What has the latest round of market turbulence told us about the Euro crisis?
First, that nobody in the Eurozone is safe from contagion.
Second, the politicians are finally realizing that things can get much worse much faster than they ever thought possible.
And finally, that Angela Merkel may yet achieve her goal of closer European integration – with the help of the financial markets.
Chancellor Merkel has long been distrustful of the markets − and the feeling is mutual. Both have blamed the other for an ever-deepening crisis across Europe. More recently, though, both sides might have woken up to the fact that becoming allies would not be that outlandish.
It was market forces that recently put a gun to the heads of countries like Italy, Spain, and even France, forcing them to take steps Germany had pushed for repeatedly −most notably to get serious about reducing the debt burden, perhaps even by adopting constitutional debt limits similar to those in Germany. It is thanks to the markets that the spirit of the moribund stability pact has received a jolt of new life.
Some Eurozone governments are even starting to recognize the need for deeper, structural reforms of their economies, changes that would go well beyond the immediate task of reducing the burden of public debt. All members of the Eurozone, at least in principle, now seem to accept the notion that without closer integration, or at the very least, coordination, Europe could very well implode.
This is an important lesson for Merkel, who could now reconsider her troubled relationship with the markets. Instead of finding ways to punish speculators − from pushing for a permanent Europe-wide ban on naked short selling to forcing private investor’s participation in the Greek bailout − she should realize that market forces are not the root cause of the euro crisis, but rather a thermometer tracking Europe’s rising fever.
But markets, too, need to look more carefully at Merkel and what she is trying to achieve. Up to now, they have reacted nervously to every new proposal the Chancellor has made. Many still see “Madame No” as one of the main reasons for the markets’ distrust of European politicians. If the cost of saving the Euro is rising to astronomical levels, critics say, Merkel’s slow and over cautious manner is to blame. She is seen as, at best, a passive bystander; at worst, an impediment to a solution of the crisis. On any reckoning, she is not seen as someone who understands the workings of the markets. Her mentor, former Chancellor Helmut Kohl, has even accused her government of losing its foreign policy compass. Over time Merkel has become a scapegoat for Europe’s drift. However, this narrative should be revisited.
Ultimately, markets want to know that Europe is a safe place to invest, and Merkel is working towards the same objective. At times she has pursued this goal with little tact or grace, but she doesn’t deserve the scathing critique she is currently receiving at home and abroad.
Her plan is to bring the Eurozone countries closer together, not by creating new centralized bureaucracies, but rather by addressing their national, structural weaknesses. She is pushing them to be ready for a world that is being reshaped by what Nobel Prize winner Michael Spence calls the “next convergence” between the developing and the developed world. Merkel sees Germany relatively well equipped for this challenge, after long and painful adjustments. But she realizes that her country would be weak if her troubled Eurozone partners continued to drift.
Markets and Merkel seem to share the analysis that the Eurozone finds itself in the middle of a painful and necessary process of economic readjustment, one that goes well beyond the current financial crisis. There is too much structural public debt and many member states are simply ill equipped for the globalized economy.
In Merkel’s view, throwing more and more money at the problem will not solve it. It took Germany more than a decade to digest the first currency union of its recent past, that between the Former GDR and West Germany. Merkel is well aware of the fact that in the case of some European partners, notably Greece, the healing process might also take a decade. But being a cautious politician by nature, Merkel has resisted tackling big problems head on. She believes that by simply throwing her weight around, as advocated by some in search of ‘strong leadership’, she would only harden political resistance. At the same time, gentle reminders uttered around a big conference table are not sufficient either.
Merkel should finally start thinking outside the box. In the past weeks, when markets pushed spreads of Spanish and Italian interest rates into dangerous territory, she witnessed how effective brutal market pressure on peripheral countries can be. Sheer fear is proving to be the only tool powerful enough to convince Eurozone partners to undertake necessary reforms.
In Frankfurt, the European Central Bank (ECB) is proving to be a trustworthy ally of the Chancellor, stepping in cautiously and with perfect timing, just before fear turns into panic. ECB president Jean Claude Trichet and his successor, Mario Draghi, share the bulk of Merkel’s strategy. Draghi argues that solving the crisis in the long term will depend on addressing the core causes rather than the rescue mechanism. He has described the rising interest rate spreads of Eurozone bonds as a legitimate re-pricing of sovereign risk (completely absent in pre-crisis years). That said, he underlines the importance of managing the process carefully, pointing out that some re-pricing of Eurozone government debt “had overshot,” which could lead to “excessive oscillations result(ing) in permanent damage.” But countering does not mean bailing out. Hence Merkel’s stubborn resistance to introducing Eurobonds. They would simply amount to a blank check for all Eurozone members, she argues, and freeze the monetary union in the current state of structural weakness.
Italy is a painful reminder of how a bailout can destroy the incentive to enforce structural reforms in a peripheral country. The Berlusconi government has been the first and most vocal advocate of the common bond, but instead of obtaining a new tool to issue cheap debt, it has been targeted by the markets and now finds itself forced to undertake painful reforms. When the ECB stepped in and bought distressed Spanish and Italian bonds, it dictated strict conditions in exchange for its intervention. Markets and Merkel are now anxiously watching to see if the ECB will keep its tight grip on Rome and Madrid.
At first, Berlusconi’s Government appeared to understand the urgency of the moment, and albeit reluctantly, sped up the tightening of fiscal policies that otherwise would have been enforced over a much longer time period (giving political actors ample time to water them down or even reverse them). But neither the Italian Finance Minister, Giulio Tremonti, nor his boss, Silvio Berlusconi, believe there is anything fundamentally wrong with the Italian economy. They blame the panic-driven, ill-informed international markets, and to some degree, the stern German lady in Berlin who refuses to consider Eurobonds as a way out of the crisis.
So, it was not surprising that, no sooner had the markets calmed down, Rome quietly announced changes to its austerity package. Some of the reforms that would have tackled wasteful public spending were to be delayed or even scrapped, and the focus was to turn on tightening the fiscal screws. This change of strategy would have failed to address the longstanding structural problems of the Italian economy. Ultimately, only renewed pressure on Italian bonds by market forces convinced the Berlusconi Government to change its mind once again and maintain the bulk of its commitments to fiscal discipline and structural reforms.
If she really wants to achieve her goals, Merkel must hope that markets continue to be watchful and ready to unleash fear, even if that means turbulence for all. Defending her crisis management before parliament on September 7th, Merkel reminded Germans that a radical change in attitude was needed to resolve the crisis. “This will be a long, hard path, but one that is right for the future of Europe.”
Alexander Privitera is a news anchor for the German television station N24 and has frequently participated in AICGS events.