Angela Merkel, a rock beneath the European feet

By J Brooks Spector 14 September 2011

In the latest installment of the European financial storms, German Chancellor Angela Merkel went on German radio Tuesday morning in an attempt to calm banker, investor, government and pretty much everybody else’s nerves as rumours began to spread that Greece would default on its sovereign debt – and that Germany was about to give Greece a shove right out of the eurozone. By J BROOKS SPECTOR.

Merkel said on her radio interview:

“The top priority is to avoid an uncontrolled insolvency, because that would not just affect Greece, and the danger that it hits everyone – or at least several countries – is very big. I have made my position very clear that everything must be done to keep the eurozone together politically. Because we would soon have a domino effect.”

Investors must be scratching their collective heads over those rumours if Merkel had to go on air to deny they were German international financial policy. The rumours – and then her denial of them – came after ostensible political ally, German Deputy Chancellor Philipp Roesler, said over the weekend Greece might have to carry out an “orderly default” on its debts. Not surprisingly, that quickly gave global bourse prices a knock when trading began on Monday. Worst-hit were French shares because that nation’s banks are heavily into Greek bonds – something that is almost certainly going to cost them by the time everything is wrapped up.

Merkel sought calm by explaining eurozone rules do not actually have any procedures for an “orderly default” on sovereign debt – by contrast to the disorderly default where everyone stampedes towards the doorway in the more usual “every man for himself” manoeuvre of financial panics. In a bit of a slap at her deputy, Merkel said “I have said ‘if the euro fails, Europe fails’ – that that applies here and therefore everyone should very carefully weigh their words. What we don’t need is unrest in the finance markets – the uncertainties are already big enough”.

Chancellor Merkel steadfastly insisted Greece was actually getting its financial house in order, saying, “Everything I hear from Greece is that the Greek government has hopefully seen the writing on the wall and is now doing some of the things that are required.” Some people have not been listening to words like this as ten-year Greek government bonds now pay 24% interest, making them interesting portfolio additions – but only for the truly nerveless. In an effort to staunch its continuing financial bleeding, Greece has been authorised two international bailouts at about $110 billion each, although the second one has yet to be paid out. Regardless of these guarantees, Greece’s financial health remains virtually on life support.

However, Merkel did offer a bit of optimism that the next tranche of funds from the European Commission, the European Central Bank and the IMF would be paid out – as representatives from the three bodies are due back in Athens this week. Greece obviously wants to convince its international creditors it has earned the right to get the next tranche of money from the bailout fund.

But this crisis is about to confront Merkel with a stark, fundamental choice, analysts say. Given Germany’s weight in the eurozone, it means that more than any other European politician, Merkel may have to find the reservoir of leadership to rescue the euro – or acknowledge European political will simply isn’t there. American officials have been telling media sources in the meantime that if Merkel does not act decisively, bank lending could freeze up, generating another sharp financial downturn in America and Europe.

Meanwhile, Merkel’s domestic critics say she has focused too much on protecting her political standing, in lieu of bolder leadership to rescue the European currency zone. But that would mean betting even more German capital on an ever-deepening economic union that her voters clearly have little stomach to support. In fact, her awkward three-way governing coalition is already fragmenting over this Greek bailout. Her own party, the Christian Democratic Union, just took a shellacking in regional elections, including in the state where her own district is located, Mecklenburg-West Pomerania.

Merkel’s conservative and free-market allies in Parliament – and even a growing chorus of well-respected German economists – have increasingly harsh judgments about Greece. Germans are hearing, from the right side of the political spectrum, a demand not only to cut off aid but, indeed, to force Greece out of the eurozone.

Meanwhile, back in Greece, the government there has kept promising to get its financial house in order – but these efforts have provoked strikes, walkouts, demonstrations, and violent protests, as well as weeping, the renting of garments and the wearing of sack cloth and ashes. The government has promised accelerated public sector cuts and now, most recently, a two-year blanket tax on property. Greece is now essentially relying on the life preserver of these international rescue loans to remain solvent. But its troubles in actually taming its budget deficit and enforcing its promised reforms are threatening that very lifeline, even as the disbursements of the bailouts are dependent on progress in taming the country’s fiscal circumstances.

