injecting no net stimulus into the euroland system. This resassertion of political primacy is entirely appropriate. The idea that central banks should not be accountable to democracy is monstrous and untenable. Besides, they had their chance.
They showed themselves unfit for independence. Their doctrines were found to be pseudo-science. Why did the ECB pursue policies that were so destructive for the GIPS? Because it was helping to nurse Germany through its long post-reunification slump in Phase I, and then bowed to Germany's phobia of non-existent inflation in Phase II from 2008 onwards. ECB policy was twisted from the start to help one (mentally unhinged?) country. Let us at least be honest about this.
I do not envy David Cameron and George Osborne as they navigate these lethal waters. As Bruno Waterfield reports from Brussels, they will face their first clash next week when the new Chancellor is presented with the Barroso proposals, that is to say proposals for a reversal of the English Civil War and the re-establishment of Stuart monarchical absolutism. The truth is that no British government can ever put Europe on the back-burner and hope it goes away. It hits you in the face, again, and again, and again. This is why so many British ministers end up feeling a visceral hatred for the project.
In my view, the EU elites overstepped the line by ignoring the rejection of the European Constitution by French and Dutch voters, then pushing it through under the guise of the Lisbon Treaty without a popular vote, except in Ireland, and when Ireland voted 'No', to ignore that too. The enterprise has become illegitimate— it is starting to exhibit the reflexes of tyranny.
The moment of definition is fast arriving from Britain. The measures now being demanded to save monetary union cannot and will not be accepted by this Government, Nick Clegg notwithstanding. The most eurosceptic people I have ever met are those who have actually worked for the European Commission, though it takes a while— and liberation from Brussels— for these views to ferment. The outcome— un véritable gouvernement économique— will put Britain and the eurozone on such separate courses that it will amount to separation in all but name. The sooner we get the nastiness of divorce behind us, the better.
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Portugal Takes Its Punishment With Fresh Taxes
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By Ambrose Evans-Pritchard | 13 May 2010
Socialist Portugese premier Jose Socrates aims to cut the deficit by an extra 1% of GDP to 7.3% this year and 4.6% next year, but has refused to follow yesterday's move by Spain for broad-based cuts in public wages owing to constitutional constraints. The package relies on revenues, including a rise in VAT to 21%, higher income tax, and a range of corporate levies. "I ask my countrymen to make this sacrifice to defend Portugal, defend the single currency, and defend Europe," he said.
Paul Portas, leader of the free market conservatives, said the mix of policies amounted to a "fiscal bombardment of the economy" that would crush wealth creation and fail to put the country on a viable path back to recovery. The austerity plan follows a dramatic crisis last week when yields on 10-year Portuguese bonds surged to over 6%, above the level that led Greece to request an EU-IMF bail-out. Escalating distress in Portugal— and the risk of contagion to Spanish banks that hold €86bn of Portuguese debt— is what forced EU leaders to put together a combined package of €720bn to defend EMU over the weekend. The European Central Bank has been buying Portugal's bonds on the open market to force down spreads.
The quid pro quo was a pledge by Mr Socrates for further belt-tightening, no easy task for the leader of a minority government. Opposition leader Pedro Cassos Coelho said his party would back the measures since the country faces a "state of emergency". The combined austerity packages in Greece, Ireland, Spain, and Portugal cover a substantial part of the eurozone and may have broader ramifications. Italy is also considering a public sector wage freeze.
"This Club Med tightening is deeply worrying," said Charles Dumas from Lombard Street Research. "Some of these economies are going to be contracting at an annualized rate of 4% by the end of this year and that is going to spill back into Germany". Southern Europe is having to squeeze fiscal policy without offsetting stimulus from monetary policy or the exchange rate. Deutsche Bank said membership of EMU had deprived these states of all key instruments of economic management. This is not what political leaders expected in embracing the euro.
There is a risk of populist backlash if citizens start to think that they are powerless, with no clear way out of a deflation trap. Fernando Texeira dos Santos, the finance minister, said he expected "violent episodes" comparable to those in Greece but insisted that there was no other option. The CGTP trade union federation vowed to mobilize its forces. "Either we come up with a very strong reaction or we will be reduced to bread and water," he said.
