Yesterday,, March 14, Germany left the EuroZone.
Oh, nothing official. And I’m not holding my breath waiting for any objective confirmation such as the re-introduction of the Deutschmark. But the new German budget marks the beginning of the eventual effective end of the EuroZone and the euro.
What exactly happened that’s so momentous? How can a single national budget make such a difference?
The German budget for 2014, announced by German Finance Minister Wolfgang Schauble Wednesday, March 13, on the eve of the March 14-15 European summit, includes another 5 billion euros in spending cuts. Total net new borrowing for 2014 will drop to 6.4 billion euro, a 40-year low. And it puts the German budget on a path to balance in 2015. That’s a year earlier than required by the German constitution.
If fiscal prudence is your goal, then this budget deserves the praise heaped upon it by Philipp Rosler, Germany’s Economy Minister, who said: “With all modesty, this is a result of historic proportions. The lesson from the sovereign debt crisis is that solid finances are essential. Thanks to this approach Germany is in the vanguard in Europe. Our success with a policy of growth-oriented consolidation is the envy of the world.”
The problem—aside from the smugness of those comments–is that fiscal prudence isn’t the most pressing goal in the biggest economies—next to Germany—in Europe.
Everyone knows the Greek economy is a disaster—and that was pressed home in new unemployment numbers released on March 14. Unemployment hit 26% in the fourth quarter, up from 24.8% in the third quarter. For workers between 15 and 24, the unemployment rate is 57.8%. The percentage of the unemployed who have been looking for a job for more than a year hit 65.3%.
But the real problem isn’t Greece. The real problem is that the rest of Europe—except for Germany—is, like Greece, facing growing unemployment with no medium term relief in sight. Employment in the EuroZone as a whole fell by 0.3% in the fourth quarter from the third quarter as only Germany, among the EuroZone’s major economies, showed an increase in jobs. The decline in fourth quarter employment is particularly ominous because the Christmas shopping season usually generates jobs.
And the prospects for improvement? Grim. Ernst & Young, for example, projects that unemployment will continue to climb in 2013, and the recovery from 2014 is likely to be anemic. By the end of 2017, Ernst & Young estimates that the unemployment rate in Europe will remain stuck above 11%.
The European summit that began on March 14 is supposed to propose measures to promote growth in European economies. But it’s not clear where that growth could possibly come from.
Germany’s neighbors have pleaded with the country to stimulate its own economy because more spending by German consumers might produce added demand for goods from Spain, Italy, and France. The new German budget seems to have taken that off the table.
The European Central Bank seems disinclined to intervene. The International Monetary Fund has called on the ECB to stimulate growth in Europe by cutting its benchmark interest rate, but the bank continues to insist that current monetary policies combined with austerity budgets from European governments will be enough to lead to higher growth in the second half of 2013. At the moment the bank is committed to waiting for structural economic reforms to work. Take this growth alternative off the table.
Other EuroZone members, most especially France, have called for relaxing the EuroZone’s 3% budget deficit to GDP ratio rules to allow governments to run higher cyclical deficits in tough economic times. The French are clearly pleading their own self interest—it looks like France will run a budget deficit to GDP ratio of 3.7% or more in 2013 rather than hitting the 3% target. Germany, however, has continued to insist that countries follow the budget rules—and has been especially emphatic about the need for big economies, such as France, to set a fiscal example for smaller EuroZone economies. So remove this last alternative.
And yet, somehow, the leaders gathered at this summit are supposed to produce a growth plan for the EuroZone. The eventual post-meeting statements for these meetings are always drafted in advance—and then modified by discussion. The draft for this meeting, according to the Financial Times, called for “short-term targeted measures to boost growth and jobs.”
Even before the meeting that language was taking fire from Germany, Finland, and the Netherlands. The announcement of the 2014 German budget—an announcement moved up a week so the budget would be released before the summit—seems intended to put pressure on the summit to hold the line on fiscal discipline. German and European Commission austerity advocates such as European Commission minister Olli Rehn have heaped scorn on French calls for relaxing the budget rules.
So what happens now?
European leaders have become extremely accomplished at papering over disagreements and I’m sure that they’ll manage to produce language that downplays disagreements at this meeting.
But I think these disagreements are coming to a head, soothing language or not. The European Parliament has just rejected a budget with modest cuts in spending for the European Union that took a year—including a last minute deal worked out last month—to put together. Politics in Italy may preclude the formation of a new government in Italy until after new elections in June that could raise the large vote total recently garnered by anti-euro parties. Auditors from the International Monetary Fund, the European Central Bank, and the European Commission have just left Athens without approving the next, relatively small 2.8 billion-rescue payout due to Greece. The approval ratings of France’s President Francoise Hollande and Spain’s Prime Minister Mariano Rajoy continue to sink. Politically these leaders can’t accept calls for greater austerity. June brings a series of important deadlines for EuroZone policy on budget rules and strengthening economic coordination among member countries. It’s hard to see how an agreement on those rules comes out of June meetings.
Most discussions of the break-up of the euro focus on the forced exit of one of the troubled economies—Greece—or a decision by Spain or Italy that the pain of staying in the euro just isn’t worth it.
But I think it’s increasingly likely that the effective-if-not-official end of the euro will result from actions by the stronger economies in the EuroZone. For example, Finland’s government has made it clear that it won’t fork over any more rescue money—looking at the needs of its own aging population, the country can’t afford it, the government has said. And this most recent German budget has made it clear that Germany—at least Germany before its national elections in September—isn’t willing to sacrifice one pfennig of its insistence on fiscal discipline.
The first step in a breakup coming from Germany and it allies is a deadlock in the EuroZone that prevents any movement on growth, increased economic and monetary integration, and the development of EuroZone-wide banking regulation. I think we’re close to that gridlock now—the results of this summit and progress on the June deadlines will tell us how close.
Gridlock isn’t a tenable long-term strategy. Recessions continue to grind down economies and governments in Italy, Spain, and most importantly France. Voters are moving toward parties that reject the euro. Germany, rather than getting more willing to compromise, seems to be locked into its position that austerity is all that’s needed.
Gridlock leaves the euro and the EuroZone technically intact but unofficially marks the end of the euro project. I don’t know how long it will take for gridlock to become so intolerable that somebody leaves officially leaves the euro. But if the EuroZone countries can no longer agree on anything, the euro as a unified currency for a unified monetary bloc is done.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post.. For a full list of the stocks in the fund see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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