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Michael Coote examines some likely exit strategies to manage the eurozone break-up and draws some parallels with Afghanistan
By Michael Coote*
The feckless war in Afghanistan comes to mirror ever more closely the potentially impending breakup of the euro zone. In Afghanistan, Western forces are busy organising the exit they are already completing in Iraq, another place where they weren’t popular, earned no gratitude, and squandered much blood and treasure for scant returns to show for the sacrifice.
In Iraq and Afghanistan a whole lot of people have suffered and died without Western liberal democratic triumph being achieved to the point where it has become recognised that the local survivors are best left to their balkanised fate killing and persecuting each other as they have done for centuries.
In the euro zone, Germany is also getting ready to “evacuate”, if necessary, euro currency union member states that are not up to operating under the hegemony of the Deutsche mark in drag. Like the Western forces in Iraq and Afghanistan, the Germans are sagely implementing the strategic plans required to exit unwanted member states out of the euro common currency bloc, even if those same countries remain on as part of the European Union (EU).
Thus it was uncanny what the UK’s chief of defence staff General Sir David Richards recently told the Royal United Services Institute in the course of confirming that 500 British troops would be withdrawn from Afghanistan by year end, leaving 9,000 remaining as the rump of a supposedly successful drawdown strategy under way.
“Perception is lagging reality by some 18 months,” the general claimed. “While we are, like a chess player, planning three or four moves ahead, we cannot signal our plans openly.” “That leaves the media frequently, and understandably, to... draw the wrong conclusion.”
A losing battle
Let us transpose the general’s remarks to apply to the situation that Germany faces with respect to its possible “drawdown” from the euro zone. The general’s words can be minimally recast to apply to a losing battle being waged in the peripheral economies of the euro common currency zone.
“Perception is lagging reality by some period of time that Germany alone decides,” said German Chancellor Angela Merkel. “While we are, like a chess player, planning by reverse engineering the checkmate of all euro common currency member states who fail to meet our unyielding standards, we cannot signal our plans openly, for example by listing which countries we are willing to be rid of.”
“That leaves the media, financial markets, and credit rating agencies frequently, and understandably, to draw the wrong conclusion.”
Indeed, we have the media, financial markets, and credit rating agencies jumping up and down, dumping risky assets, anticipating Armageddon, and damning the Germans for their Teutonic arrogance and complacency in stupidly letting things drag on so long. Yet can it possibly be imagined that the Germans haven’t already secretly costed out a list of successive “Iraqs” and “Afghanistans” to be unceremoniously abandoned as failed and irredeemable “Muslim” states on the fringes of the euro zone?
Chancellor Merkel is privy to some of the best advice in the world and so it is hard to believe that the Germans lack a euro “war zone” selective withdrawal strategy.
Pawns on the playboard
The list, of course, would be top secret, because like the British in Afghanistan, the Germans in peripheral Europe “cannot signal our plans openly.” If the Germans did signal openly by – say – declaring that Greece, Ireland, and Portugal could be kicked out of the euro zone, and maybe also Spain and Italy, then all hell would break loose before German banks – including the Deutsche Bundesbank - were ready to cope with the traumatic shock.
No – the list is surely drawn up, but some stealth and cunning is yet required to set about implementing its accompanying strategy. Some preparatory moves on the chessboard are necessary. First, certain avenues need to be closed off. Thus Germany and its glove puppet the European Central Bank (ECB) have lined up against printing either euros or eurobonds.
Many have argued for the ECB to undertake unlimited quantitative easing by printing as many euros as are required to staunch the sovereign debt gaps of ailing common currency union states. The anti-inflationary hawks of Germany and the ECB have firmly scotched this suggestion.
The alternative is to print eurobonds that are jointly and severally guaranteed by all seventeen euro zone member states. Just as turkeys don’t vote for Christmas, however, the Germans aren’t interested in the issuance of shared liability sovereign bonds to fund countries that are not trussed up in fiscal straitjackets.
Without the straitjackets, Germany and its fiscal surplus northern European brethren can foresee the day when they will get to pick up the tab for the profligate south’s deficit debts. Supposing the other euro zone members even wanted the straitjackets, it will take some time to get them tightly fitted into their lacy attire. So no printing of euros or eurobonds any time soon, if at all – what’s next? Some hints have emerged.
The Christian Democratic Union (CDU) – the governing political party of Chancellor Merkel – passed a motion at a mid-November party conference in support of changing the EU’s Lisbon Treaty in order to permit euro member countries voluntary exit from the common currency without requiring their accompanying departure from the EU itself.
Parting ways but keeping company
The party’s wording went that the Lisbon Treaty should be amended to enable euro member states “unable or unwilling to permanently obey the rules connected to the common currency… to voluntarily… leave the euro zone without leaving the European Union.”
Presently there is no provision in EU treaties for countries to exit the euro once they have signed up to it, so the CDU’s vote was symbolic but nonetheless telling in signalling that Germany’s governing party would not stand in the way on principle. So goodbye to Greece and all that at the top political level in Germany.
Then in early December, the ECB announced newly liberalised rules for unlimited lending to European banks at 1% interest for three years, including accepting a wider range of collateral with lower credit ratings than before.
This ruse will permit Europe’s commercial banks to borrow at 1% to buy the government bonds of euro zone states and make an easy profit on collecting the yield differentials. Under the rules of Basel III commercial bank recapitalisation implementation currently underway, banks can allocate the highest regulatory capital adequacy ratings to the government securities of their state of domicile.
Thus it is likely that the banks of each euro zone member country will prefer to buy their own government’s debt securities as part of their Basel III regulatory capital requirements. The effect will be to concentrate the government debts of euro zone states within their own domestic banking systems (and borders), meaning that if such states did exit the euro and suffered exchange rate devaluation crises by reverting to their old currencies (eg., the drachma for the Greeks), then their own domestic banking systems would be cushioned by holding drachma-denominated assets on both sides of the ledger.
Exit from the euro zone system under these conditions would not be painless, but it certainly wouldn’t be as painful as leaving in a disorderly manner while holding large quantities of government debts denominated in euros that could not be devalued by the departing country. The Germans of course insist that they have no plans for the breakup of the euro zone, but then they would say that, wouldn’t they?
However, moves afoot by the CDU and the ECB point to the existence of a German Plan B based on assisting the exit of unwanted euro zone members in a manner that would allow the exiting country to stay in the EU while at the same time softening the impact of reintroducing a national currency capable of devaluation.
*Michael Coote is a freelance financial journalist whose publication list includes interest.co.nz, the National Business Review, New Zealand Investor, The Press, and the New Zealand Centre for Political Research.