While Portugal's public debt is average for EMU states at around 84% of GDP this year, the private sector is heavily indebted and reliant on external funding. Fresh EU data shows that Portugal's total debt is 331% of GDP, compared to 224% for Greece. The IMF said Portugal's labour market is the most rigid in Western Europe.
Brian Coulton, director of Fitch Ratings, said the new measures are a great improvement on the "underwhelming" plan put forward earlier this year. The agency has a rating of AA— on Portuguese debt with a negative outlook. "The country has already made substantial progress on spending cuts over the last four years and is replacing every two civil servants who retire with just one, so it make sense to rely on taxes to raise revenue quickly," he said.
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EU Imposes Wage Cuts On Spanish 'Protectorate'.
Calls For Budget 'Primacy' Over Sovereign Parliaments.
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By Ambrose Evans-Pritchard | 12 May 2010
Premier Jose Luis Zapatero told a stunned nation that public sector pay will be reduced by 5% this year and frozen in 2011. "We must make an extraordinary effort," he said. Pension rises will be shelved. The country's €2,500 baby bonus will be cancelled. Aid to the regions will be slashed and infrastructure projects will be put on ice. Mr Zapatero's own monthly pay will fall 15% to €6,515.
Mariano Rajoy, the conservative opposition leader, said years of ostrich-like denial by the Zapatero team had reduced the country to an EU "protectorate". Commission president Jose Barroso unveiled plans for EU control over national budgets, including an incendiary demand that Brussels should vet budgets before their first reading in Westminster, the Bundestag, and other parliaments. Current account deficits and credit growth will be monitored. Brussels can imposing sanctions on states that let booms run out of control. "We must get to the root of the problems," he said.
Such a plan would greatly improve the working of the EMU system, but it would also entail a drastic erosion of sovereignty. The intrusive surveillance is a wake-up call for states that have tended to view the euro as a free lunch. Mr Zapatero— who long prided himself on being an "anthropological optimist"— plans to cut the deficit from 11.2% to 6% of GDP this year, with further cuts next year. The fresh move is to placate bond vigilantes and to calm German fears that eurozone 'discipline' is breaking. He has already raised income taxes and lifted VAT from 16% to 18%.
US President Barack Obama played a key role behind the scenes, pleading with Mr Zapatero for "resolute action". The telephone call from the White House is a clear indication that contagion from Greece and Portugal to the much larger debt markets of Spain had become a global systemic threat by late last week. "The markets were going in for the kill: the eurozone itself was on the brink of collapse," said Jose Garcia Zarate from 4Cast. The austerity package has gained time but investors are eyeing the response of the Spanish people.
"Just months ago the government said it would never cut wages, so this is a very humiliating U-turn. There will be protests, but we don't know yet whether there will be a general strike," he said. Spain's UGT union federation warned of "social conflict" and vowed to inflict "maximum punishment" on the government. However, the nation as a whole has so far handled a property slump and a rise in unemployment to 20% with stoicism, befitting the tradition of the Spanish-born Stoic philosopher Seneca.
Javier Perez de Azpillaga from Goldman Sachs said Spain has climbed rapidly up the technology ladder. Its exports have grown faster than those of Italy or France. It has a low public debt of 53% of GDP, but a "highly leveraged" private sector. Real estate companies have debts of €445bn, or 45% of GDP. "Banks may not be able to recoup large parts of these loans. These losses will have to be recognized eventually, bringing down many institutions and forcing the government to recapitalize them," he said.
The 'Cajas'— public sector banks— have assets of €1.3 trillion and account for most mortgage debt. Many are struggling. The saving grace is that the two giants, Santander and BBVA, have global portfolios and are in "excellent shape". Caixa Catalunya said the stock of unsold homes in Spain reached 926,000 at the end of last year, equivalent to 6.5m in the US. It expects the market to touch bottom this year with real falls of 20% to 25% from the peak. Spanish households have been able to draw on a very high savings rate of 17.9% to absorb the shock.
