<nettime> Other News - Why The European Periphery Needs A Post-Euro Strategy

["Michael Gurstein" <gurstein@gmail.com>]

It appears that Germany is proposing to impose similar regimes to those
of Greece on other of the "periphery" countries at an accelerated pace.

M

Why The European Periphery Needs A Post-Euro Strategy

Thomas Fazi - Social Europe

In recent weeks, Germany has put forward two proposals for the 'future
viability' of the EMU that, if approved, would radically alter the
nature of the currency union. For the worse.

The first proposal, already at the centre of high-level
intergovernmental discussions, comes from the German Council of Economic
Experts, the country's most influential economic advisory group
(sometimes referred to as the 'five wise men'). It has the backing of
the Bundesbank, of the German finance minister Wolfgang Schaeuble and, it
would appear, even of Mario Draghi.

Ostensibly aimed at 'severing the link between banks and government'
(just like the banking union) and 'ensuring long-term debt
sustainability', it calls for: (i) removing the exemption from
risk-weighting for sovereign exposures, which
 essentially means
that government bonds would longer be considered a risk-free asset for
banks (as they are now under Basel rules), but would be 'weighted'
according to the 'sovereign default risk' of the country in question (as
determined by the fraud-prone rating agencies depicted in The Big
Short); (ii) putting a cap on the overall risk-weighted sovereign
exposure of banks; and (iii) introducing an automatic 'sovereign
insolvency mechanism' that would essentially extend to sovereigns the
bail-in rule introduced for banks by the banking union, meaning that if
a country requires financial assistance from the European Stability
Mechanism (ESM), for whichever reason, it will have to lengthen
sovereign bond maturities (reducing the market value of those bonds and
causing severe losses for all bondholders) and, if necessary, impose a
nominal 'haircut' on private creditors.

The second proposal, initially put forward by Schaeuble and fellow
high-ranking member of the CDU party Karl Lamers and revived in recent
weeks by the governors of the German and French central banks, Jens
Weidmann (Bundesbank) and François Villeroy de Galhau (Banque de
France), calls for the creation of a 'eurozone finance ministry', in
connection with an 'independent fiscal council'.

At first, both proposals might appear reasonable -- even progressive!
Isn't an EU- or EMU-level sovereign debt restructuring mechanism and
fiscal authority precisely what many progressives have been advocating
for years? As always, the devil is in the detail.

As for the proposed 'sovereign bail-in' scheme, it's not hard to see why
it would result in the exact opposite of its stated aims. The first
effect of it coming into force would be to open up huge holes in the
balance sheets of the banks of the 'riskier' countries (at the time of
writing, all periphery countries except Ireland have an S&P rating of
BBB+ or less), since banks tend to hold a large percentage of their
country's public debt; in the case of a country like Italy, where the
banks own around 400 billion euros of government debt and are already
severely undercapitalised, the effects on the banking system would be
catastrophic.

We know for fact -- despite the feeble reassurances of the eurozone's
finance ministers -- that the banking union's bail-in rule -- for reasons
that I have explained at length here -- is already causing a slow-motion
bank run on periphery banks, with periphery countries experiencing
massive capital flight towards core countries (almost on par with 2012
levels), as bondholders and depositors flee the banks of the weaker
countries in fear of looming bail-ins, confiscations, capital controls
and bank failures of the kind that we have seen in Greece and Cyprus.
Extending that same rule also to sovereigns would simply mean doubling
down on a measure that is already exacerbating core-periphery imbalances
and increasing (rather than reducing) the risk of banking crises. The
risk is not limited just to periphery countries, of course, as the
recent panic over Deutsche Bank testifies.

Moreover, the proposed measure, far from 'severing the link between
banks and government', would almost certainly ignite a new European bond
crisis -- of which are already witnessing the first signs -- as banks rush
to offload their holdings of 'risky' government debt in favour of
'safer' bonds, such as German ones (as the German Council of Economic
Experts report acknowledges, 'as a result of the risk-adjusted large
exposure limit, there is more leeway for holding high-quality government
bonds than with a fixed limit'). The report estimates that banks will
have to divest around 600 billion euros of government debt. As Carlo
Bastasin of the Brookings Institution writes:

    Sovereign bonds have a unique and pivotal role for the financial
    systems of the euro-area. So, once sovereign bonds in some euro-area
    countries become more risky, the whole financial system might turn
    frail, affecting growth and economic stability. 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.

