Creditors and Bureaucrats Push Back

Currency in Crisis

The financial crisis has called into question political and economic orthodoxies. In Europe, EU officials and the ECB President have encouraged new bold thinking. Anything seems possible. Moreover, the push-back against austerity, which began prior to the French elections, perhaps when Draghi endorsed calls for a growth pact, also has re-open the debate about more support for the debtors in Europe, including joint bonds, EU wide deposit guarantees and maybe even direct bank access to ESM funds.

In today's Financial Times, Martin Wolf is critical of Germany's refusals...its blanket "nein". The judgment may be premature. The creditor nation, led by Germany, are preparing a response.

It will include more on structural reforms than new money, but there will be new funds. The creditors will say "ja" to more EIB funding and increase structural funds. The latter may help fund joint projects with private sector investors for cross border infrastructure and energy undertakings.

Yet the essence of the German proposals seem to be scaling up the strategy employed when the Berlin Wall fell. Germany had to restructure and it was painful. It included using state funds, like the KfW to help promote start ups and small and medium-size businesses (SMEs). It included labor market reforms, relaxing protections, lowering the tax on employment and introducing "mini-jobs".

Education reforms to promote vocational training and expanded apprenticeships will also be advocated. Privatizations will raise revenue and promote greater economic efficiency and profit-seeking behavior over rent-seeking. There is talk of the special economic zones. The creditors may also encourage the greater development of renewable energy and increase worker mobility. Merkel can boast that immigration into Germany is at its highest level since prior to the start of EMU.

The creditors are not the only ones preparing for a new attempt arrest the crisis. European officials like Barroso and Van Rompuy want to get ahead of the curve too. The proposals that will likely come from them will involve greater integration and cooperation in areas, like bank supervision and taxation. They also are interested in a EU wide deposit guarantee and seem sympathetic to a EU wide bank resolution scheme.

The EU Commission suggestion that the ESM might be used to directly recap European banks is a non-starter, though it caused a flurry of activity in the fx market earlier today. . The ESM treaty simply does not allow it. Nor will the creditors because it would deny them leverage over the borrowing nation to implement reforms.

Yet it does reveal the kind of direction that the EU/EC officials want to move. Last week, Draghi suggested that "We have reached a point in which the process of European integration needs a courageous leap of political imagination to survive." The EU and European-wide policy makers see the solution as greater integration, which of course boosts their role and gravitas.

The one yes that Wolf does not credit Germany for saying is that it too wants greater fiscal integration as a precondition for a joint bond. Creditors have to know that they are not putting money into a bottomless pit. There will be much jockeying for position ahead of the late June EU Summit.

If the New Democracy and PASOK are able to form a new Greek government after the mid-June elections, the summit can be devoted to another attempt to find a comprehensive solution. If either not government can be formed or if Syriza leads the next government, the end of June summit may seem more like a war council. Even if Syriza wins, a Greek exit is not the done deal that many in the Anglo-American press seem to be haranguing for.

The policy "betting" web site www.intrade.com, now puts the odds of a country leaving EMU by the end of this year at 40%. This seems fairly conservative compared with the market chatter, but even that may error on the high side. The cost of a Greek exit seem larger than modifying its memorandum of understanding, which must be done regardless of the electoral outcome and making it easier for Greece to access infrastructure funds.