Spain's wage cuts amount to an "internal devaluation" within EMU. Stephen Lewis from Monument Securities said the EU is pushing a clutch of countries into contractionary policies at the same time. These will feed on each other, creating a deflation bias across the region akin to the 'Gold Bloc' in the 1930s.
"It is not a viable policy. Weakening demand will cause the tax base to shrink. If the population could see light at the end of the tunnel, they might put up with it, but there is no light: it is a long dark passage leading nowhere," he said. The EU cites the Irish austerity plan as a model, but Ireland has an open economy with a dynamic export sector, and may be sui generis. In any case, Ireland's nominal GDP has fallen 18.6%, with no commensurate fall in debt. Ireland is not yet safely out of its debt-deflation trap.
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ECB Risks Its Reputation And A German Backlash Over Mass Bond Purchases
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By Ambrose Evans-Pritchard | 11 May 2010
Jean-Claude Trichet, the ECB's president, denied there had been any political interference. "We are fiercely and totally independent," he said. It is clear, however, that the two German members of the ECB's council voted against the move, a revelation that may cause a catastrophic political backlash in Germany. Axel Weber, ultra-hawkish head of the Bundesbank, told Boersen-Zeitung that the emergency move over the weekend had been a mistake.
"The purchase of government bonds poses significant stability risks and that's why I'm critical of this part of the ECB's council's decision, even in this extraordinary situation," he said. The rebuke is devastating. The ECB draws it authority from the legacy and aura of the Bundesbank.
The European Commission made matters worse by announcing the decision in the small hours of Monday morning before the ECB had spoken, fuelling suspicions that monetary policy is being dictated by the political authorities. French President Nicolas Sarkozy further enraged Berlin by claiming that 95% of the $1 trillion "shock and awe" rescue package was based on French proposals. "Germans are watching this in horror," said Hans Redecker, currency chief at BNP Paribas. "If this ends up in full-blown quantitative easing, people are going to be up in arms."
As recently as last Thursday Mr Trichet said the governing council had not even discussed buying bonds. Julian Callow, of Barclays Capital, described the volte-face as incredible. "The ECB has ripped up its exit strategy. They have always prided themselves on transparency and consistency, and now they have done this abrupt U-turn."
The ECB said it was intervening in "those market segments that are dysfunctional", almost certainly buying Greek, Portuguese, Irish and Spanish bonds. It will sterilise purchases through other means so that the action will not add net stimulus or undermine monetary policy, at least for now. Spreads on 10-year Greek debt fell 467 basis points to 7.75% in euphoric trading. Crucially, spreads fell 163 points to 4.62% in Portugal and 51 points to 3.92% in Spain.
Marco Annunziata, chief economist at UniCredit, said the ECB alone is powering the market, raising concerns that any rally will be short-lived. "The spread tightening has so far been driven mostly by ECB purchases and some short-covering, with much less buying interest from real money accounts," he said. Mr Redeker said China and other emerging powers have lost confidence in EU management and stopped buying Club Med bonds, leaving the euro vulnerable to further sell-offs.
The bank is predicting parity against the dollar by early 2011, but the immediate panic is over. "The ECB has done what it had to do: if spreads had continued to widen after what happened on Friday we would have faced a death spiral," he said. Marek Belka, head of the IMF's European operations, said the show of financial power buys time but cannot solve EMU's deeper structural crisis.
"It has a potential of calming the markets for a moment. I obviously don't treat it as a long-term solution. This is morphine that stabilises the patient, and the real medication and the real treatment has yet to come," he said.
Fresh EU data shows that total debt is 224% of GDP in Greece, 272% in Spain, 309% in Ireland, and 331% in Portugal, each with a heavy reliance on external finance that can dry up at any moment. They are all being forced to impose austerity measures, risking a slide into deeper slump and a potential debt-deflation trap. Details of the rescue plan are becoming clearer.
The EU has invoked the "exceptional circumstances" clause of Article 122 of the Lisbon Treaty to beef up the EU's balance of payments fund from €50bn to €110bn. The money can be used to bail-out countries within the eurozone for the first time. This is a "Euro Bond" by any other name, evoking the German nightmare of an EU debt union.
