New Fault Line at the Heart of Europe

05/28/2012 10:15 am EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

The emerging Latin and Germanic blocs bickered fruitlessly at last week’s Euro summit. Germany’s hard line is likely to prove very costly, writes senior editor Igor Greenwald.

Was last week’s economic summit the beginning of the end for Europe? The inconclusive and divisive meeting certainly had that feel, with the Franco-German alliance at the center of the continent’s integration push for 62 years breaking apart into rival Latin and Germanic factions working at cross-purposes.

Newly elected French President Francois Hollande, a Socialist, didn’t bother to negotiate the summit’s outcome beforehand with German Chancellor Angela Merkel, as his conservative predecessor Nicolas Sarkozy liked to do.

Instead, he conferred in Paris with the embattled Spanish prime minister, then showed up in Brussels calmly advocating an idea everyone knew Germany would oppose: the issuance of Eurobonds, jointly guaranteed by every member of the Eurozone, and leaning heavily in practice on Germany’s AAA credit.

Merkel said Germany had “huge difficulties” with the notion, and spent the summit missing the old “Merkozy” condominium. Germany got support from traditional and conservative allies Austria and Finland, but found itself beseeched by needy Latins, with France, Italy, and Spain demanding new crisis solutions.

Hollande said the debate has only just begun. Spain’s Mariano Rajoy continued to ask that the European Central Bank start buying his country’s depreciating bonds in bulk. Italy’s technocrat prime minister, Mario Monti, played the good cop, predicting that Germany would soon see the merit of Eurobonds.

But he’s now willing to openly discuss what was until recently unmentionable. “If Italy one day left the euro and reacquired its own autonomous currency, with interest-rate freedom, and the new lira was devalued, it would be a huge problem for Germany’s exports,” Monti warned.

Greece, of course, would not pose the same commercial threat, were it to discard austerity, the euro, and its debt obligations after the June 17 rerun of the recent inconclusive election. But these repudiations would still prove hugely expensive for Germany, in terms of the required support for German banks, as well as French and Spanish banks and Spanish and Italian bonds, all of which would be subjected to severe market pressure.

So the Greeks do have some negotiating leverage left, no matter how fervently Berlin and Brussels might claim otherwise at the moment. For Greece, the costs of a default and exit would be high, but almost certainly not higher in the long run than staying within a currency regime that condemns it to permanent misery.

The race in Athens seems to be down to New Democracy, the traditional party of conservatives, and leftist Syriza, a new grouping and the only one to repudiate the austerity foisted on Greece. Syriza’s victory wouldn’t mean an immediate exit from the Eurozone either, but might hit bonds and banks in Spain and Italy so hard that it will hardly matter what Greece decides later.

That means the next three weeks are unlikely to offer much relief from European angst, unless Merkel relents on Eurobonds in record time.

The markets she clearly distrusts will force this issue, because that’s what markets do. And then Germany will need to decide quickly whether it wishes to be at a center of a united Europe or the forefront of a northern European rump beset by reinvigorated southern competition.

The advantages of the status quo to Germany are so numerous and obvious that it’s very hard to believe that it will ultimately cast its lot with Finland instead of France. But these are pretty crazy times we live in. And while Merkel’s poker face remains inscrutable, her bluff will be called soon enough.

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