Feint and Parry and the Three No's

In the diplomatic dance in Europe, investors are rightfully confused what is a feint and negotiating tactic and what is parry or strategic principle. A new French president and changing tone in Europe appears to have re-opened debates that had previously seemed closed. The range of possibilities all of the sudden seems large again--joint bonds, recapitalization of banks from the ESM, more aggressive ECB support for the sovereign bond markets. 

Yet there is more and less here than meets the eye. In order for Hollande to maximize his negotiating position, he must press ahead with elements he knows full well that Germany cannot accept. By pressing ahead he can win concessions in other areas. 

We have argued that "three no's" characterize the investment climate in Europe. No collective euro bond. No ECB backstop for sovereigns. No euro zone break up. Although the risks of a Greek exit would appear to have increased, this formulation still seems appropriate. 

Germany cannot agree on a jointly guaranteed bond now. It is the fruit of fiscal integration not a means to that end. Putting the cart before the horse would jeopardize Germany's strategic interests. Germany would in essence be offering a blank check to its neighbors. It remove the pressure on countries to institute structural reforms. If some one else is going to pay for (part) of your spending, then there is less incentive to be responsible. Joint bonds now would bring Europe no closer to is goal of a solid sustainable fiscal position, from which non-debt driven growth can proceed.

Hollande cannot, though, simply not discuss it because Germany is opposed. That would not be politically savvy. France sees its interest to have joint bonds. Sarkozy did. Hollande does. In order for France to sacrifice its interest, it ought to get something in exchange.

On the other hand, EFSF bonds and bonds that the ESM will issue and the EU bonds and EIB bonds are joint issues. These coupled with the fiscal compact are what we have called the "scaffolding" of a fiscal union. Some observers argue that monetary union has failed and it will disintegrate. We have argued to the contrary that the resolution will be greater integration rather than less.

It took the fall of the Berlin Wall and that threat of a united Germany for countries to overcome their nationalism and surrender monetary sovereignty (though they have retained central banks, suggesting that monetary unification is not complete). It may require the worst financial crisis in a couple generations and the threat of fiscal ruin to get countries to overcome their nationalism and surrender fiscal sovereignty.

When European countries get their fiscal house in order and future excesses blocked, then a European bond can be agreed by Germany. German officials, most recently deputy fin min Kampeter, and previously Asmussen and Stark have all suggested those are the only terms that are acceptable.

France's new finance minister Moscovici seemed to acknowledge the importance of the German position, even though the OECD seemed support euro zone bonds just today. Yesterday Moscovici was quoted on the news wires saying that although France still supported euro bonds, it recognized that this could not be forced on others. Germany, of course, is not the only country that is opposed to euro bonds. So is Austria and Netherlands.

We continue to insist that there still is plenty of room for compromises. France keeping items like euro bonds, and a more aggressive and pro-growth ECB makes a compromise more likely rather than less. There does seem to be a consensus emerging for a reinvigorated EIB, easier access to cohesion funds and structural funds and project bonds. It was reported just yesterday that Spain will get faster access to about 1 bln euros from the EU cohesion funds for environmental and transport infrastructure projects.

Our key point here is that the discussion of joint bonds is a bargaining chit for France (and others) to win more concessions from Germany. The austerity will be joined by some more efforts to promote growth and public investment. Joint bonds will be the result of greater fiscal integration not the cause of it. In the larger sense, rather than the contradictions in the euro zone being resolved by dissolution, we continue to think that way forward will be greater integration and increasing encroachments on fiscal sovereignty.