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European Poker and the German Bluff

 

eur feb 11

He who can destroy a thing, can control a thing 

Dune, Frank Herbert 

The dispute between Greece and its European lenders has not yet reached the point where the parties are frankly contemplating the results of their own intransigence.  

Greece says it wants to remain within the euro but end its forced austerity.  Germany is demanding Athens fulfill the terms of the rescue agreements. Markets assume that the hardline rhetoric from each side is a negotiating tactic.

The question is who has more to lose?

If Greece leaves the euro economic chaos will result, at least for a time. But in a country that has seen its economy shrink by 25 percent, whose unemployment rate is over a quarter of the population, and whose people are looking at unending hardship that they feel has been imposed by Germany, chaos may be a relative term. At any rate, Greek voters elected Alexis Tsipras to do exactly what he is doing.

Germany and Angela Merkel know if they permit Greece to escape austerity the demand for relief will soon redound throughout the European Monetary Union. Why should Ireland, Spain, and Portugal not have received similar relief? What of Italy and France whose economies are stagnant and face the need for harsh and unpopular economic reforms? 

German leaders also know, though not voicing the concern in public, saying only that they are prepared for Greece to leave the euro that once Greece departs, the entire unification project threatens to go into reverse.  The apparent inevitability of the union has been one of its greatest strengths. Remove that and national agendas will become dominant, with each country trying to get the best deal for itself from Brussels. 

Thus far German insistence on fiscal austerity has triumphed because the fear of euro dissolution has kept the nationalist tendencies of the 19 member union in check. Those tendencies are now ascendant, if not yet in control, in the politics of several EMU states.

For large numbers of people in Europe, the simple fact is that since the debt crisis exploded five years ago, the euro has made their lives worse and not better. There should be no surprise that political parties and leaders have arisen seeking to turn popular discontent into political power. 

If Greece leaves the currency union those separatist tendencies will surge, regardless of the actual outcome of the Greek departure. The agendas of the National Front in France, the Northern League in Italy or Podemos in Spain will become more credible and a threat that Brussels dare not ignore.

Germany's interest in maintaining the EMU is more than just the allegiance of its elites and population to a political ideal, the goal of a united Europe.  

Half of German GDP is tied to exports and the majority of those products go to its European partners. The loans that have gone to Greece, Ireland, Portugal and Spain have kept those countries in the EMU, buying German products.

The euro has also been a boon to Germany’s export economy. The drag of the poorer EMU members has kept the euro weaker against the currencies of Germany’s non-EMU trading partners than would have been the value of the Deutsche Mark. Germany’s worldwide exports have benefited from the artificially low level of its currency.

If the EMU begins to sunder, the negative effect on Europe’s economy, which is already near recession and deflationary, would mean near and medium term disaster for Germanys’ exports industries. If Europe enters a prolonged economic downturn, which is possible in the wake of a Greek exit, Germany will be not escape the pain.   

Even the beneficial effects of a weak currency could end. Once the euro is reconstituted as the coin of the fiscally prudent and economically successful nations of Northern Europe, it will necessarily rise in value and this time there will be no internal counter from the southern tier.

Despite the appearance that it holds the purse strings in the dispute with Athens, Germany has as much to lose in the dismemberment of the euro as does Greece.

Germany is prosperous. The German economy and population have benefitted more than any other in Europe from the euro. Germany, because of its history, has also been the European nation most devoted to the idea and institutions of a continental union.

The euro has been a disaster for Greece; as the monetary union is currently constituted that will not change.  

Greece will never be able to pay back its loans. Even servicing its debt is highly problematical without a reduction in the outstanding amount. The vast majority of the 240 billion euros lent to Athens has gone to pay its creditors; little has gone to help Greece improve its economy or the lives of its people.

Athens has long chafed under the regime of Brussels and ignored its dictates.  Greek loyalty to the European project was already the lowest in Europe before the crisis; it is lower now.

Greece is far along the road to disunion. If it leaves, it will be followed, partly or fully, by others. The Germans know this, their bluff is hollow.  

 Joseph Trevisani

Chief Market Strategist

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