In Defence of PIGS

Readers have asked for a quick verdict on the Merkel-Sarkozy deal.

I have nothing to say. There was no deal. It was a vacuous restatement of clauses that already exist in the Lisbon Treaty, or an attempt to pass off retreads such as the Tobin Tax and harmonization of the corporate tax base as if they were new.

No eurobonds, no fiscal union, no boost to the EFSF rescue fund, no change of policy on the ECB’s mandate. Zilch.

More fiscal austerity for laggards, without even the Marshall Plan we had on July 21. It is all a step backwards into the black hole.

As for appointing EU president Herman van Rompuy head of a eurozone panel, I find it remarkable that anybody should take this seriously (much as I like the poet Van Rompuy, among the best of the lot). There is already a Eurogroup, headed by Jean-Claude Juncker.

The emptiness of the summit – coupled with Sarkozy’s deliciously absurd theatrics – tells us all we need to know. Neither Merkel nor Sarkozy seem capable of rising to the occasion. Europe is drifting towards its existential crisis.

The ECB can hold the line for now by purchasing €20bn of Spanish and Italian bonds each week. But once the ECB nears €150bn or so, the markets will brace for the next crisis.

Italy alone has to raise or roll-over €68bn by the end of September. You can be sure that a great number of investors will take advantage of ECB intervention between now and then to lighten their holdings, and switch the risk to eurozone taxpayers. The ECB may have to buy at least €100bn of Italian bonds alone by late September to cap the 10-year yield at 5pc.

Perhaps the Chinese and Gulf states will keep buying. Perhaps not.

So enough on the summit.

What is exercising me more is an interview by George Soros in the German press calling for Greece and Portugal to prepare for an “orderly exit” from the eurozone. “The EU and the euro would get over it,” he said.

(”Mit dem griechischen Problem ist so grundlegend falsch umgegangen worden, dass jetzt ein möglichst geordneter Ausstieg vielleicht wirklich der beste Weg wäre. Das gilt auch für Portugal. Die EU und der Euro würden es überleben”).

This is of course music to German ears. It conforms to the Bild Zeitung narrative that Europe’s crisis is a morality tale, a debacle caused by Greco-Latin debt addiction and fecklessness. It is the Big Lie of EMU.

Mr Soros does Portugal an injustice. The country has behaved OK over the last eight years (having had its credit bubble in the late 1990s when the EMU effect caused rates to drop from 16pc to 3pc, destroying Portugal’s economy).

It has worn a hairshirt for since 2003, no little avail. By then the country was trapped in slump with chronically low productivity, the victim of an intra-EMU currency misalignment against the German bloc and an extra-EMU misalignment against the Chinese yuan.

Yes, Portugal made plenty of mistakes – didn’t we all – but it did not violate the Maastricht rules or lie about its budget figures or persistently break the EU Stability Pact.

Nor did Spain violate Maastricht. It ran a fiscal surplus of 2pc of GDP during the boom (So did Ireland). It had modest public debt. The Bank of Spain tried heroically to stop the ECB’s uber-loose monetary policy (double-digit M3 growth) from fuelling a property and credit bubble. It pioneered `dynamic provisioning’.

Italy has a primary budget surplus, mid-level total debt at 250pc of GDP, and a reformed pensions system. The European Commission estimates that on current policies Italy will have the lowest public debt to GDP ratio in Euroland by the middle of the century. I kid you the not. The lowest.

We all agree that these countries should have shaken up their labour markets. No doubt the boom-busters (Greece, Ireland, Spain) could have done more to “lean against the wind” – ie, by copying Hong Kong, which gets around the problems of the dollar peg by slashing mortgage ratios to choke property booms – but neither the ECB nor the European Commission pushed particularly hard for such measures, if at all.

The complacency was endemic in the entire EMU system. So there is something unpleasant about the attempt to blame the victims now.

The German claim that Euroland’s crisis is caused by Club Med profligacy is intellectual chutzpa. None of us should give this self-serving argument any credence.

The problem is deep and structural. These countries were thrown together into monetary union by high-handed politicians before there was any meaningful convergence of productivity, growth patterns, wage bargaining, inflation proclivities, legal systems, or sensitivity to interest rates. The Maastricht rules targeted one variable (debt) but missed all the others.

The damage was compounded by the ECB. It ran a loose monetary policy in the early Noughties, breaching its own M3 and inflation targets year after year, in order to help Germany when Germany was in trouble (for cyclical reasons, obviously)

This greatly aggravated the credit bubbles in Ireland and the South. There are no innocents in this story. All countries share blame. Germany is a sinner in all kinds of ways, not least because it seems to think it can lock in a permanent structural trade surplus, and then order others to stop running deficits.

Dr Merkel, you have a PhD in nuclear physics. You must know there cannot be good imbalances (your surplus) and bad imbalances (the Spanish, Italian, French, Portuguese deficits). The maths have to add up within a currency union.

In the old days these intra-EMU imbalances would have corrected naturally. The D-Mark would have risen. The lira and peseta would have crashed. The drachma would have crashed even more. Problem solved.

That corrective mechanism has been jammed by political forces.

We now have a remarkable situation where Merkel is pushing Southern debtors into drastic fiscal tightening without offering any offsetting stimulus in the North. This is so stupid (within a currency union) it leaves you breathless. German policy risks a self-feeding implosion of the whole system, much like the early 1930s Gold Standard – unless the ECB counters this with QE a l’outrance, which is also against German policy.

Yes, I know, a lot of readers favour fiscal austerity as an end in itself. Fine up to a point. But don’t conflate the morality of family finances (saving is good) with the entirely different imperatives of macro-economics (too much saving is extremely bad, and leads to depression).

Sarkozy has not shown much imagination or leadership. Instead of acting as Chancellor Merkel’s sidekick, he might usefully take charge of the crisis and lead a Latin liberation.

If all else fails, he should draft a letter from the leaders of France, Italy, Spain, Portugal, Ireland, Cyprus (plus Belgium, Malta and Slovenia, if they want) requesting the withdrawal of Germany and its satellites from monetary union. Germania would get the strong currency it wants and needs.

If the German bloc thought the new super-Mark would rise too far – and cause huge losses to Teutonic banks with Club Med exposure – they could peg the currency to the Latin euro at a 30pc premium and use capital controls until things calm down.

My guess is that Europe would start to recover remarkably fast once the boil had been lanced. The Latin bloc would become the growth region, and eat Germany’s lunch for a decade or so. The debt crisis would fade away like a forgotten nightmare. Sarkozy would walk tall, so to speak.

Germania can accept this or keep stumping up rescue loans and pay transfers for year after year until their citizens revolt. What they cannot expect is to have it all their way by retaining export share through a rigged currency system forever.

Ah, but what if Germany refuses either to back fiscal union or leave EMU?

Götterdämmerung.