WELL that didn’t last long, did it? The financial market euphoria, which greeted the announcement that the ECB would buy bonds in unlimited quantities, has melted away. In its place, the realisation that Europe’s economy is weakening quickly is puncturing short-lived optimisms.
Yesterday, we had more evidence from Germany that business confidence is ebbing more quickly than anyone anticipated. The IFO index of businesspeople’s expectations about the future has now fallen for the fifth consecutive month.
The rolling recession, which started with the collapse of Lehman, initially affected highly leveraged countries like Ireland, Iceland and Greece, then mutated into a slump in Spain and Italy and it is now moving in a crashing wave to the core of Europe. Affecting France at the beginning of this year, it is now being felt in the industrial powerhouse of Europe, Germany.
Until recently, China’s demand for German exports — particularly heavy machinery, which Germany excels at — kept order books healthy. But now Chinese demand is not there any more as its exports and economy weaken. The real fear in China is that it will prove to be the mother of all property bubbles, which will burst.
This is its own fault because, as money flooded into China, the revenue from its exports should have caused the Chinese currency to rise. But the Chinese didn’t allow this to happen and they allowed the local money supply to grow, providing cheap loans for speculation on property. Now the result isn’t just ghost estates, but entire ghost cities of unsold apartments.
All this is having an impact on Germany. The economy that was once a powerhouse may well prove to be regular after all. The slowing in Germany will cause a renewed crisis in the eurozone because Germany, as well as being an exporter, is an importer and France and Italy are her main clients.
As always happens when there is a slowdown, the least competitive supplier loses. This will put the spotlight again on Italy and, for the first time in the crisis, on France.
If growth stumbles again, the inconsistencies in France will become more evident. France is a country which has been running a budget deficit for years, but in recent times it has also been running a current account deficit. Of more concern is that France is a country that has proved itself incapable of even the most modest reforms to its labour market. This inflexibility will prove to be highly damaging if it has to seek ECB assistance (as Spain will definitely require and Italy is likely to need). In short, France is Europe’s Achilles heel and, next year, we should expect more financial fireworks as the French bondmarket is sold by investors.
This cyclical slowdown is coming in a German election year when the hostility between the German Bundesbank and the ECB’s Italian leadership will be difficult to conceal.
You know the world is in a strange phase when the Pope is a German and the head of the central bank is an Italian. But just how Italian, is now dawning on many in Germany. Make no mistake about it, Mario Draghi is turning the euro into the lira because he realises that in order to survive, the euro needs to look and feel much more like the lira than the Deutschemark.
Whatever the Germans were expecting when they reluctantly gave up their Deutschemark, they sure as hell weren’t expecting the lira. But this is what they are getting.
As growth wanes, open war is likely to erupt between the Bundesbank and the ECB in a philosophical as well as economic confrontation.
The Germanic view of money, exemplified by the Bundesbank, sees money as a ‘common good’, protected by treaties and laws and it is a common good that no government or institution owns: the economy adapts to money, not the other way around.
The alternative school of thought, exemplified by Mario Draghi, views money as a tool: the state or institutions have a responsibility to use money to achieve desired outcomes, such as full employment, or economic growth, or saving the euro.
Thus we are set for a titanic struggle in Europe and the trigger for this struggle will be a crisis in France, where faltering growth will force it into an economic adjustment, which the country is simply incapable of effecting.
Europe’s economic problems are: too much debt, too little growth and a lack of coherent political leadership.
None of these issues has been addressed by what is in effect monetary financing through the back door announced by the ECB two weeks ago. These problems will resurface in 2013 and, when they do, expect the next move from Draghi in 2013 to be printing of more money as the gradual but unambiguous “lira-isation” of the euro continues.
This is good for us because our major trading partners are Britain and the US, so anything that weakens the euro is good for Ireland. In addition, the bank debt deal will be supported by Draghi and we should play to this audience and for his affection in the months ahead.
But the question for the euro is how long Germans will tolerate the debasing of a currency that they intended to be as least as strong as the Deutschemark. In the past few days, the financial markets are suggesting that the Germans will not remain sanguine forever.
In the next few weeks, economists and analysts at large banks and pension funds will be locked in meetings trying to figure out what is likely to happen next year and how to position their funds accordingly.
Looking at the recent numbers, we are likely to see recessionary conditions in core Europe in 2013. Before the end of the year, Greece will need another bailout and Spain will be bounced into an IMF/EU programme.
But the big story for 2013 is likely to be France and the row, in a German election year, between Germany and the rest as the euro morphs from a mini-Deutschemark to a mini-lira under the eye of Mario Draghi.