Revenge of the Sovereign Nation

Greek presidential guards perform a change of shift in front of the parliament in Athens (Photo: Reuters)

Greece’s astonishing decision to call a referendum – "a supreme act of democracy and of patriotism", in the words of premier George Papandreou – has more or less killed last week’s EU summit deal.

The markets cannot wait three months to find out the result, and nor is China going to lend much money to the EFSF bail-out fund until this is cleared up. The whole edifice is already at risk of crumbling. Société Générale is down 15pc this morning. The FTSE MIB index in Milan has crashed 7pc. Italian bond spreads have jumped to 450 basis points.

Unless the European Central Bank step in very soon and on a massive scale to shore up Italy, the game is up. We will have a spectacular smash-up.

If handled badly, the disorderly insolvency of the world’s third largest debtor with €1.9 trillion in public debt and nearer €3.5 trillion in total debt would be a much greater event than the fall of Credit Anstalt in 1931. (Let me add that Italy is not fundamentally insolvent. It is only in these straits because it does not have a lender of last resort, a sovereign central bank, or a sovereign currency. The euro structure itself has turned a solvent state into an insolvent state. It is reverse alchemy.)

The Anstalt debacle triggered the European banking collapse, set off tremors in London and New York, and turned recession into depression. Within four months the global financial order had essentially disintegrated.

That is the risk right now as the reality of Europe’s make-up becomes clear.

The Greek referendum – if it is not overtaken by a collapse of the government first – has left officials in Paris, Berlin, and Brussels speechless with rage. The ingratitude of them.

The spokesman of French president Nicolas Sarkozy (himself half Greek, from Thessaloniki) said the move was “irrational and dangerous”. Rainer Brüderle, Bundestag leader of the Free Democrats, said the Greeks appear to be “wriggling out” of a solemn commitment. They face outright bankruptcy, he blustered.

Well yes, but at least the Greeks are stripping away the self-serving claims of the creditor states that their “rescue” loan packages are to “save Greece”.

They are nothing of the sort. Greece has been subjected to the greatest fiscal squeeze ever attempted in a modern industrial state, without any offsetting monetary stimulus or devaluation.

The economy has so far collapsed by 14pc to 16pc since the peak – depending who you ask – and is spiralling downwards at a vertiginous pace.

The debt has exploded under the EU-IMF Troika programme. It is heading for 180pc of GDP by next year. Even under the haircut deal, Greek debt will be 120pc of GDP in 2020 after nine years of depression. That is not cure, it is a punitive sentence.

Every major claim by the inspectors at the outset of the Memorandum has turned out to be untrue. The facts are so far from the truth that it is hard to believe they ever thought it could work. The Greeks were made to suffer IMF austerity without the usual IMF cure. This was done for one purpose only, to buy time for banks and other Club Med states to beef up their defences.

It was not an unreasonable strategy (though a BIG LIE), and might not have failed entirely if the global economy recovered briskly this year and if the ECB had behaved with an ounce of common sense. Instead the ECB choose to tighten.

When the history books are written, I think scholarship will be very harsh on the handful of men running EMU monetary policy over the last three to four years. They are not as bad as the Chicago Fed of 1930 to 1932, but not much better.

So no, like the Spartans, Thebans, and Thespians at the Pass of Thermopylae, the Greeks were sacrificed to buy time for the alliance.

The referendum is a healthy reminder that Europe is a collection of sovereign democracies, tied by treaty law for certain arrangements. It is a union only in name.

Certain architects of EMU calculated that the single currency would itself become the catalyst for a quantum leap in integration that could not be achieved otherwise.

They were warned by the European Commission’s own economists and by the Bundesbank that the undertaking was unworkable without fiscal union, and probably catastrophic if extended to Southern Europe. Yet the ideological view was that any trauma would be a “beneficial crisis”, to be exploited to advance the Project.

This was the Monnet Method of fait accompli and facts on the ground. These great manipulators of Europe’s destiny may yet succeed, but so far the crisis is not been remotely beneficial.

