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Back to today’s news. And I think this morning we’ll turn to the latest damp squib out of the eurozone...
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Europe’s biggest problem is the same as always – who pays?
The EU has been trying to pull together an agreement for a “recovery fund” that will help its hardest-hit members to get back on their feet after the coronavirus storm has passed. It had another meeting last night, one that didn’t really seem to advance the cause very much. Everyone agrees that there should be a big package, into the trillions of euros. The fundamental problem, as ever, is agreeing who will pay for it all.
Putting it simply, the countries with the money (loosely speaking, a “northern” coalition led by Germany, along with Austria, the Netherland, Sweden and Denmark), want the money to be in the form of loans. In other words, you get it now, but you have to pay it back eventually.
Meanwhile, the countries more likely to be in receipt of the money (let’s call it a “southern” coalition even although that’s geographically questionable, given that it's increasingly led by France) want it to be in the form of grants. In other words, you don’t have to pay it back.
It’s summed up by the comments of German chancellor Angela Merkel, and those of French president Emmanuel Macron. Merkel said that grants “do not belong in the category of what I can agree”, whereas Macron said that there have to be “real budgetary transfers”.
Clearly, the EU (and the eurozone specifically) is suffering from its usual problem. It is an unsatisfactory and unsustainable halfway house between a federation and a trading bloc.
Again, as I’ve stated before, the real problem is the euro. You can’t share a currency across a region for long if you don’t also share tax revenues. That means that you also need to share politics and laws and institutions – you need to be a union.
And ultimately, that’s what this argument – and all the other arguments – are about. There isn’t enough appetite to go towards closer union. But there’s not enough appetite to split up again either.
The problem is that the halfway house leads to economic sclerosis for a lot of countries (Italy being the notable laggard). So the status quo cannot just rumble on. But what could force a change?
If the eurozone breaks up, it will be voters, not markets, that drive it
During the Greek debt crisis, the big risk was that markets could force the eurozone to a crisis point. That was when Greece was locked out of borrowing any money from international markets, and was forced into a deflationary depression by its lack of control over its currency.
I don’t think that this is a genuine risk anymore. Italian bond yields are worth paying attention to, but it still seems clear to me – maybe I’m wrong, maybe I’m missing something – that the European Central Bank (ECB) now has all the leeway it needs to prevent any eurozone country from being forced into sovereign default, if push comes to shove (which it will).
As I’ve noted many times in the past, Mario Draghi – with the assistance of a rolling financial crisis – did all of the heavy lifting required to drive the ECB into a position where it could bypass political objections to printing money, which meant it could cap sovereign bond yields in the eurozone.
A push towards unlimited quantitative easing (QE), just to make sure of this, is a much simpler task, particularly if the ECB just declares that it will buy whatever it takes in order to maintain bond yields across the eurozone at a certain level.
Meanwhile, that buys the EU space to find yet another fudge on the loan/grants front that probably won’t make anyone happy but that staves off crisis for another few months.
The thing is, the pressure always comes out somewhere. If the EU keeps relying on the ECB to paper over the institutional gaps that it finds otherwise politically impossible to fill, then the contradictions will show up elsewhere, mainly in the form of ongoing weak growth.
And while central banks are less prominent in the public consciousness than politicians, the moral hazard created by promising an unlimited backstop to Italian government debt, for example, will not go unnoticed by the northern countries for very long.
I’ve said before that the eurozone will not break up until a group of voters in one of the bigger member nations put an explicitly anti-euro party into power. I still think that this is the thing to watch out for.
And despite the attention focused on Italy, I think it’s the northern countries you’ll have to watch. It’s a lot less scary to leave the euro if you expect your redenominated savings to rise in value, rather than fall.
In short, then, if you’re wondering about a eurozone break up, I’d keep an eye on elections as well as the economic data.
By the way, thanks very much for all your emails and comments about house prices. I’ve had 60-odd so far, so I haven’t had a chance to look at them all yet, but I’ll be reading through them all and sharing some of the most interesting points and experiences in Money Morning all through next week. Check out the piece if you haven’t already, and do please keep the comments coming.
