The Germans have already blinked

The talk about Greece being kicked out of the euro zone has clearly been overdone. Some have suggested that the Germans had reached their fill and that they would ‘stare the Greeks down’ in this high stakes game of chicken. I have maintained that European policy makers in Greece, in Germany and throughout the euro zone are steadfastly committed to the euro. Recent reports of discussions now ongoing support this.

Moreover, these reports show that Germany is indeed willing to compromise on core issues causing crisis in the euro area. These reports also hint at the form that euro zone compromises will take on the fiscal and growth pacts now being contemplated as the silver bullet to Europe’s sovereign debt crisis. I do not believe the compromises currently on discussion are going to be a definitive solution for Europe. I would sooner label them a variant of ‘extend and pretend’ than something definitive. Nevertheless, these talking points do demonstrate continual movement toward fiscal integration in the manner I indicated in November during the Italian crisis.

As a reminder, this is what I was saying six months ago:

While Merkel has seemed to be more unilateralist than previous German Chancellors, she is still very much wedded to the European project. If the euro zone is to survive, as I indicated earlier this month, greater fiscal integration is the only direction that the EU can move.


I continue to predict that the move will be toward temporary ECB intervention followed by tighter fiscal integration and explicit mechanisms for euro zone exit. Sources indicate that Germany may already be preparing for a Greek exit from the eurozone. Now we learn that the Germans may also be pushing for euro area fiscal integration and oversight as well.

Now going forward, let’s start by looking at what Greek politician Alexis Tsipras is saying. He is the leader of Syriza, a fringe leftist party that has risen from getting under 5% of the electorate to perhaps becoming the leading political party in June’s national elections. Contrary to the talk about Grexit, even he is steadfastly opposed to a Greek exit as his answer in the transcript from a recent Guardian interview with Helena Smith attests (underlining added).

HS: Are you against the euro or are you against the policies being conducted in the name of the euro?

AT: Of course we are not against the euro or the idea of a unified Europe or monetary union. We believe that resolution of the problem is not found in friction or in the struggle for competitiveness between different nations. We have to understand that when we have a common currency we owe it to every member state that it has the right of last lender. If California has a huge problem with its debts, Congress and the Fed aren’t going to decide to expel California from the dollar or the US. Instead, the Fed assumes the cost of it being able to borrow cheaply until it the state can borrow again on markets. If we want a strong Europe and a united Europe we’ve got to show our teeth to the markets. When you create an EFSF that resembles a yacht when it is trying to pass off as a cruise ship, markets are not going to be appeased.

Translation: we are against front-loaded austerity. But we are decidedly pro-euro.

I would bet that Tsipras may even be willing to sign an austerity memorandum that is backloaded if the Germans are willing to go along with this. So the question in Greece is not so much one of immediate expulsion or unilateral departure in my view. Rather it is a question of what kinds of reforms Greece can make in order to stop the economic spiral down while staying in the euro zone.

Next, let’s look at what the Germans are saying. ECB policymaker Joerg Asmussen, despite being a member of the SPD, could be considered a confidant of German Chancellor Angela Merkel and German Finance Minister Wolfgang Schaeuble because Asmussen was deputy finance minister of Germany from 2008 and is now moving to the ECB to replace Juergen Stark. So what he says represents the leading edge of German thinking on the crisis. Here’s how Reuters describes his thinking:

[I have underlined the parts that reinforce what i have been saying these past months]

Presenting a vision for Europe over the next 10 years, Asmussen, who joined the ECB’s Executive Board this year after serving as German deputy finance minister, said the right crisis response was "not less, but more Europe" and that fiscal union was ultimately the right path.

There is a growing push in the euro zone, led by newly elected French President Francois Hollande, to do more to stimulate growth and not just focus on reducing deficits – German Chancellor Angela Merkel’s mantra.

Asmussen said the debate on growth versus austerity was the "wrong debate" to hold.

"We need both," he said in a speech in Berlin, though he stressed the need for fiscal consolidation and reforms.

"The fiscal compact can be complemented by growth-enhancing measures. This makes sense as a supplement, but the fiscal compact cannot be renegotiated or softened," he said.

The ECB has helped fight the debt crisis by cutting interest rates to a record low of 1 percent, flooding financial markets with more than 1 trillion euros in three-year loans and buying struggling euro zone countries’ bonds in the secondary market.

Asmussen stressed that the ECB’s non-standard measures were of a temporary nature and could be withdrawn any time if inflation risks emerged.


Asmussen suggested adding goods and labor market reforms to the existing fiscal compact. Such reforms could, for example, boost the mobility of the labor force and include offering language courses and a European network for job placement, which Asmussen said could be financed via the European Investment Bank or so-called project bonds underwritten by the EU budget to finance infrastructure.

"The growth-enhancing measures will only have an impact, if a critical mass is implemented. The legal form that the measures then take is less important," Asmussen said.

Asmussen stressed that such project bonds were not the same as jointly issued euro bonds, an idea which Hollande and some other euro zone leaders are expected to promote at an informal summit in Brussels this week.

Germany reiterated on Monday its opposition to the introduction of euro bonds.

Germany has said it will only consider jointly underwritten euro area bonds once the conditions are right, meaning closer economic integration and coordination across the euro zone, including on fiscal matters. But this is still a long way off.

So where does this leave us? Here’s my suggestion of how what Asmussen is saying translates into actionable policy making:

  1. The Germans want fiscal discipline. In their view, two things are necessary for this: a fiscal pact with teeth and an ECB that is independent of the euro area member states. Everything else is negotiable.
  2. You can see from Asmussen’s comments that the Germans will compromise on Eurobonds. Asmussen has said this directly as did Juergen Stark his predecessor. I think this is key to note: The German are in favour of Eurobonds only after fiscal integration. Getting from here to there will require the compromises now being discussed.
  3. One compromise that is definitely coming: funnelling the Eurobond idea through joint infrastructure bonds in the short term before actually having Eurobonds in the long-term once fiscal integration is complete.
  4. Another compromise that will happen: backloading more of the fiscal consolidation to appease France, Spain and Italy.
  5. Another compromise I believe will happen: banks getting direct access to European/IMF bailout funds.
  6. Final compromise likely under duress: temporary ECB sovereign backstop.

The goal here for the periphery is to backload austerity and to get to Eurobonds and/or ECB backstops more quickly. The goal for Germany is to maintain adherence to fiscal discipline by giving the stability and growth pact more teeth and by limiting any ECB action on sovereign borrowing to temporary measures. The compromise now taking shape will negotiate over these issues with the likely result being a combined fiscal and growth compact that includes penalties for nations that do not meet their targets including loss of fiscal sovereignty through EU oversight and including euro zone exclusion if the issues cannot be remedied through that mechanism. This has been where I have said things in Europe were headed and they look more than ever to be heading in this direction.

UPDATE: 945PM ET – Jean Claude Trichet is already acknowledging this is where leaders want things to head. See Ex-ECB head unveils bold plan to save the euro which shows how the loss of fiscal sovereignty through EU oversight is being contemplated.

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