The sovereign nation of Germany has blocked every move to fiscal union, whether Eurobonds, debt-pooling, fiscal transfers, or shared budgets. It has blocked use of the ECB as a genuine central bank. The great Verfassungsgericht has more or less declared the outcome desired by those early EMU conspirators to be illegal and off limits.

And as my old friend Gideon Rachman at the FT writes this morning: the Greek vote is “a hammer blow aimed at the most sensitive spot of the whole European construction – its lacks of popular support and legitimacy.”

Indeed, how many times did we chew this over in the restaurants of Brussels, Stockholm, Copenhagen, Dublin, or the Hague years ago, as one NO followed another every time an EU state dared to hold a referendum.

I think it is fair to say events are unfolding more or less as we expected.

Europe’s Punishment Union

Herman Van Rompuy at the end of the summit (Photo: EPA)

Very quickly, there has been much loose talk about EU fiscal union. What was agreed at 4AM this morning is nothing of the sort.

It is a "Stability Union", as Angel Merkel stated in her Bundestag speech. Chalk and cheese.

"Deeper economic integration" is for one purpose only, to "police" budgets and punish sinners.

It is about "rigorous surveillance" (point 24 of the statement) and "discipline" (25), laws enforcing "balanced budgets" (26), and prior vetting of budgets by EU police before elected parliaments have voted (26).

This certainly makes sense if you want to run a half-baked currency union. As the statement says, EMU’s leaders have learned the lesson of a decade of self-delusion. "Today no government can afford to underestimate the possible impact of public debts or housing bubbles in another eurozone country on its own economy."

But none of this is fiscal union. There is no joint bond issuance, no move to an EU treasury, no joint budgets with shared taxation and spending, no debt pooling, and no system of permanent fiscal transfers. Nor can there be without breaching a specific prohibition by Germany's top court, a prohibition that could be overcome only by changing the Grundgesetz and holding a referendum.

(Yes, you could argue that leveraging the EFSF bail-out fund to €1 trillion with "first loss" insurance of Club Med debt implies a massive German-Dutch-Austrian-Finnish-Estonian-Slovak transfer one day to the South. But again, is that really a fiscal union? Mrs Merkel says this money will never be needed because the mere pledge will restore market confidence.)

As Sir John Major wrote this morning in the FT, this does not solve EMU’s fundamental problem, which is the 30pc gap in competitiveness between North and South, and Germany’s colossal intra-EMU trade surplus at the expense of Club Med deficit states.

It is therefore unlikely to succeed. It means that Italy, Spain, Portugal, et al must close the gap with Germany by austerity alone, risking a Fisherite debt deflation spiral. As I have written many times, this is a destructive and intellectually incoherent policy, akin to the 1930s Gold Standard. It risks conjuring the very demons that Mrs Merkel warns against.

Sir John is less categorical, but the message is the same. Europe will have to evolve into a fiscal union to make the system work, but that would be inherently undemocratic without a genuine European government, parliament, and civic union. Such a supra-national union cannot enjoy democratic vitality because there is no European demos, or shared view of the world, or indeed any popular support for such a revolutionary step. Such a union would castrate historic national parliaments, to the advantage of whom?

So this "solution" leads ineluctably to an authoritarian regime. Bad situation.

The alternative is to break monetary union into viable parts, preferably with the withdrawal of greater Germania from the euro. This is off the table.

So, EMU break-up is Verboten, fiscal union is Verboten, full mobilization of the ECB – either to lift the South off the reefs through reflation, or to back-stop the system as a lender-of-last resort – is Verboten. Germany will have none of it.

Instead we have the summit conclusions – EUCO 116/11 of October 27 2011 – and a great deal of coercion.

Please tell me what exactly has been solved.

Thank you Germany

Angela Merkel glowers at the Bundestag today (Photo: Reuters)

Alone among EU leaders, Chancellor Angela Merkel goes to tonight’s summit in Brussels with an iron-clad mandate. It is a remarkable moment. Never before – to my knowledge – has a national parliament demanded and held a prior vote on an EU summit accord.

Had this principle been established a long time ago, we might have avoided much of the relentless Treaty creep and EU aggrandizement advanced by secret deals at the Bâtiment Justus Lipsius. Thank you Germany.

