Will Merkel's Greek Gambit Backfire?
Germany and France’s drive to force Greece to honor its euro commitments risks backfiring on Chancellor Angela Merkel and President Nicolas Sarkozy.
A week after the currency’s guardians declared for the first time that countries can be ejected from the 17-nation bloc, U.S. stocks tumbled on concern German politicians are already creating exit chutes for the weakest members.
The sell-off suggests Europe’s crisis is spiraling into a new stage as investors bet on which countries are most likely to quit the euro, starting with Greece. The risk is that this will make it harder for debt-laden countries to convince investors they can get their finances in order and for policy makers such as Merkel, Sarkozy and European Central Bank President Mario Draghi to bolster the euro’s defenses.
“This is a dangerous phase,” Neil MacKinnon, global macro strategist at VTB Capital in London and a former U.K. Treasury official, told Bloomberg Television’s “On the Move” with Francine Lacqua today. “All of a sudden, we’re talking about the future of monetary union in its current format.”
U.S. stocks dropped late yesterday as news broke that members of Merkel’s ruling Christian Democratic Union party plan to debate a motion next week allowing countries to leave the euro region. The Standard & Poor’s 500 Index fell as much as 1 percent. In Europe, the Stoxx 600 Index has lost 2.6 percent in the past two sessions. U.S. stocks rose today after Standard & Poor’s confirmed its AAA rating on France.
Merkel and Sarkozy ignited speculation that the euro area could contract near midnight on Nov. 2 in Cannes, France, when they warned outgoing Greek Prime Minister George Papandreou that a planned referendum on his country’s latest bailout must serve as a ballot on whether Greece wants to stay in the euro.
“The referendum will revolve around nothing less than the question: does Greece want to stay in the euro, yes or no?” Merkel said with Sarkozy beside her.
While the ploy worked and Papandreou shelved the referendum, it undermined the message of the euro’s founding treaty that membership was “irrevocable” -- a line Sarkozy and Merkel had stuck to in the two years since the crisis broke out.
Sarkozy and Merkel opened a “Pandora’s Box,” said Stephen King, chief economist at HSBC Holdings Plc in London, this week. He was referring to the Greek myth in which the first woman on earth disobeys orders of the gods by opening a jar and unleashing evil around the world, leaving only hope behind.
Countries unable to play by the euro’s rules may now have to leave the bloc, upending the assumption that “once in the euro a country could never escape,” King said in a note to clients. Now “what’s true of Greece may now also be true of Italy.”
Italian 10-year bond yields surged to a euro-era high of 7.46 percent yesterday as investors questioned the ability of its lawmakers to restrain the euro-region’s second-largest debt load after Greece. While the yield slipped to 6.89 percent today, the crisis showed signs of spreading to France. Credit default swaps on the euro region’s second-largest economy rose eight basis points to a record 204 today, CMA prices showed.
Some politicians are already working on a plan to push out errant members that can’t get their finances in order. Merkel’s Christian Democratic Union may adopt a motion at an annual party congress next week to allow euro members to exit the currency area, Norbert Barthle, the ranking CDU member on the German parliament’s budget committee, said today.
The drive was dismissed by other members of Merkel’s party. Germany will resist any attempt to reduce the euro to its strongest members, the parliamentary finance spokesman for the CDU said today. “Such a shrinking process would be deadly for Germany,” Michael Meister said in a telephone interview.
Any pan-European appetite for a re-drawing of the euro’s boundaries may be on show Dec. 9 when leaders hold another summit, this time to discuss deepening euro-area convergence, tightening fiscal discipline and strengthening economic ties.
“They might be talking about an exit clause for the euro area after Greece,” said Daniel Gros, director of the Centre for European Policy Studies in Brussels.
It wouldn’t be the first time the strategy of Merkel and Sarkozy has ended up hurting rather than calming markets. Thirteen months ago they agreed at the French resort of Deauville that private investors must contribute to future European bailouts. The resulting bond-market selloff played a part in Ireland and Portugal subsequently requiring bailouts.
Any change in composition would validate the opinions of academics and investors including Harvard University’s Martin Feldstein and Mohamed El-Erian, chief executive officer of Pacific Investment Management Co.
