By Marc Chandler
Over the past several weeks, both Spain and Italy have indicated they will not reach the initially projected deficit targets. Nearly all the polls suggest that the (moderate) Socialist Hollande will win the second round of France’s presidential contest. Greek national elections, also on May 6, may result in a fragmented parliament, undermining the probability of strong leadership. The Netherlands are on the verge of being formally (rating action) or informally (market behavior) pushed out of the core.
These events mark the beginning of the push back against German-led austerity, but it is even bigger as the IMF’s call for the ECB to cut rates illustrates. Draghi, however, is more than reluctant and the IMF’s recommendation is likely to fall on deaf ears. Instead, Draghi supported a call for a growth compact, like his fellow countryman and Italian PM Monti and politicians like Hollande.
The German government appears to be trying to stay ahead of the curve. A government spokesperson indicated that Germany is not opposed–that it wants both fiscal discipline and economic growth. And even Merkel herself has chimed in endorsing Draghi’s call for a growth pact.
This seems a far cry from the Bundesbank’s position of a few days ago, where a board member was quoted on the wires on April 17 saying that "putting too much weight on short-term, demand-side risks misjudges the root cause of the current crisis, namely a profound loss of confidence in the markets." In effect, what was being suggested was the short-term growth concerns are not as important as pressing ahead with budget cuts to rebuild investor confidence.
Does this mean a rift opening between Merkel’s government and the Bundesbank? The answer may be found in the nuances. Merkel talks the language, but means something different by the words. Growth compact, in her apparent meaning, is really structural reforms and most certainly not fiscal stimulus, a la the United States. Merkel was clear: she is opposed to stimulus spending to revive growth.
That fact that Draghi called endorsed a growth pact today is important. It means that there is a political vacuum. On the two-pillar configuration (Berlin and Paris), France should check Germany. However, this has not been the case. Merkel has out-maneuvered Sarkozy at almost every turn of the crisis, forcing Sarkozy to change tactics, until the campaign heated up, and appear as Merkel’s partner. Draghi’s call for a growth compact was quickly seized upon by Hollande’s campaign as a "validation" of its stance.
Up until a few weeks ago, it appeared that Italy’s Monti, not Draghi, was the leading counter-weight to Germany. However, Monti’s star has dimmed as his austerity program is beginning bite, with rising unemployment and record low consumer confidence, and this is before all the tax increases, that have been agreed upon are implemented. Monti is facing a political backlash of sort in the May local elections, which will be seen as a referendum on the technocrat PM.
The fact that Draghi has ventured into these waters instead of Sarkozy or Monti reflects the political fragility of Europe. At the same time, there seems to be another layer in the chess game. Traditionally, the UK and the US have pursued what the political scientists call "balance of power" strategy in Europe. Both would act to prevent a single hegemon from dominating the Continent.
The UK’s opting out of the fiscal compact is a break from this traditionally strategy–go with the flow to influence its direction, prevent Germany from dominating. The US has been supportive of greater European integration since the 1950s as long as it did not develop into Fortress Europe (a protectionist bloc). The US seems more accepting that that integration will be led by Germany.
Perhaps this is a reflection of comfort with the level that the rule of law, such as the WTO, has achieved. Perhaps the US stance is also a recognition that there is a "natural" limit on Germany’s ability to be the regional hegemon, as too much can, as we see now, spur a political backlash in other countries in the euro area. Perhaps it is also a reflection of the marginalization of Europe. A local hegemon, even if constrained, may be desirable when the real power, growth prospects, and more important issues seem to be in Asia.
The fact of the matter is that for than a quarter of a century, more goods cross the Pacific than the Atlantic. The role of Europe in the world economy is continuing to be downgraded. Estimates suggest that this year China will replace France as Germany’s largest trading partner. One need not be a crude economic determinist to appreciate that the changing economic fortunes will have knock on political consequences.