Thank you too, judges of the Verfassungsgericht, for giving the Bundestag a veto on EU encroachments on fiscal sovereignty. The court is seemingly the only tribunal willing and able to defend the liberties of European citizens against EU over-reach, and is therefore my supreme court too even as a British citizen.

Dr Merkel has won her vote. She secured an "own majority" for proposals to leverage the €440bn bail-out fund (EFSF) into the stratosphere, with the support of some very sheepish looking law-makers from posturing Free Democrats and Bavaria’s Social Christians.

But what a price she paid. The credibility of her team is shattered. Europe has all but destroyed her, even if she manages to limp on to the next crisis.

As she glowered darkly, speaker after speaker from the Social Democrats (SPD), the Greens, and Die Linke, asked how she could possibly reconcile her plan to leverage the EFSF to €1 trillion or €1.5 trillion (we still don’t know how much) with solemn pledges to the Bundestag just three weeks ago that there would be no such leverage.

"Shameless abuse of the truth," was the verdict of SPD leader Frank-Walter Steinmeier. The government had acted "tactically" at every turn, "misled the people", "held back information", "crossed every red line", brought Europe "to its knees" with botched policies, and lied blatantly about EFSF leverage.

"You came here to say there would be no leverage, not three years ago, not three months ago, but three weeks ago. You denied everything."

"This is a matter of democracy in our country. Trust is the resource with which we all work." (For those German speakers who watched the debate, excuse my instant and loose translation, but I think it is not far off.)

Die Linke (Left) leader Gregor Gysi was electrifying. "It is the arrogance of power," he began, and never let go.

"Every week you come up with a different story about this crisis."

"We were told there would be no leverage and you have reversed everything in a matter of weeks. Now we learn that the 20pc loss will fall entirely on taxpayers. They alone will pay. That is the decision you are taking."

"Why don’t you tell German taxpayers the truth? They are being asked to pay the losses for French banks."

Green leader Jürgen Trittin rebuked Dr Merkel for hiding the true implications of EFSF leverage, particularly the plan to insure the first 20pc of losses on Club Med bonds.

"Why are you shying away from telling the people the truth? You must tell people what this leverage means. You must explain to them what the risk is, and why it is necessary. But you wriggled out of it."

"You came here three weeks ago and said there would be no leverage. This is the sort of thing that unnerves people."

And so it went on, raw red-blooded democracy.

The unpleasant truth is that the EFSF leverage proposals are idiotic, the worst sort of financial engineering, legerdemain, and trickery.

As countless economists have pointed out, it concentrates risk. Germany’s €211bn commitment to the fund is not technically breached but the risk of suffering large and perhaps total loss is vastly increased. Creditor states switch from protected senior status on Greek, Portuguese, or Italian debt to the bottom rung on new slabs of sub-prime structured credit. The bluff might well be called.

The consequence will be to bring forward the downgrade of France and other states. It will accelerate contagion to the core, not stop it.

Why is Germany pushing for such a destructive policy? Because it dares not cross the €211bn red-line that has become totemic in the Bundestag, and because it has for ideological and cultural reasons excluded the one option that can plausibly halt the eurozone crisis – which is mobilizing the full fire-power of the European Central Bank.

It should be obvious by now that euroland needs an authentic lender-of-last-resort. Yes, there is a risk that ECB bond purchases could degenerate into chronic monetisation of deficits. But it is an even greater risk that the EFSF – as proposed – will set off a calamitous chain of events.

Personally, I felt almost swept along by Chancellor Merkel as she pleaded for support to help put Greece "back on its feet again", etc, etc, and warned with pathos that another fifty years of peace in Europe cannot be taken for granted.

But as soon as you think about it, such a claim to idealism is make-believe. Her own government is the architect and enforcer of one-sided austerity policies – without offsetting monetary and exchange stimulus, or demand growth in the North – that are pushing Southern Europe into debt deflation and a downward economic spiral.

It is her own call for bondholder haircuts in Greece that set off contagion from Greece, first to Ireland and Portugal, and then to Italy and Spain. It is her refusal to contemplate a change in the mandate of the ECB – by treaty if necessary – that is now exacerbating the crisis.

