Hamish McRae: Summits cannot rebalance Europe
Sunday 01 July 2012
So it is all going to be all right then. The German taxpayer will back the recapitalisation of Europe's banks and will throw a lifeline to Spain and Italy.
Share prices, particularly of the banks, leap in what is known as a relief rally. Ireland celebrates the possibility that it might be able to return to the markets to fund itself. Angela Merkel, at 4.30 last Friday morning, caved in to the massed ranks of other EU leaders. This week the European Central Bank will cut interest rates. Europe can breathe again.
Except it is not really like that, is it? The latest EU summit, number 19 since the Greek crisis unfolded, is more of the same. Gradually, inexorably, the burden of holding the eurozone together is being loaded onto Germany, because only Germany is perceived as credit-worthy enough to bear the burden. Indeed Germany remains, just, the most creditworthy nation on earth. If you take 10-year bond yields as a proxy for strength, she can borrow more cheaply than the UK and even the US.
As Mrs Merkel told the German parliament just ahead of the summit: "Germany is an economic engine and an anchor of stability in Europe, but not even Germany's forces are infinite. Not even Germany's strength is unlimited; we must also not overestimate Germany's strength. If we take that to heart, then Germany's forces can be fully effective for the benefit of our country and for the benefit of Europe.
"If we do not take that to heart, then everything we are planning, agreeing, implementing would ultimately be worthless, because it would be clear that it demanded too much of Germany and that would, in turn, have unforeseeable consequences for Germany and Europe. We will not allow that to happen."
The question a week or so ago was whether Germany would indeed deploy its economic strength, in the months to come, I expect the focus will shift more and more to the limits of German strength.
The starting point here is that the divergence between German funding costs and those of the two largest weak economies, Spain and Italy, is huge. For savers, it is as though the euro never existed. You can catch a feeling for this from the graph, which shows the gap between German 10-year yields and those of Spain, Italy, Belgium and France. The right-hand side of the graph will be a familiar one to readers here, but have a look also at the left-hand side. Before the euro was invented Spain and Italy had to pay between 4 to 6 percentage points more to borrow than Germany because people feared that they might devalue their currency, which they had periodically done since the Second World War.
Now the gap is essentially the same, a bit less for Italy and a bit more for Spain. You are not going to reverse that in a few months. Even France and Belgium are back to their pre-euro relationship with Germany. Indeed, looking at that graph, you could conclude that the oddity is the long, flat period where the yield gap had disappeared, not the present divergence of rates. For savers, there is a renewed awareness that leopards do not change their spots.
This is a gap that Germany cannot bridge. The present pots of European money will now be deployed somewhat earlier than previously expected and it will be directed to support banks as well as sovereign debts. But that means they will be used up sooner, so the question in a few months' time will be how to top them up.
The two main pots, the European Financial Stability Facility and the soon-to-be founded European Stability Mechanism have some €500bn (£400bn) available to buy debt. But the sovereign debt of Spain and Italy totals some €2,400bn and past experience of publicly funded purchases of sovereign debt (indirectly with ECB loans) have been that putting public money in merely allows private savings to get out. The available funds could be used up very fast.
When that happens once again, the German taxpayer will be asked to take on more potential liabilities. Once again, we have to assume, the German government will reluctantly cave in. Indeed it will go on caving in until … until, well, it doesn't.
The timing of that will depend on politics as much as economics. My own guess is that the final crunch point is still some years away.
Germany, or rather the old West Germany, has been spending some 4 per cent of GDP supporting the former East Germany. This burden has been carried as an essential price for regaining part of the territories it had lost. So politically it is acceptable. But even this subsidy has not yet resulted in a self-sustaining East Germany, for there is still a drift of population from east to west.
It is hard to see a cross-European subsidy from north to south on anything like this scale, and it seems probable that southern Europeans of working age will continue to migrate north. In Britain, we are particularly aware of young French and Italian people migrating to London, while our own retirees have tended to migrate south, particularly to Spain.
So the economic imbalances within Europe are showing up in the movement of people as much as the movement of money. Money moves because people are worried they won't get their savings back. People move because there are better job opportunities. Now, it may be that Germany's economic growth will continue to be strong enough to give jobs to migrants from the south. But, of course, if young people move abroad for jobs this further undercuts the tax revenues of the home country, so the cross-border subsidy needs to be ever larger.
It is an odd situation. Taken as a whole, eurozone budget deficits are around 4 per cent of GDP, about half that of the US and UK. Total debt, relative to GDP, is about the same, maybe a bit lower. So the eurozone ought to be as attractive a place for global savings as the US and UK. But only bits of it are: in fact only Germany is, for even France is suspect.
The reason is the internal tensions evident in the graph. Those tensions cannot be fixed by even a successful summit number 19, nor I fear number 20, nor the many more to follow.
Your guide to untangling the five strands of bank reformation
Banking will be different for a generation. We have known that for some time but last week's events have speeded up the transformation. There are at least five strands to this and it might be helpful to sketch them here.
First, banks will become less international. That has already begun at retail level in Europe, as they have focused on home markets. For example, at the height of the boom roughly half of UK mortgages came from non-British banks; that flow has stopped. With the possible exception of Spain, banks have lost far more on foreign loans than on domestic ones.
Second, there will be some sort of split between commercial and investment banking, though it is not yet clear how this will be managed or how far it will go. In the UK, with the exception of Barclays, the high street banks have relatively small investment operations. On the continent there is a tradition of universal banking, where the functions are blurred. In the US, combined commercial and investment banking is relatively recent, mostly following the easing of the 1933 Glass-Steagall Act in 1999.
The argument for a split is usually made on the grounds that savers' money (and the promise of government guarantees) should not be risked on "casino banking". That is a weak argument, for the main banking collapses have been the result of poor commercial lending, not investment banking. Look at Northern Rock, HBOS or even Royal Bank of Scotland. But there is a decent case to be made in that the skills and mind-set of investment bankers are quite different from supposedly risk-averse commercial bankers and merging the two has somehow corrupted the latter.
Third, banking will be smaller relative to the total size of the economy. Instead of banks doing so much intermediation between borrower and lender, more of the weight of capital-raising will be on securities markets.
Fourth, there will be a number of innovations aimed at boosting competition between banks.
Finally, regulation everywhere will be tightened – as it should be. But I think we all knew that.
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