The eurozone bill will eventually be paid by Germany in part

This is a version of a column in the Irish Examiner

The Eurozone crisis has not gone away. It has been temporarily muted by a combination of a more assertive ECB and a remarkable if sullen acquiescence by Eurozone voters that debt fueled growth is unsustainable and the path to a more sustainable growth future involves significant pain.

But quiescence is not cure. Across the Eurozone unemployment, in particular amongst the younger cohorts, is high and in some cases on the rise. There is a realization that in some countries (Greece, Cyprus) debt is unpayable; in other countries (Ireland, Italy) it may become so under even mildly worse than planned economic conditions. Eurozone banks remain fragile

In the medium term then there will have to be a more definitive solution. In my reading every possible solution leads to German taxpayers picking up a tab. German politicians have for the last 18 months asserted that nothing can be done in terms of implementing lasting solutions until after the German elections. These now loom so the time is coming when either Germany accepts its role as the economic leader and with it the costs, or it continues its policies of ‘Economically, im all right Jack” . Either lead to outcomes that are costly for them, and none of these it seems are being discussed by the contenders for Dr Merkels job.

Breakup of the euro has receded as a possibility but that is merely due to the fact that it has already in part happened. We have now two parallel euros – one that is stuck within Cyprus and the other outside. Cyprus operates capital controls. This is the first step to withdrawal from a currency. The problem from the perspective of Europe as a whole is that while Cyprus is containable a Cypriot withdrawal from the currency acts as a demonstration effect. It shows what is possible. In a breakup we end up, I think, not  with two currency blocks of a weak and strong euro but with a central core of Germany plus perhaps Austria and Finland and a plethora of weaker currencies all seeking competitive devaluations along with a international banking system so ruptured as to be irreparably damaged. In that context Germany will find itself slowly drifting back into the problems that a high currency generates- lets not forget that in the early years of the last decade it was being seen as the sick man of Europe with stratospheric wage costs and a sclerotic banking system.

To retain the euro in the longterm as a viable currency requires at the barest minimum a functioning banking union, which requires as a prerequisite that there be a functioning regulator and that there be agreed loss sharing and winddown protocols. At present this is not in sight; Germany has rejected a number of proposals that would have enabled this. There is a persistent and pervasive policy expressed by some in Germany that sees German law as superseding European law, and this constitutional wrangle emerges time and again as a delaying tactic.  In addition Germany is desperately seeking to have special status granted to its politicized Landesbanks, ideally to exclude these from the banking union. Germany has granted too big to fail status to all its banks, and the consequence is that they enjoy a competitive advantage over all other states banks. This translates into a lower cost of capital for german borrowers. A properly functioning banking union will cover all banks, and so a cost is there to be borne when a banking union emerges.

Alternative approaches to dealing with debt also result in a cost to the German taxpayer. Mutualisation of debt or Eurobonds will result in the cost of borrowing for high yield countries (Such as Ireland or Italy) falling while it rises for the core. To be sure if this were to come to pass there would be massive conditionality. We have already seen that the Bundestag gets to run its eyes over the Irish budget before the Irish parliament. This would become the norm. German taxpayers would have it no other way, quite understandably. But there would be a cost. Debt writeoffs would be similar.

The final approach to dealing with unpayable debts is to inflate their nominal value away. For cultural and historical reasons inflation is anathema to Germans. And yet, outside Germany, this is probably seen as the most feasible and economically least dislocative way of dealing with these debts.

So, whatever path is taken Germany ends up picking up a tab, sooner or later. This is not politics, it’s the inevitable outworking of the economics of the union. German taxpayers are ill served by anyone pretending to them that they will not, in some fashion at some stage, be presented with a bill for the design flaws of the Euro. Every other country has paid. Germany is not immune.

 

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