Far from preserving the peace of Europe for another fifty years, her policies are more likely to bring about the very mischief and grief she warns against.

So let us take her Rhetorik with a pinch of salt.

Still, a splendid day for German democracy.

A leveraged EFSF is pure poison

French banks are vulnerable (Photo: Reuters)

Big snag. If Europe’s leaders do indeed leverage their €440bn bail-out fund (EFSF) to €2 trillion or €3 trillion through some form of "first loss" insurance on Club Med bonds – as markets now seem to assume – the consequences will be swift and brutal.

Professor Ansgar Belke, from Berlin's DIW Institute, said any leveraging of the EFSF would be "poisonous" for France’s AAA rating and would set off an uncontrollable chain of events.

"It counteracts all efforts made so far to stabilize the eurozone debt crisis, which are premised on the AAA rating of a sufficiently large number of strong economies. In extremis, it would probably cause the break-up of the eurozone", he told Handlesblatt.

France is already vulnerable. It has the worst budget deficit and primary deficit of the AAA states in Euroland. (Yes, Britain is worse, but the UK has a sovereign currency and central bank. Chalk and cheese.)

Dr Belke said France is already under pressure. BNP Paribas, Société Générale, Crédit Agricole may need €20bn in fresh capital, with knock-on risk for the French state. He warned that France’s public debt (Now 82pc of GDP) would shoot up to 90pc of GDP if the debt crisis rumbles on. Variants of this theme were picked up by other German economists in a Handelsblatt forum.

Thorsten Polleit from Barclays Capital said France’s banking woes could put "massive pressure" on French finances, but the risks do not stop there. Germany itself is at risk. "The bail-out burdens taken on by the German government could lead to a drastic deterioration of our own debt, and put Germany’s AAA in doubt."

Mr Polleit told me Germany’s debt was 83.2pc of GDP at the end of last year (higher than France, but the current deficit is much lower). "Of course there is a danger. We are in a tough situation and there is no easy way out."

We will find out soon enough what EU leaders actually intend to do – rather than what the European Commission would like them to do. As US Treasury Tim Geithner said "the devil is in the details", not in the headlines.

Chancellor Angela Merkel sought to play down the Grand Plan earlier today. "Dreams that everything will be resolved and dealt with by next Monday cannot be fulfilled," said her spokesman. There is no "big bang" miracle cure.

So far there is an ominous silence from the rating agencies. One has to wonder what they think of apparent plans to use the EFSF for "first loss" guarantees of EMU debt — debt to be upheld by states that may or may not be solvent, depending on the trajectory of the world economy and the trigger-happy reflexes of uber-hawks at the European Central Bank.

At the moment the EFSF is a privilleged creditor (or so we assume: this is not contractual).

Banks, life insurers, pension funds, and others who bought Greek debt in good faith will (and Portuguese debt?) take the loss. Only once they are reduced to zero with a 100pc haircut does EFSF debt start to be written down – ie, this is "last loss".

The new "first loss" idea inverts the order. The EFSF would take the first hit. That changes everything. Surely the EFSF deserves no more that BBB rating, or perhaps just CCC, if EU leaders really embark on this course.

The whole discussion has become surreal.

The dangerous subversion of Germany democracy

The Bundestag and the German people are being undermined (Photo: Alamy)

Optimism over Europe’s "grand plan" to shore up EMU was widely said to be the cause of yesterday’s torrid rally on global markets, lifting the CAC, DAX, Dow, crude and copper altogether.

This is interesting, since Germany’s finance minister Wolfgang Schäuble has given an iron-clad assurance to the Bundestag that no such plan exists and that Germany will not support any attempt to "leverage" the EU’s €440bn bail-out plan to €2 trillion, or any other sum.

"I don’t understand how anyone in the European Commission can have such a stupid idea. The result would be to endanger the AAA sovereign debt ratings of other member states. It makes no sense."

