By Wolfgang Münchau
I was speaking recently to a group of investors who forced me – all but at gunpoint – to tell them how long I thought the euro would last. I normally prefer conditional forecasts but, in this case, I was asked to make an unqualified prediction. And so I yielded. My answer was that the eurozone would probably not survive the decade in its current form. As it turned out, I was the most optimistic person in the room, by far.
There are few people in Brussels – where I live and work – who would consider me an optimist. The point is not so much about how policymakers and investors relate to my predictions, but how the two groups relate to each other. They are worlds apart. Europe’s political classes still believe they are in control of the situation – and that a combination of austerity and financial repression will do the trick. Investors, meanwhile, do not understand how Greece, Spain and Germany can coexist in a monetary union.
I have noticed that whenever the European Council meets in Brussels, the European bond markets tend to slump with short delay. Yields are now close to the level they were at in early May, when the European Council set up the €440bn ($540bn, £360bn) European Financial Stability Facility and when the European Central Bank started to buy bonds. This crisis goes on and on.
The reason is that investors have lost confidence in the political economy of the eurozone. European politicians such as Wolfgang Schäuble, German finance minister, praise their own long-termism. But investors ask with some justification: what is long-termist about a bank bail-out without bank resolution? Or a sovereign bail-out without fiscal union?
I recently had an eye-opening experience appearing in the finance committee of the German Bundestag as a witness to testify on the proposed legislation to ban naked short sales. It turned out that the finance ministry could not produce the basic statistics on short selling, let alone provide even an anecdotal link between short selling and the bond crisis. I told the Bundestag that this cynical piece of legislation has contributed far more to the European bond market crisis than the naked short sales it purports to ban. Helmut Schmidt, the former German chancellor, said later that he almost died laughing when he heard about this legislation.
The proposed ban is the latest reminder that European Union members, and Germany in particular, have not learnt a single lesson from their serial communication failures during the crisis. In February, they made the mistake of announcing a political agreement on a Greek rescue package without backing it up for another three months. In May, they hailed the stability facility as a historic breakthrough in political governance; it then turned out to be little more than bail-out facility.
I only hope that they know what they did when they recently announced the publication of the stress tests for 25 banks. Once these are published, the markets will immediately demand to see the tests for all banks. Once that happens, in turn, governments will need to produce a convincing recapitalisation strategy. I fear, however, that they are once again committing themselves to going down a road without a map.
Without an endgame, this exercise will end in disaster. At some point the markets will realise that large parts of the German and French banking systems are insolvent, and that they are going to stay insolvent. You might think that Europe’s policy elites cannot be so stupid as to commit themselves to stress tests without a resolution strategy up their sleeves. But I am afraid they probably are. Europe’s political leaders and their economic advisers are, for the most part, financially illiterate.
Is there a way out? Yes there is, but the chance of a resolution to the crisis is starting to fade. The first step would have to be a serious attempt to resolve bank balance sheets. This is as much a German and French banking crisis as it is a Greek and Spanish debt crisis. You need to resolve both problems simultaneously. Resolution would require a large fiscal transfer, not from Germany to Greece, but from the German public sector to the German bank sector – in the form of new capital. The same would apply to France.
Beyond this restructuring, the eurozone will need to commit itself to a full-blown fiscal union and proper political institutions that give binding macroeconomic instructions to member states for budgetary policy, financial policy and structural policies. The public and private sector imbalances are so immense that they are not self-correcting. And you have to be very naive to think that peer pressure is going to resolve anything.
There is no point in beating about the bush and issuing polite calls for the creation of independent fiscal councils or other paraphernalia. This is not the time for a debate on second-order reforms. I am aware that, at a time of rising nationalism and regionalism throughout the EU, there is no consensus for such sweeping reforms. But that is the choice the EU’s citizens and their political leaders will have to make – a choice between reverting to dysfunctional and, as it transpires, insolvent nation states, or jumping to a political and economic union.