Just a few days before the next European Union summit in Brussels begins, it is time to lower expectations. This will not be one of those gatherings that lends itself to be branded as a make or break moment for the euro zone.
Those who expect the summit to include a Spanish bailout request, a deal to keep Greece afloat, and serious progress towards a banking union could end up being seriously disappointed. Europeans are not close to a breakthrough on any of these three topics. After all, they are also waiting to see what happens on November 6th, as well as in the following weeks when the U.S. will try to tackle its own fiscal cliff. Nevertheless, this week’s gathering in Brussels is still a serious test. It should at least allow us to better understand how committed European leaders still are in completing the tasks they gave themselves at their ‘historic’ summit meeting in late June. Most importantly it will shed some light on Germany’s true intentions.
Let’s begin with Greece. All the noise coming out of the German government indicates that a ‘Grexit’ is not in the cards − not now, not in the future. “It will not happen that there will be a ‘Staatsbankrott’ in Greece,” German Finance Minister Wolfgang Schaeuble said while touring Asia after the annual World Bank and International Monetary Fund meetings in Japan. He added that speculating on Greece leaving the euro does not make any sense. German Chancellor Angela Merkel’s recent visit to Athens, while largely tailored to meet demands of her domestic audience, carried the same message. However, in order to avoid sudden, unforeseen hick ups, Berlin needs some help from Athens, i.e credible reforms. That is where things get complicated, and that is also why timing events matters. In order to avoid market turbulence before the U.S. election, a decision on Greece will probably be taken later in November. There is just enough time to do that. By its own accounts, the Greek government will run out of cash at the end of that month.
This takes us to Spain. It is not only the government in Madrid that still resists making a bailout request. Spanish Prime Minister Mariano Rajoy’s stubbornness is equal only to Schaeuble’s refusal to expedite the process. Germany is trying to hold off as long as it possibly can, as the Germans are not at all convinced that Spain needs a new bailout.
They believe that Spanish banks’ needs are already taken care of through the 100 billion euro heavy war chest dedicated to that very task. Schaeuble believes that financial markets have not yet understood how much progress Spain has made. When they do, he argues, Madrid will be rewarded and pressure on Spanish sovereign bonds will ease. Unfortunately, the German posture is almost exclusively driven by the need to protect German taxpayers and voters from a new round of financial transfers to the periphery, not by underlying economic realities on the ground. Germany wants to bundle any help to Spain, Greece and Cyprus into one big package in order to confront the German Bundestag only once and not three times. Even Berlin knows that despite some recent competitiveness gains, the Spanish economy is not likely to bounce back anytime soon and will likely need more help. The recession continues to negatively impact tax revenues and is putting additional strains on the Spanish budget. Austerity could indeed become self-defeating. Moreover, if Spain does not request a ‘full macro economic adjustment program’, the European Central Bank’s bond buying program cannot be activated. Financial markets could end up perceiving the Outright Monetary Transactions (OMT) as a giant bluff. We know what that means: a negative reaction by financial markets, pushing yields for Spanish and possibly Italian bonds up dramatically. More importantly, investors could even start questioning the ECB’s credibility.