The country’s finance chief, Evangelos Venizelos, has issued new pledges to accelerate the heretofore-delayed measures to shrink the cost and size of the public sector, and he has even raised the prospect of firing up to 20,000 public servants. If he actually makes this stick, it would cross a major societal threshold in a nation where getting a government job has traditionally meant gaining a guaranteed position for life.

Across the Adriatic, Italy’s ruling coalition has been busy trying to carry out its own austerity measures to calm financial markets. In Italy’s case, they are apparently trying to entice China to buy Italian sovereign debt and bonds from government-owned companies to inject some capital into Italian coffers. The Wall Street Journal and the Financial Times, among others, have reported that the China Investment Corporation (CIC), a wholly-owned Chinese government institution, and Italian officials have recently held meetings over this possibility.  The CIC has around $400 billion in assets so this is no small beer.

Mark Young of Fitch Ratings told the BBC, “When you introduce a large buyer like China, it brings down the interest rate. [Then] they can then fund their economic growth more easily. It is a natural consequence of creditor and debtor nations, one supporting the other.” Like Greece, Italy has been forced to pay sky-high interest rates to attract capital. The Chinese have been reported to be interested in diversifying their investment portfolio away from US dollar instruments in response to their expressed concern about the US government’s deficit, and a nice pumped up Italian rate of return could be pleasant.

According to the BBC, Wu Xiaoling, a former deputy governor of the People’s Bank of China and now a senior government official, said China was ready to work with Europe to boost market confidence. Wu said “We will continue to support Europe’s measures in maintaining a stable euro.” Italy’s national debt has now reached 120% of its GDP and actually accounts for nearly a quarter of the entire eurozone’s sovereign debt. The IMF says Italy will need to raise a stupendous 20% of its GDP to refinance its national debt in 2012. By contrast, China has a cash horde of more than – wait for it – US$3 trillion to be put to use.

Nevertheless, not everyone is convinced this is the answer to the whispered prayers of European bankers. Makoto Noji of SMBC Nikko Securities said “Europe is not just lurching from one crisis to another. It is lurching into a new one before the previous one is solved.” And New York University Professor Neil Barofsky adds, “You will continue to see this real crisis of confidence, continued concern.  In a way it is a little bit like 2008, nobody is sure exactly what is going to happen if these dominoes start to fall.  And I think it is kind of a scary place right now.” You simply have to love the cheerfulness of economists in a crisis.

Okay then, that was the bell at the end of this class, so let’s summarise what we’ve learned today:

There is a near-permanent Greek crisis, an Italian government trying to entice Chinese investment capital onto its balance sheet, French banks concerned about their increasingly shaky Greek debt holdings and a German government that is either pushing the Greeks towards a slow-motion sovereign debt default or desperately trying to prevent that, and its departure from the eurozone to some uncertain financial purgatory. This list, of course, doesn’t even take into consideration Portugal, Spain or Ireland’s serious problems.

Presumably, then, this helps explain the Swiss National Bank’s move to drive down the value of the Swiss franc. The Swiss franc is another of those last-resort investments whose recent dramatic rise has been tormenting Swiss exporters. Also, there is the growing movement to US bonds from anywhere else, the rise of the dollar against the euro, the rise of gold against pretty much everything and the general retreat from emerging markets risks. That dollar rise may be initially confusing but, remember, the recent ratings downgrade was not primarily because of the country’s economic fundamentals, but more a ding because of its lack of its political will. No one, after all, seriously expects the US to renege on its debt or abandon its currency. But, nevertheless, please remind me again, where is that secret compartment in the mattress where we put all those Pieces of Eight, Thalers and Kruger Rands? DM

Read more:

  • Angela Merkel tries to allay Greece default fears at the BBC website;
  • Greece, Europe struggle to contain debt crisis at the AP;
  • Italian government ‘in bond buying talks with China’ at the BBC;
  • European, Asian Markets Tumble on Greek Default Fears on the VOA website;
  • German Leader Faces Key Choices on Rescuing Euro at the New York Times;
  • Merkel chief whip set on profound EU reform in the Financial Times;
  • Greek bail-out: A pillar in peril in the Financial Times;
  • Germany’s euro question – Nobody knows the answer, especially not the Germans themselves in the Economist;
  • Francs for Nothing – the Swiss Drive Down the Value of their Currency in the Economist.




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