The big loser in Germany’s surprise election result is much-needed eurozone reform. Investors must accept that the eurozone and some banks remain prone to crises, writes Brian Caplen.
Even before the German election, chancellor Angela Merkel was cool on proposals from French president Emmanuel Macron for a eurozone budget of several percentage points of GDP. There is resistance within Ms Merkel’s own Christian Democratic Union (CDU) to anything that involves more German funds being used to solve the economic problems of other eurozone countries.
But now things are doubly difficulty. One of the CDU’s likely coalition partners, the Free Democratic Party, is even more hardline on the use of German resources in this way while the shock winners of about 12% of the vote, the anti-immigrant Alternative for Germany (AfD), was founded because of dissatisfaction with the terms of the Greek bail-out.
By contrast Mr Macron, on a recent trip to Athens, was calling for more help for Greece to ease its fiscal burden and was keen to stress that Germany’s idea of transforming the eurozone’s rescue fund, the European Stability Mechanism, into a European Monetary Fund was not a substitute for a common budget with a eurozone finance minister.
In fact, a eurozone budget of several percentage points of GDP would be too small to perform the kind of Keynesian fiscal stimulus that many economists advocated in the wake of the eurozone crisis. That would need a budget more like 40% to 50% of eurozone GDP.
What this means is that the eurozone will remain crisis-prone, especially with high sovereign debt ratios being carried as a result of the last crisis – Greece 175%, Italy 132%, Portugal 129%, Spain 98%, France 95%.
Meanwhile, banking reform may not be the panacea that some had hoped for. In a recent article for the FT, a global strategist at Pimco, Gene Frieda, wrote: “The bank resolution regime imposes heavy burden sharing on private bank creditors without having repaired the banking system first. Pockets of bad legacy debt persist. Moreover, much of the system remains poorly profitable and in desperate need of consolidation. Forced to issue expensive bail-in-able debt, weak banks become weaker still, thus reinforcing procyclicality. Similar to the wholesale funding crisis of 2008, bank creditors are prone to run away in periods of uncertainty.”
Brian Caplen is the editor of The Banker. Follow him on Twitter @BrianCaplen
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