All of this was out in the open and widely reported. Markets appear to be acting on the firm belief that he is lying to lawmakers, that there is indeed a secret plan, that it will be implemented once the inconvenience of the Bundestag’s vote on the EFSF tomorrow is safely out of the way, and that German democracy is being cynically subverted.

The markets may or may not right about this. Mr Schäuble has a habit of promising one thing in Brussels and stating another in Berlin.

But it is surely an unhealthy state of affairs. One of the happiest achievements of the post-War era is the emergence of a free, flourishing, and democratic Germany under the rule of law.

Carsten Schneider, finance spokesman for the Social Democrats, spoke for many last week, denouncing the shabby back-room dealings as a scandal. "A new multi-trillion programme is being cooked up in Washington and Brussels, while the wool is being pulled over the eyes of Bundestag and German public. This is unacceptable."

Indeed it is.

Mr Schäuble has now been forced to give a categorical assurance that the EFSF will not be expanded. He cannot break his word without very serious consequences, or before the financial crisis turns deadly.

We have reached the point where the unseemly scramble to find ever more inventive and extreme ways to save monetary union – yet without coming clean, and invariably by trying to deceive German citizens about the real implications of each deal – is clashing directly with the integrity of German democracy.

Andreas Vosskuhle, head of the constitutional court or Verfassungsgericht, specifically warned this week that Germany is entering treacherous waters.

He said that the improvisation of far-reaching policies to shore up EMU had become "dangerous", and warned against schemes to circumvent the rule of law with backroom deals. "Germany has a great affinity for the rule of law. People expect the political class to obey the rules."

"There is little leeway left for giving up core powers to the EU. If one wants to go beyond this limit – which might be politically legitimate and desirable – then Germany must give itself a new constitution. A referendum would be necessary. This cannot be done without the people," he told the Frankfurter Allgemeine.

Dr Vosskuhle reminded politicians that they do not have the legal authority to sign away German constitutional prerogatives.

"The sovereignty of the German state is inviolate and anchored in perpetuity by basic law. It may not be abandoned by the legislature (even with its powers to amend the constitution)," he said.

He repeated that the Court had set clear boundaries to EU bail-outs in a ruling earlier this month. "Our judgment makes clear that the Bundestag cannot abdicate its fiscal responsibilities to other actors. And no permanent mechanism may be created that entails taking over the liabilities of other states," he said.

Otmar Issing, the ECB’s founding guru, has gone even further in recent weeks, warning that the current course must ultimately provoke the "resistance of the people" and perhaps civil wars.

Dr Issing is not a German nationalist. He is open to the idea of an authentic union with a "European government controlled by a European Parliament" on democratic principles.

What he opposes is the deformed halfway house that is now Europe, where supra-national bodies – accountable to no elected body and taking decisions behind closed doors – are usurping legislative primacy over tax and spending. As he reminds us, it was monarchical assault on the power of the purse that led to England’s Civil War, and America’s Revolution.

Large matters.

As for the assurances of Mr Schauble, either he really is lying, in which case there will be all Hell to pay in the Bundestag, and most likely a massive political backlash that will change German politics profoundly.

Or he is not lying, in which case there is no plan to save the eurozone, and we therefore face the mounting risk of a spiral into a banking crash, serial sovereign defaults, and a disorderly break-up of EMU.

Not pretty.

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.

Eurogeddon postponed again as ECB gains three weeks

ECB president Jean-Claude Trichet

Eurogeddon is postponed again. Jean-Claude Trichet has saved civilization. There will not be a spiralling bond crisis in Italy and Spain in early August after all. An imminent disintegration of Europe’s financial system has been averted.

On balance, this is good, though not optimal. (Lancing the boil immediately by organising an orderly German exit from EMU would be better: it would halt the Fisherite debt-deflation spiral in Club Med and clear the way for recovery.)

Spanish 10-year yields dropped 85 points to 5.2pc, Italian yields fell 76 points to 5.32pc in the first hour or so of trading after last night’s announcement.

Now for the hard part. Unless the ECB is willing to back up its new role as lender-of-last-resort with massive purchases of Italian and Spanish debt, it will inevitably be tested by markets. Weak hands will take advantage of rallies to offload holdings onto the ECB, i.e. onto eurozone taxpayers. Frankfurt will find itself underwater very quickly without a legal mandate or EU treaty authority.

