Sunday, August 21, 2011

Germany's Merkel Says Nein On Eurobonds

This is one of those stories of huge importance that usually slips under the radar of the news cycle.

As you remember, I reported about two weeks ago on the stiff opposition in the Bundestag over deals that were made in Brussels back in July to bail out some of the failing members of the Eurozone...much of it coming from Chancellor Angela Merkel's own Christian Democratic Union party.

The heart of the deal was the use of eurobonds to bail out financially troubled countries countries like Greece and Portugal, because the eurobonds would have interest rates lower than the government bonds of those countries, thus allowing them to to reduce their debt-to-GDP ratios.

The only catch ( and what the Germans strongly objected to) was that the eurobonds would be based on Germany's credit rating, thus subsidizing the government spending of these other countries at Germany's expense.

With the export dependent German economy stagnant at 0.1 percent growth in the June quarter and both parties in her ruling coalition revolting, Chancellor Merkel was faced with an unpleasant choice. Either she scrapped the Eurozone deal, in which case either negotiations would resume or the Eurozone would crumble with every man for himself. Or she would have faced cutting deals with the Left wing opposition parties, the Social Democrats and the Greens to get the deal through, which meant Merkel and the CDU would have had to absorb considerable electoral and political damage, perhaps even enough to cause her government to fall.

Well, Chancellor Merkel has made her decision, and it's a grim one for the Eurozone. Instead of issuing the Eurobonds, she announced that the emphasis is going to be on what she referred to as the “extremely difficult task” of cutting debt and raising competitiveness in member countries, rather than issuing joint bonds:

“Politics cannot and will not simply follow the markets,” she told German public television on Sunday in her first interview after returning from holiday a week ago. “The markets want to force us into doing certain things – and that we won’t do.”

[...] Ms Merkel told ZDF television that “solving the current crisis won’t be possible with eurobonds” as the crisis had been brought about by investors losing confidence in the ability of member states to achieve enough growth to pay off their debts.“That’s why eurobonds are not the answer,” she said, exhorting eurozone members to go on tackling the financial markets’ crisis of confidence “at the roots” – by improving competitiveness and economic growth, and aiming to cut excessive debt.

“The ’debt union’ has to be replaced by a ‘stability union,” she said. “This is a hard and arduous path, which we will not be able to avoid by means of some magic bullet, like issuing eurobonds.” The latter could even lead further into a “debt union”.

Well, she's right, especially from the German prospective. The answer to out of control debt is not more debt, something the current occupant of the White House seems not to understand. And in another lesson in basic econ for our fiscally challenged president, 'new revenues' (the rest of us call them by their right name, taxes) aren't the answer either. At this point,most of the eurozone countries have everything the Democrats drool over - high energy taxes, high VATs, high personal and corporate income taxes, huge taxes on property, costly regulations and a welfare state gone amuck. All those 'new revenues' haven't kept pace with government's desire to spend other people's money.

But while Merkel has the right ideas, the timing is a bit late. The problem is that her solution is not going to be able to be implemented overnight, especially given the massive resistance to be expected in certain quarters to the kind of cuts that are going to be necessary. Had measures to cut welfare state spending and increase productivity been put in place a few years ago, it might have had a chance. As it is now, the eurozone is already on life-support from the European Central Bank...and time is one thing it doesn't have.

The situation in the eurozone is exactly where America is heading if we don't change course quickly.

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