As noted by the German economist Peter Bofinger, the only member of the
German Council of Economic Experts to vote against the sovereign bail-in
plan, this would almost certainly ignite a 2012-style self-fulfilling
sovereign debt crisis, as periphery countries' bond yields would quickly
rise to unsustainable levels, making it increasingly hard for
governments to roll over maturing debt at reasonable prices and
eventually forcing them to turn to the ESM for help, which would entail
even heavier losses for their banks and an even heavier dose of
austerity (which is the main reason that periphery banks are in such a
terrible state in the first place).

It would essentially amount to a return to the pre-2012 status quo, with
governments once again subject to the supposed 'discipline' of the
markets (what Merkel calls 'market-conforming democracy'), as if the
2011-12 sovereign debt crisis hadn't made clear that financial markets
are just as incapable of efficiently assessing and managing the public
finances of countries as they are of disciplining or correcting
themselves (which, of course, is why Draghi was ultimately forced to
intervene with his bond-buying program). 'We can't allow a regime where
markets are masters of governments... It [would be] the fastest way to
break up the eurozone', says Bofinger.

As it turns out, the scenario foreseen by Bofinger is arguably already
under way: in recent weeks the yields on Italian, Spanish and especially
Portuguese government debt have started surging again for the first time
since 2012, reviving fears of the sovereign 'doom-loop' that ravaged the
region four years ago. As Wolfgang Münchau writes, we are witnessing
'the return of the toxic twins: the interaction between banks and their
sovereigns', which the journalist blames squarely on the bail-in
mechanism contained in the Bank Recovery and Resolution Directive
(BRRD).

As for the proposed 'eurozone finance ministry', it has been argued that
an effective fiscal union would require tax-raising powers at the EMU
level in the order of at least 10 per cent of the EMU's GDP; fiscal
transfers from richer to poorer countries; a federal authority with the
capacity to engage in deficit spending; the support of the ECB in the
operation of fiscal policy; a proportionate transfer of democratic
legitimacy, accountability and participation from the national to the
supranational level; etc.

Unfortunately, the fiscal union proposed by Weidmann-Villeroy, and by
Schaeuble-Lamers before that, is very different: it revolves around the
creation of a European 'budget commissioner with powers to reject
national budgets if they do not correspond to the rules', in
Schaeuble-Lamers' own words, but doesn't foresee the creation of a
federal institution with legislative and spending powers. This would
subject the EMU to an even tighter deflationary, contractionary and
mercantilist straitjacket, effectively depriving member states of
whatever small leeway they would have left under the current rules to
respond to another (likely) financial crash. It's not hard to see why
such a development would be not only economically self-defeating but
politically destabilising as well.

Which begs the question: why is Germany pursuing so vehemently two
proposals that are bound to increase the likelihood of a break-up of the
monetary union? One possible explanation is that the German political
establishment does not believe in the viability or desirability of the
currency union anymore (in its current form at least) and is therefore
either (i) planning for what it considers to be an inevitable outcome
(by inflicting as much damage as possible to its potential competitors,
for example) or (ii) deliberately creating a situation so unsustainable
that periphery countries will have no choice but to exit.

Of course, this scenario implies that in the unlikely event that a
proposal for reform of the EMU in a more Keynesian, progressive
direction were to gain traction among member states, Germany would
simply drop out of the monetary union (leading to a possible collapse of
the entire currency system). Another theory is that Germany is so
enamoured with its own economic model -- Hans Kundnani in his book The
Paradox of German Power speaks of the rise of a new form of German
economic nationalism, which he dubs 'export nationalism' -- that it is
blinded to the fact that it is sowing the seeds of its own demise (since
it is the country that benefits the most from monetary union). According
to this view, Germany would be erring 'in good faith', so to speak.

A third hypothesis is that Germany is pursuing an explicit strategy of
continental domination in the knowledge that, ceteris paribus, monetary
union will almost certainly not implode, regardless of how bad the
situation gets in the European periphery. Partly because the EMU
establishment will always be ready to do 'whatever it takes' to save the
euro, partly because periphery countries continue to be governed by
parties wedded to the euro 'whatever the case'. This is arguably the
most disturbing scenario of all, since it implies the economic
desertification (or mezzogiornification) of the entire Southern bloc,
reduced to the hinterland of Germany's new economic empire.

All of the above scenarios hold rather grave implications for periphery
countries: the unforeseen implosion of -- or 'forced exit' from -- the
monetary union on one hand; endless suffering within the EMU on the
other. Does this mean that periphery countries should prepare for
unilateral exit? Not necessarily. Why precipitate a scenario that, given
the current balance of power between capital and labour, could prove
disastrous for the workers of the weaker countries of Europe (and for
the Left)? But it does mean that the Left, especially in the periphery,
desperately needs a post-euro strategy, whether it's to deal with the
effects of an unforeseen break-up or to navigate a country through the
uncharted waters of a unilateral exit.

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