RBS calculates that the ECB will have to buy roughly half the outstanding tradeable debt of the two countries to defend the line. RBS calculates €850bn. I would put it nearer €1 trillion.

This is currently impossible. The ECB is acting as a temporary back-stop until the revamped EFSF bail-out fund is ratified by all parliaments over coming months. The EFSF will then take the baton.

Yet as we all know, the EFSF has no money. The parliaments have not even ratified the earlier boost to €440bn. As of today, the fund has barely €80bn left after all the commitments to Greece, Ireland, and Portugal. It remains a fiction.

As for boosting it further to €2 trillion or more – as suggested by Citigroup, RBS, and the European Parliament – we face a little local difficulty across the Rhine. Bavaria’s Social Christians said they will not back one bent Pfennig for extra bail-outs, and the FDP Free Democrats are almost of the same mood. Angela Merkel’s CDU base is more mutinous by the day. In any case, such an expansion of the EFSF would set off its own chain-reaction as France and then Germany lost their AAAs and slithered into the swamp.

So, obviously markets will turn very nervous once ECB purchases approach the level that corresponds to the EFSF ceiling. They know that the ECB’s Teutons will die in a ditch rather than cross that line, taking the bond risk directly onto the ECB’s own balance sheet.

That moment could come within three weeks.

Gary Jenkins from Evolution Securities notes that Greek yields fell from 12.43pc to 7.35pc in the week following the ECB’s first bond purchases, only to fly out of control six weeks later.

Good template.

Whether buying time can solve anything depends on whether investors believe that Italy and Spain can grow their way out of debt traps. If we are on the cusp of a new global boom, then Italy and Spain can make it within EMU’s current structure.

If we are going into a global double-dip (defined as global growth below 2.5pc), they have no chance at all unless the ECB throws all caution to the wind, defenestrates the two German members from the 36th floor of the Eurotower, and embraces QE a l’outrance.

Germany might not like that.

I have a nasty feeling that nothing whatsoever has been resolved.

Euroggedon postponed again as ECB gains three weeks

ECB president Jean-Claude Trichet

Euroggedon is postponed again. Jean-Claude Trichet has saved civilization. There will not be a spiralling bond crisis in Italy and Spain in early August after all. An imminent disintegration of Europe’s financial system has been averted.

On balance, this is good, though not optimal. (Lancing the boil immediately by organising an orderly German exit from EMU would be better: it would halt the Fisherite debt-deflation spiral in Club Med and clear the way for recovery.)

Spanish 10-year yields dropped 85 points to 5.2pc, Italian yields fell 76 points to 5.32pc in the first hour or so of trading after last night’s announcement.

Now for the hard part. Unless the ECB is willing to back up its new role as lender-of-last-resort with massive purchases of Italian and Spanish debt, it will inevitably be tested by markets. Weak hands will take advantage of rallies to offload holdings onto the ECB, i.e. onto eurozone taxpayers. Frankfurt will find itself underwater very quickly without a legal mandate or EU treaty authority.

RBS calculates that the ECB will have to buy roughly half the outstanding tradeable debt of the two countries to defend the line. RBS calculates €850bn. I would put it nearer €1 trillion.

This is currently impossible. The ECB is acting as a temporary back-stop until the revamped EFSF bail-out fund is ratified by all parliaments over coming months. The EFSF will then take the baton.

Yet as we all know, the EFSF has no money. The parliaments have not even ratified the earlier boost to €440bn. As of today, the fund has barely €80bn left after all the commitments to Greece, Ireland, and Portugal. It remains a fiction.

As for boosting it further to €2 trillion or more – as suggested by Citigroup, RBS, and the European Parliament – we face a little local difficulty across the Rhine. Bavaria’s Social Christians said they will not back one bent Pfennig for extra bail-outs, and the FDP Free Democrats are almost of the same mood. Angela Merkel’s CDU base is more mutinous by the day. In any case, such an expansion of the EFSF would set off its own chain-reaction as France and then Germany lost their AAAs and slithered into the swamp.