Feldstein, who warned in a 1998 paper that monetary union would prove an “economic liability,” and El-Erian both say ensuring the euro’s existence may require a smaller, stronger bloc.
A report last month from the London-based Economist Intelligence Unit, titled “After Eurogeddon?,” said any fracturing would likely leave the euro in the hands of a strong northern core featuring Germany, Austria, Belgium, Finland, Luxembourg, the Netherlands, Slovakia, Slovenia and Estonia.
While France would suffer from a likely surge in the new euro it would remain a member because its monetary union with Germany is fundamental to France’s political and economic interests, the report said. Greece would be first to leave followed eventually by Portugal, Ireland, Italy, Spain, Malta and Cyprus, it said.
“If they push out weaker countries and the euro stays, it would represent a smaller number of countries, so the currency should be stronger,” said Nicola Marinelli, who oversees $153 million at Glendevon King Asset Management in London. “But we don’t know the knock-on effects that could come from a country leaving so there would be a period of great uncertainty and weakness.”
European leaders will still do their utmost to keep the euro-zone in its current form, said Marc Chandler, chief currency strategist at Brown Brothers Harriman & Co. in London.
“Rather than break-up, the solution for Europe’s crisis will be more integration,” he said. “European officials, including Germany and France, in word and deed recognize the important of preserving the euro zone as currently constituted.”
A break-up could threaten a repeat of the Great Depression, HSBC’s King said in an analysis last month. For the exiting country, the banking system could face collapse, capital controls would be needed to stop citizens moving savings out of the country and companies would face default. On top of that, inflation would spiral, technical problems such as updating computer codes would be required and the accompanying departure from the European Union would leave it subject to trade tariffs, he said.
Turmoil could also spread to other debt-strapped nations, featuring bank runs “in countries perceived to be at risk of leaving,” Deutsche Bank AG chief economist Thomas Mayer told clients this week.
King says with banks in pain and restricting credit, the ECB would have little option but to inject a vast amount of liquidity and print money to buy potentially unlimited quantities of bonds.
“The seismic shift in European convictions presented in Cannes could come back to haunt its authors,” said Mayer.
Let me be crystal clear, the seismic shift in European convictions will come back to haunt Europe's stewards. Papandreou's gamble may have backfired but so will Angela Merkel's if she thinks she can easily boot Greece out of the eurozone. As Soros stated in unequivocal terms, Merkel is responsible for this EU crisis and European policy blunders can lead to another global meltdown. This is no time for political dithering. Europeans have to come up with a comprehensive solution to their debt crisis or risk throwing their continent and the rest of the world into a deep depression.
I've said it before and I'll say it again, Europe without Greece, Italy, Spain, Portugal or even Ireland and Cyprus, is not Europe, it's just France, Germany led by "Merkozy". And with speculators now chomping at the bits, attacking French debt, it could just end up being a much weaker Germany. It's easy to use Greeks as a scapegoat but I'd love to see Germans or those Brits who mock "Going Greek for a Week" try living the reality that Greeks face. With no jobs, no pensions, lower wages, higher taxes, their standard of living is being decimated to protect the interests of German, French and US banks and corporations. It's not a Greek bailout, it's more corporate handouts.
But there is hope for Europe which is why I distance myself from the fools on other blogs like Zero Hedge who keep warning of the "imminent collapse" of the euro. This is pure drivel. With a groundswell of Italian politicians voicing support for a technocratic government led by Mario Monti, the former European Union competition commissioner, Greece and soon Italy will have experienced technocrats at their helm:
As in Greece, where economist Lucas Papademos was appointed prime minister Thursday, there are hopes that Monti's experience in global finance and his noninvolvement in partisan politics will help the country through market turbulence.
Isn't it ironic that the two countries at the epicenter of the European crisis are now going to be led by people who can teach "Merkozy" a lot on properly dealing with Europe's debt crisis? Merkel's Greek gambit was foolish and it may backfire. She better listen carefully to her new southern European allies. If she doesn't, Germany and the rest of the world will pay the ultimate price.
Below, Neil MacKinnon, global macro strategist at VTB Capital, discusses the eurozone crisis and his view that the European Central Bank should act as a lender of last resort with Francine Lacqua on Bloomberg Television's "On the Move."