The eurozone will create a Special Purpose Vehicle able to marshal a further €440bn. This is to be a outside the EU institutions on German insistence in order to circumvent the EU's "no bail-out" law. The hope is to head off trouble at Germany's constitutional court, though it is certain to be challenged anyway.
The IMF will match this with another €220bn or so, taking the whole package to roughly €750bn. Ulrich Leuchtmann, currency chief at Commerzbank, said it is far from clear whether EU states can cover their pledge, since most have their own debt problems. "Not even the eurozone as a whole has sufficient finds to provide for member states in trouble. The volume of aid is likely to be much smaller than the official figures suggest," he said.
The ECB resisted the purchase of state bonds after the Lehman crisis, arguing such action would amount to a subsidy for the most indebted states. But it also made no secret of its disdain for quantitative easing by the Bank of England and the US Federal Reserve, viewing this as the start of a slipperly slope towards "monetisation" of deficits. ECB board member Lorenzo Bini Smaghi went so far as to deride QE as an inflation policy, saying: "It is not what people in Europe want". The sudden change in policy will come as a shock to those who see the ECB as last bastion of orthodoxy in a world of heretics.
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Europe Prepares Nuclear Response To Save Monetary Union
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By Ambrose Evans-Pritchard | 9 May 2010
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Great caution is in order. German Chancellor Angela Merkel has so far said little. The descriptions of the deal agreed by EU leaders in the early hours of Saturday are coming from the French bloc and EU bureaucrats. How many times during the Greek saga of the last four months have we heard claims from Brussels that turned out to be a distortion of what Germany had actually agreed, causing each relief rally to falter within days? They had better get it right this time.
But if the early reports are near true, the accord profoundly alters the character of the European Union. The walls of fiscal and economic sovereignty are being breached. The creation of an EU 'rescue' mechanism with powers to issue bonds with Europe's AAA rating to help eurozone states in trouble— apparently €60bn, with a separate facility that may be able to lever up to €500bn— is to go far beyond the Lisbon Treaty.
This new agency is an EU Treasury in all but name, managing an EU fiscal union where liabilities become shared. A European state is being created before our eyes. No EMU country will be allowed to default, whatever the moral hazard.
Mrs Merkel seems to have bowed to extreme pressure as contagion spread to Portugal, Ireland, and— the two clinchers— Spain and Italy. "We have a serious situation, not just in one country but in several," she said. The euro's founding fathers have for now won their strategic bet that monetary union would one day force EU states to create the machinery needed to make it work, or— put another way— that Germany would go along rather than squander its half-century investment in Europe's power-war order.
Whether the German nation will acquiesce for long is another matter. Popular fury over the Greek rescue has already cost Mrs Merkel control over North Rhine-Westphalia and with it the Bundesrat, dooming her reform agenda. The result was a rout. Events are getting out of hand, and not just on the streets of Athens.
For now, the world has avoided a financial cataclysm that would have been as serious and far-reaching as the collapse of Lehman Brothers, AIG, Fannie and Freddie in September 2008, and perhaps even worse given the already depleted capital ratios of banks and the growing aversion to sovereign debt. Bond risk on European banks as measured by the iTraxx financial index reached even higher levels late last week than in the worst moments of the Lehman crisis. The safe-haven flight into two-year German Schatz was flashing the most extreme stress warnings since the instruments where created forty years ago.
"We're seeing herd behavior in the markets that are really wolfpack behavior," said Anders Borg, Sweden's Finance Minister. Credit specialists in Frankfurt, London, and New York feared a blow-up by Thursday afternoon, when ECB president Jean-Claude Trichet said the bank's council had not even discussed the 'nuclear option' of buying Club Med bonds. The ECB seemed to be on another planet.
It was the fall-out from that press conference— at a moment when markets were losing all confidence in EU leadership— that had much to do with the DOW's 1000 point drop in New York hours later. This is not to blame Mr Trichet. He did not have a mandate to go further at that stage. The Bundesbank had blocked him, knowing full-well that ECB purchases of bonds is the end of monetary discipline and the start of a Primrose Path to Hell.
