Britannia Radio

This article by A.E-P. takes the eastern european infection of the 
eurozone to its logical conclusion.  It boils down to two points.  
Firstly,  with the unpopularity of the German socialists will their 
finance minister and his 'bail-out of the east' policies survive 
electoral defeat this year?  And secondly will this crisis bring 
about full political union of the EU?

Both questions are critical for all of us!

All of this must be seen in the context of yesterday's (totally 
misreported) Berlin summit, mounting civil unrest and the April 2 
summit of the G20 group, which I will deal with separately.
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TELEGRAPH 23.2.08
Will Germany deliver on the Faustian bargain that created monetary 
union?
(OR - NEWSPAPER VERSION - IS IT REALLY FAIR TO ASK GERMANY TO BAIL 
OUT HALF OF EUROPE?)

If Der Spiegel is correct, the German finance ministry is drafting 
rescue plans to prevent default on the edges of the eurozone leading 
to a full-blown collapse of Europe's monetary system.

By Ambrose Evans-Pritchard

This is an entirely appropriate policy in economic terms. One dreads 
to think what would happen if the world's twin reserve currency were 
to disintegrate at this stage.

But what about the solemn pledge to voters by Germany's political 
elites - promiscuously given over the years - that monetary union 
would never leave them on the hook for the debts of half Europe?

The vast imbalances that have been allowed to build up under the 
seductive protection of EMU leave German taxpayers facing bail-out 
liabilities that exceed the cost of reparations after the First World 
War,  [These onerous reparations are often cited as the original 
reason for Germany's economic collapse and the rise of the Nazis . . 
but see A.E-P's comment below -cs] in proportional terms.

The political ground has not been prepared for this. EMU was foisted 
on the German people without a referendum, in the face of deep public 
scepticism and scathing criticisms by the professoriat. This failure 
to secure a mandate for such a revolutionary undertaking is coming 
back to haunt them.

Berlin is at last having to deliver on the Faustian bargain made by 
Germany's political class when it swapped the D-Mark for French 
acquiescence in reunification. It must either go the whole way 
towards EMU fiscal union and take responsibility for Italy's public 
debt (111pc of GDP by next year), Austria's loans to Eastern Europe 
(70pc of GDP), the adventures of Ireland's 'Canary Dwarf' (?400bn or 
so in liabilities), and Spain's housing collapse (1m unsold homes), 
or jeopardize its half-century investment in the political order of 
post-war Europe. Letting EMU fail at this stage would have far higher 
costs than never having launched the project in the first place.

The alleged bail-out options include "bilateral bonds" where big 
brother countries agree to shoulder the credit risk for siblings, 
(who vouches for Italy and Spain?), or some form of EU bond.

Finance minister Peer Steinbruck [a socialist finance minister in a 
coalition government -cs]  - erstwhile Scrooge - has become the 
unlikely champion of open-ended help for all. "We have a number of 
countries in the eurozone that are clearly getting into trouble ... 
Ireland is in a very difficult situation ... The euro-region treaties 
don't foresee any help for insolvent states, but in reality the 
others would have to rescue those running into difficulty," he said.

In case there was any misunderstanding, he upped the ante two days 
later with a pledge to "show ourselves to be capable of acting" if 
any euro member proves unable to roll over its debts. This is a 
radical shift in policy.
For now, the bail-out talk has cowed speculators. The euro has 
rallied after weeks of sharp descent against the dollar. Credit 
default swaps (CDS) on Irish debt have fallen back below the red 
alert level of 400 basis points. But it has not been lost on the 
markets that Germany's own CDS spreads have risen to a record 86. Are 
traders starting to ask whether Berlin is in a fit state to rescue 
anybody?

The German economy contracted at an 8.4pc annual rate in the fourth 
quarter as exports to Eastern Europe, Club Med, and the Anglo-sphere 
collapsed. The GM subsidiary OPEL is running out of cash and risks 
going the way of Sweden's SAAB without a ?3.3bn rescue.

Mortgage lender Hypo Real Estate is imploding despite ?87bn in state 
guarantees and capital injections. Mr Steinbruck said nationalisation 
is inevitable. If Hypo collapses with ?400bn of liabilities, it would 
risk a "second Lehman Brothers", he said. Like Northern Rock, it 
relied on short-term funding to lend long. Game over.

Hypo has been infecting the ?850bn Pfandbriefe market (covered 
bonds), the rock core of Germany's credit system. Spreads on Postbank 
issues have jumped from 40 to 80 basis points. Pfandbriefe are not 
covered by Berlin's emergency guarantees (unlike 3-year bank debt). 
That may need to be changed soon. Mr Steinbruck still insists that 
German banks are in fine fettle. The rest of us notice their leverage 
ratio is 52, the highest of any major country in the world. We are 
assured they have good assets. Let us hope so.

Time will judge whether Mr Steinbruck's bail-out rhetoric is hollow. 
I wonder whether any German government can in fact deliver on his 
pledge. He is unlikely to be finance minister after the elections in 
September. The Social Democrats are heading for the most crushing 
defeat in a free election since July 1932 - and for the same reasons 
- because they are associated with a deflationary collapse of 
Germany's core industry. Their Left flank is peeling away to the neo-
Marxist Linke party, just at it peeled away to the Communists in 
1932.  [and 1933 saw Hitler in power -cs]

There is much talk in the German and global media perpetuating the 
myth that it was German hyperinflation in 1923 that destroyed Weimar 
and led to Nazism. This is a fatal misreading of events. What led to 
Hitler was the Bruning deflation of the early 1930s.

What is true is that the 1923 trauma caused the Reichsbank to wait 
too long to ease monetary policy from 1930 to 1933, though Gold 
Standard ideology played its part. The European Central Bank has done 
better. At least it has followed Bagehot's advice to "lend 
generously" even if rates have been too high, but it has been 
paralysed by its own institutional hang-ups and its need to prove 
itself a hard-money successor to the Bundesbank.

Last week chief economist Jurgen Stark attempted to head off the bail-
out plans, reminding Berlin last week that rescues are prohibited by 
EU law. This is not strictly true - Article 100.2 allows aid in 
"exceptional circumstances" - but it gives powerful cover to anybody 
wishing to oppose the Steinbruck policy.

But whatever the legal theory, the political reality is that 700,000 
Germans are going to lose their jobs this year as unemployment rises 
to 4.3m (IFO Institute). Voters are not going to look kindly on any 
party seen to divert German savings to Ireland or Club Med.

Architects of EMU were well aware that a one-size-fits-all monetary 
policy for vastly disparate nations would create serious tensions 
over time. They gambled that this would work to their advantage. The 
EU would be forced to create new machinery to safeguard its 
investment in the euro. It would be a "beneficial crisis", bringing 
about the great leap forward to full union.

We are about to find out if they were right