Chancellor Merkel announced she will be going home tomorrow when the summit ends and not sticking around for any weekend post-game quarterbacking. She has said her piece—the first step is not “collectivization.” That’s the last step. We wonder why Merkel does not get respectful attendance. Would her comments be more powerful if they came from some big guy with a handlebar mustache? But a chancellor is a chancellor. If German banks have to take huge losses on defaulting peripheral country bonds, Merkel is saying “so be it.”
Political and social change moves by months and years, while market change moves by minutes and hours. The two are out of sync. This is hardly a fresh observation, but what is really amazing is that politicians never learn how quickly markets can come to a negative judgment. They never heard of net present value in that California town whose entire budget goes to pensions. Meanwhile, markets never learn that political change is grindingly slow, and overreact to what seems like unresponsiveness when what they are seeing is actually the normal pace. To be fair, the structural change that is needed in Greece, Spain and Italy to make their economies viable faces giant cultural obstacles. And what would be needed in Germany to allow “mutualization” is constitutional change, as Merkel point out. As things stand today, eurobills, Eurobonds and debt redemption funds are unconstitutional in Germany, she says. She didn’t have to add that they would also be “wrong and counterproductive.”
We are astonished that nobody is listening to Merkel. The WSJ writes “The markets have largely tuned out the two-day EU summit that begins today, and for good reason. The usual routine with these things is the eurocrats get together, talk in byzantine circles, sing a Kumbaya-style song of shared purpose, and then promptly go home and do absolutely nothing. This week, the only part of that routine that might survive is the last.”
This is cute, but wrong. Leaders will go home and do something—they will start preparing for new pleas for bailouts and if they are smart, for budget cuts to avert higher funding costs that would lead to default. The press is positioning Monti, for example, as a whiner who got a more flexible labor law and now wants billions from fellow members buying Italian bonds as a reward, or else he will quit. We still don’t know whether Monti actually threatened to resign, but from the German/Finnish/Dutch point of view, it doesn’t matter. He can do as he chooses. The new labor law is nice, now let him get on with the rest of it—or not. Italy’s financial fate is in Italy’s hands, and that’s the way it should be. If Italy chooses to become a ward or colony of the EU and let Brussels determine its budget, tax rates, pension rules and so on, that would be another matter.
And this is the crux of the matter—sovereignty. The Gang of Four has devised a roadmap that ends up making each eurozone member a colony of some new sovereign that resides in Brussels. Just as the EMU created a new kind of sovereignty—one that has a central bank and no other feature of a classical sovereign—the roadmap proposes a super-sovereign that has some of those characteristics but again, not all. How can you have democratic countries that elect their leaders give away financial functions to unelected people in a foreign city? We can’t imagine a single country holding a referendum on such a thing and coming up with “yes.”
That includes Germany, whose voters know full well who would be writing the checks. In fact, a poll quoted by Market News today shows Germans would support eurozone membership by 43 to 41, with the rest undecided. In short, ain’t gonna happen. The ECB’s Noyer told the press today that national sovereignty must give way to the “construction of Europe.” This is a massive undertaking that will take not the usual politicians’ years, but rather decades. Merkel may have been right that Eurobonds will occur over her dead body. We should see the comment as truthful in the context of timeframe, not her political or legal stance. Of course, it’s also true that neither Merkel nor any other elected German officials is proposing constitutional changes that would allow the Brussels super-sovereign.
So, by the end of the day tomorrow, we should not have any surprises. We know what to expect—Germany will approve EFSF aid to Spain and Italy, although in quite what form we don’t have yet. The ESFS is the existing “toolbox.” As for constructing Europe, as Noyer put it, talks can go on but some members, especially Germany, feel no urgency and in fact reject urgency. The nagging worry here is that we so often get a relief rally after an Event like this summit. Never mind that Greece is on hold and Spanish 10-year notes are yielding 7%--the market may decide the euro was oversold on excessive feelings of disappointment. In fact, the summit will be as should have been expected. A euro recovery is not out of the question going into tomorrow and the weekend, especially with the US holiday coming next Wednesday. Nobody will want to hold a big position either way.
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