As they say in Frankfurt, a central bank should be like pudding: "the more you beat it, the harder it gets". It is pointless to fault either camp in this clash of Latin and Teutonic mores. The euro was never an "optimal currency area", which is to say it was never an "optimal legal and cultural area".
It was a late 20th Century version of the same Hegelian reflex of imposing ideas from above— making facts fit the theory— that has so cursed Europe. Schopenhauer said Hegel had "completely disorganized and ruined the minds of a whole generation". Little did he know how long the spell would last.
But I digress. There is a difference between 'quantitative easing' by the US Federal Reserve and the Bank of England for liquidity purposes, and use of this policy to soak up the debt of governments dependent on external finance to cover structural deficits. The lines are of course blurred. One purpose can leak into the other.
But whatever the objections of the Bundesbank, it seems that Europe's elected leaders pulled rank this weekend— and high time too says the French Left. The reaction in Germany has already been fierce. "The ECB is going to crank up the printing presses," said Anton Börner, head of Germany's export federation. "In five to ten years we will have a weak currency, with rising inflation and higher rates of inflation that will act as a break on growth."
I don't agree with Mr Börner. The M3 money supply is contracting in the eurozone, pointing to the risk of a Japan-style slide into deflationary perma-slump, although the panic response to that down the road may well be to call in the printers. But there is no doubt that Mr Börner represents German opinion.
The EU is invoking the "exceptional circumstances" clause of Article 122 of the Lisbon Treaty, arguing that the euro is subject to an "organized worldwide attack". This is a legal minefield. A group of professors has already filed a case at Germany's Constitutional Court, claiming that the Greek bail-out is illegal and that the EMU is degenerating into a zone of monetary disorder.
The judges have denied an immediate injunction on aid to Greece, saying that it would to be too "dangerous" to take such a step on limited facts, but it has not yet decided whether to hear the case. The battle has escalated in any case. The new EU rescue mechanism is to be permanent and no longer just bilateral help, if Mr Sarkozy is right. The professors have been given an open goal.
One almost suspects that the Kanzleramt in Berlin is so weary of this dispute that it has given up worrying about lawsuits. If the judges block an EU debt union, be it on their heads. Nor is this rescue fund any more than chemotherapy for the cancer eating away at the foundations of monetary union. It is not a cure.
The rot set in when the South joined EMU before it was ready to cope with ultra-low interest rates or match German wage-bargaining. The ECB made matters worse by gunning M3 at an 11% rate during the bubble. Club Med lurched from credit boom to bust. It is now trapped in debt deflation at an over-valued exchange rate, like Argentina with its dollar peg in 2001 until air force helicopters rescued President De La Rua from the roof of the Rosada.
The answer to this— if the objective is to save EMU— is for Germany to boost its growth and tolerate higher 'relative' inflation. This would allow the South to close the gap without tipping into a 1930s Fisherite death spiral. Yet Europe will have none of it. The weekend 'deal' demands yet more belt-tightening from the South.
Portugal is to shelve its public works projects. Spain has pledged further cuts. As for Germany, it is preparing fiscal tightening to comply with the new balanced budget amendment in its Grundgesetz.
While each component makes sense in its own narrow terms, the EU policy as a whole is madness for a currency union. Stephen Lewis from Monument Securities says Europe's leaders have forgotten the lesson of the "Gold Bloc" in the second phase of the Great Depression, when a reactionary and over-proud Continent ground itself into slump by clinging to deflationary totemism long after the circumstances had rendered this policy suicidal. We all know how it ended.
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Monetary Union Has Delivered A 'German Europe' After All
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By Ambrose Evans-Pritchard | 2 May 2010
Berlin was Europe's capital last week, basking in summer heat of 79 degrees (F). The heads of the European Central Bank and the International Monetary Fund (IMF)— both French, oddly— arrived as supplicants, pleading with Chancellor Angela Merkel and a stern finance committee of the Bundestag to save monetary union. Nowhere else mattered. The markets have stopped listening to Paris or Brussels.