So, obviously markets will turn very nervous once ECB purchases approach the level that corresponds to the EFSF ceiling. They know that the ECB’s Teutons will die in a ditch rather than cross that line, taking the bond risk directly onto the ECB’s own balance sheet.

That moment could come within three weeks.

Gary Jenkins from Evolution Securities notes that Greek yields fell from 12.43pc to 7.35pc in the week following the ECB’s first bond purchases, only to fly out of control six weeks later.

Good template.

Whether buying time can solve anything depends on whether investors believe that Italy and Spain can grow their way out of debt traps. If we are on the cusp of a new global boom, then Italy and Spain can make it within EMU’s current structure.

If we are going into a global double-dip (defined as global growth below 2.5pc), they have no chance at all unless the ECB throws all caution to the wind, defenestrates the two German members from the 36th floor of the Eurotower, and embraces QE a l’outrance.

Germany might not like that.

I have a nasty feeling that nothing whatsoever has been resolved.

Please Europe, either put up or break up

So we wait to see whether the ECB is really willing to sit back and let the whole edifice collapse.

Are the Bundesbankers really so stubborn that they would rather bring down the European financial system, tank the world, and cause a deep global depression, rather than enter the bond market on sufficient scale to back-stop Italy and Spain?

Tough call. 50:50, I’d say.

The hardliners are seriously ideological people, and there seem to be some in the upper echelons of German policy-making (though obviously not the floundering bean-counter Schauble, or the battered Chancellor), who suspect that it might be better to lance the boil by forcing an immediate break-up of EMU.

I note that Belgium’s central bank Coene hinted that the ECB is withholding bond purchases to force Italy and Spain to push through – you guessed it – yet more growth-destroying austerity. Dangerous game. These 1930s deflationists really are a menace to society.

In a nutshell, unless the ECB is willing to step in – I mean really step in, not piss in the wind – until such a time as the revamped EFSF bail-out is ratified by all parliaments and is ready to take the baton (say November), and unless the EFSF itself is quadrupled in size and given to a €2 trillion mandate without all the German-imposed ifs and buts, then the game is up.

If the EU authorities refuse to do this, it is best for everybody that is recognized immediately and that arrangements are made for the orderly break-up of monetary union …  not next year, or next month, but next week.

There are two basic choices: 1) a spiralling crisis in the South, leading to a string of countries being blown out of EMU, causing a catastrophic financial collapse akin to 1931.

As Citi’s William Buiter told me yesterday, the issue is not how long Italy and Spain can ride out the storm in bond markets. There would be a banking and insurance crisis long before sovereign defaults came into play simply because the fall in bond prices on the secondary market is causing carnage to bank books (among other transmission mechanisms).

Or 2) Germany and its satellite economies withdraw immediately from EMU (let us say the Netherlands, Austria, Finland, Flanders, and Luxembourg). This allows the South to enjoy a much-needed devaluation to restore competitiveness without going through a disastrous Fisherite debt deflation. Their contracts would remain in euros, so they would not need to default.

Temporary capital controls and some form of financial repression would obviously been needed for a few weeks. The German bloc would have to stand ready to recapitalize its banking system with €100bn perhaps (peanuts in the bigger picture) to offset the shock effect on sudden exchange losses on Club Med debt.

This would require French leadership. (I have almost given up on Germany). Carried out with Napoleonic speed and determination, I think this could conceivably prove the game-changer that halted the downward global spiral.

Markets would very quickly see that the greatest impediments to recovery had been removed. We could rejoice, and breathe little easier again. My guess is that stock markets would surge in Milan, Madrid, and Paris, as occurred in London and Milan after the ERM crisis in 1992.

Yes, I know, EMU is not the ERM, blah, blah, sanctity of the Project, blah, blah, blah.

But just how different is it really?

Will this happen?  I don’t see much evidence that anybody is thinking along these lines. (The Buba men seem to want to expel Greece, Portugal, etc, which is not at all what I mean).

Just my instant thoughts on a story that is moving with lightning speed.

More later, after some Rioja, and a Vecchia Romagna to finish.