Recently, I wrote a blog – Who is responsible for the Eurozone crisis? The simple answer: It is not Germany! – where I contended that Germany was not to blame for the Eurozone crisis. I also wrote that while Germany was not responsible, single-handedly, for the creation of the dysfunctional monetary union, its politicians were surely complicit in making the crisis deeper and longer than it otherwise could have been given the circumstances. A few weeks ago, I read an article in the Italian news (December 15, 2015) – Il piano tedesco su debito e aiuti Ue (The German plan for debt and EU aid) – which I intended to comment on when time permitted. I note that the author, one Carlo Bastasin, is also associated with the American Brookings institution, and that organisation published in English-language version of the article – Mr. Schäuble’s ultimate weapon: The restructuring of European public debts – on the same day, which makes it easier for more people to read. With Germany now the dominant economic and political force in Europe, bullying other nations to support pernicious policies in southern Europe, their latest plan demonstrates clearly that their conception of European integration bears no resemblance to a structure that might allow the common currency to function effectively in the interests of European citizens.
The article essentially summarises a leaked document – “a letter sent at the end of November by the Ministry of Finance to the heads of the Finance and Budget Committee of the German Parliament”.
The letter outlines the German Finance Minister’s plan to create:
… an automatic mechanism for sovereign debt-restructuring … designed to prevent any form of risk-sharing between euro-area countries and to confine the costs of fiscal and financial instability primarily within the more fragile countries.
The plan has the following elements:
1. An automatic mechanism would be established to cut through all the political argy bargy that has surrounded the Greek crisis.
2. As soon as “a country asks for help through the European Stability Mechanism (the ad hoc fund established in 2012), for whichever reason, sovereign bond maturities will automatically be lengthened, reducing the market value of those bonds and causing severe losses for all bondholders.”
3. Eurozone government bonds would become even more “riskier assets” than they are already.
4. The “proposal by the German government” would scrap “the regulatory exception for sovereign bonds that allows banks to hold them without hoarding capital reserves to cover eventual losses”. In other words, commercial banks in Europe would “turn away from investing in government bonds”. It is claimed that this would encourage them to “engage more intensely with the real economy” and “Economic efficiency across the euro area should increase”.
The German plan is clearly designed to force nations to limit the amount of debt they issue. In turn, given the fact that the Member States do not issue their own currency and have to do raise taxes or borrow in order to spend, the proposal is designed to restrict the capacity of Eurozone governments to run fiscal deficits.
Reflecting on the current crisis, there is an on-going denial as to what occurred in 2009 as the fiscal deficits across the Eurozone increased.
As I demonstrated in my current book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale – a significant part of the deficit response was due to the cyclical impacts on spending and taxation as a result of the collapse of non-government spending.
This response of the so-called automatic stabilisers was sufficient in many cases to push the fiscal balances beyond the 3 per cent limit allowed for under the Stability and Growth Pact (SGP). It goes without saying that the imposition of fiscal austerity in those circumstances was an absurdity.
The last thing a responsible government should do is attempt to reduce its own fiscal balance when the automatic stabilisers are pushing the deficit up as a result of a slowdown in economic activity in the non-government sector and a rise in mass unemployment.
Germany led the charge in berating governments to obey the SGP, even though in 2003 it had itself, failed to meet the requirements due to an entrenched recession. The hypocrisy displayed by the current German government in this respect was quite something else.
The German Minister of Finance seems to think the placing even further restrictions on the Member States capacity will in some way protect the Eurozone from having to bail out particular Member States who can no longer fund themselves in euros.
What the proposal effectively means is that when the nation experiences a significant reduction in non-government sector spending, whether it be from a reduction in household consumption expenditure, a fall in private capital formation, or a decrease in net exports (from the export-side), it would virtually immediately encounter difficulties in accessing private bond markets virtually immediately.
There would be little incentive for private bond investors to take on paper from a government that was facing rising deficits due to the automatic stabilisers with little prospect of being able to use any discretionary fiscal stimulus to offset the decline in non-government spending.
A recession would become almost guaranteed, the deficit would worsen as the tax revenue collapsed further, and the government would be forced to default on its outstanding euro liabilities. The only way out would be exit.
In other words, the logical extension of the German proposal is that nations, which find themselves mired in recession, would exit.
The Brookings author’s contention is that it is probable that the German scheme would increase the frailty of the Eurozone in the event of a further crisis.
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.
It is quite clear that the German proposal wants to further limit any flexibility that Member States have in meeting an economic emergency.
The Brookings author notes that:
… Berlin wants to prevent each country from invoking flexibility clauses. In particular, the Italian request for flexibility showed marked weakness on the Commission’s part during negotiations … EU Commission President Juncker was forced to choose between authorizing incumbent governments to widen their deficits for a myriad of reasons, and fostering anti-European populist movements that want to scupper the entire monetary union. This precise weakness in the coordination of centralized budgetary policies has convinced the German authorities to call for decentralized risks and depoliticized controls.
The rise of extreme populist movements in Europe (particularly those on the Right) has been fostered by the failure of the monetary system to protect citizens against mass unemployment and increasing poverty.
It is a testament to policy failure rather than any so-called flexibility, which has, in an ad hoc manner, helped in a small way to prevent the Eurozone crisis from becoming an outright human disaster.
For example, the willingness of the European Central Bank to introduce the Securities Markets Program in 2010 save the Eurozone from collapse. Germany opposed that program at the time.
The flexibility that the Italian and French governments have sought in recent months, while a ‘red rag to the bull’ for the Germans, is in fact, not sufficient to redress the mass unemployment and restore economic growth.
The problem with the German proposal is that it runs counter to any notions of further political and economic integration within Europe.
The only way the Eurozone can effectively function is if a federal fiscal capacity is established and is given enough flexibility to spend sufficient amounts to offset non-government spending gaps. Whether it be allowed to issue debt, which would be the joint responsibility of all Member States is another question.
Modern Monetary Theory (MMT) tells us that once the fiscal capacity is aligned with the currency-issuing capacity then there is no need for they government to continue to issue debt. Simple accounting transactions between the central bank and the treasury can facilitate government spending without any recourse to issuing debt.
That is a defining feature of a currency-issuing government, which floats its exchange rate.
The fact that the German proposal further sequesters any ‘federal’ agency from providing necessary fiscal resources to struggling Member States is the antithesis of where the Eurozone should be heading if it wants to maintain the common currency and allow the Member States to advance the well-being of their citizens.
The German proposal is tantamount to encouraging exit as the only viable option for most of the Member States.
That should come as no surprise given the German history of gaming the system to suit itself.
Even before the creation of the common currency, the mercantile policies of the German government and the support given to German industry via Bundesbank manipulation of the exchange rate was to the detriment of France, Italy and other EEC states.
To maintain the fixed exchange rate systems that they had agreed to required symmetrical intervention from the existing Member States’ central banks. The Bundesbank failed to act symmetrically when German trade surpluses were overwhelming and putting upward pressures on the German mark and downward pressures on the French franc and the Italian lira, among other Member State currencies.
The Bundesbank fear of inflation prevented it selling sufficient German marks in return for other currencies, which meant that the fixed exchange rate systems before the Eurozone were always under threat and the trade deficit nations will always under pressure to deliberately maintain elevated levels of unemployment and domestic recession.
This proposal is just another expression of the failure to understand what a responsible role for Germany in Europe means. The current crop of German politicians do not seem to have learned from history.
That is enough for today!
(c) Copyright 2015 William Mitchell. All Rights Reserved.
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