If the aim of Helmut Kohl and Francois Mitterrand at Maastricht was to tie down a "European Germany" with the silken chords of EMU, they failed. Monetary union has delivered a "German Europe" after all. It has taken a Club Med bond crash and a contagion threat to German Landesbanken to force Berlin to blink. Backing for the €100bn (£87bn) bail-out for Greece— or €120bn, or €140bn— will be rushed through the Bundestag this week.
Let us be clear what has happened. This is a one-off rescue. The money is in the form of bilateral loans, not an EU bond. Mrs Merkel has refused to be bounced into an EU debt union or into acceptance of fiscal federalism.
By defending German sovereignty— as she must under the 1993 Maastricht ruling of her consititutional court— Mrs Merkel has left the eurozone in exactly the same dysfunctional state as it was when the Greek crisis first erupted, and therefore equally ill-equipped to cope with the next tremor. The damage already done to EMU credibility is huge.
"The crisis has shown to the whole world that Europe is unable to manage a monetary union: it has had to call in the IMF," said Wim Kosters, Monet Professor of European Economics at the Rhine-Westphalia Institute.
"We created rules that nobody followed. It wasn't the Commission that put a stop to the game, the markets had to stop it," he said, to warm applause from German fund managers at a Euromoney forum in Berlin. Across the street, Czech President Vaclav Klaus was enjoying equally warm applause at Humboldt University as he savaged Europe's "fair weather" currency with his usual gusto. "I thought I would be pelted with eggs and tomatoes. Something has changed in Europe," he said.
Indeed it has. A German chancellor has talked of expelling EMU violators. A chorus of German MPs— Free Democrats and Bavarian Social Christians (CSU)— has said Greece should leave, that the "taboo" must be broken. Broken it is. EMU looks more like a fixed exchange rate system, and less like the sacred union, "with the solidarity of a nation", it was billed.
Nor is this rescue a done deal. Four German professors will file a complaint at the constitutional court days after the bill is signed. They will allege a breach of the EU's "no bail-out" clause (Article 125) and try to block loan transfers. They will cite the court's 1993 ruling that EMU is compatible with Basic Law only as long as it remains an area of "monetary order" and stability.
The court will first have to decide whether to accept the case. This hiatus— probably a few days— might prove sobering for markets. If the court agrees to proceed, it will become even more sobering.
Bielefeld law professor Frank Meyer thinks the case will go nowhere. The no bail-out clause says only that Germany cannot be forced to rescue an EMU member. It does not prohibit voluntary help. Mrs Merkel says the rescue is to ensure EMU stability, not to help Greece.
This creates a legal loophole. Yet if the package is €120bn over three years, it clearly goes beyond liquidity support. Greece is being propped up.
When the next eruption hits, Germany's political class will be in a sour mood. Berlin is already gearing up for cuts to comply with its balanced budget law, newly written into the constitution. The crisis may come from Greece again, perhaps because Pasok leader George Papandreou cannot or will not deliver on the "great sacrifices" he unveiled yesterday, a cut of 16% in effective public wages, and a further rise in VAT to 23%; or because the policy of cutting the primary deficit by 10% to 12% of GDP in three years will tip the country into a death spiral. Athens said public debt will reach 140% by 2014 even after the cuts.
Or the eruption may occur in Portugal or any other EMU state that has suffered a deep erosion of competitiveness, and is now trapped in a deflationary currency union at an overvalued rate. Each has its own slow-burning political fuse, regardless of contagion. What is undeniable is that Club Med and Ireland are being told to implement the same policies that crippled Europe in the early 1930s, that led to Laval's "deflation decrees" in France, and led in different ways to Hitler, Franco, Antonescu, and Metaxas in Greece. Is that a good idea?
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As you can see, a small decline— say down to 1,100 (-9.2%) or 1,125 (-7.1%)— would scare many investors to death, but would be a normal occurrence in a stock bull market. It would be no cause to dump everything and move to a fallout shelter in Montana. If Friday's decline is the start of a more significant amount of selling, the S&P 500 could suffer a big correction down to the 1,075 area and still remain in the confines of a "higher highs and higher lows" uptrend. This would be a decline of 11.3%.