The two halves of the eurozone are locked in a broken marriage

By Ambrose Evans-Pritchard, International business editor

7:15PM GMT 30 Oct 2011

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http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/8858604/The-two-halves-of-the-eurozone-are-locked-in-a-broken-marriage.html

Greek premier George Papandreou and his ministers were cruelly depicted in cartoons knuckling to German orders or delivering the Nazi salute.

The yearly march commemorating the struggle against the Axis was blocked in Thessaloniki by protesters shouting "traitor" at Greece's aging president Karolos Papuolias, himself a teenage resistor.

The city band wore black ribbons of protest against the Memorandum, the hated document of EU-IMF submission. They downed instruments in silence as they passed the podium of ministers.

I do not wish to be anti-German, since German citizens have been misled by their own elites and Germany itself is the chief diplomatic and political victim of EMU's unfolding tragedy.

But this is what happens when you insert words such as "Überwachungskapazität vor Ort" (monitoring capacity on the ground) into EU summit conclusions. Europe’s inspectors will henceforth establish an occupation office in Athens to ensure the "full implementation" of austerity policies, for as long as it takes. Greece has been stripped even of the pretence of sovereignty.

This country that freed itself from Ottoman control in the 1820s (with French help), is reduced to a Sanjak of the new imperial order.

The Greeks will find out soon whether these officials answering to one Horst Reichenbach - unfortunately named for this delicate assignment (couldn't they find a Spaniard, or a Slovene?) - intend to foreclose on sovereign assets and transfer the proceeds to North European creditors. I do not think it would be wise for them to try.

Yes, Greece has gained debt relief: roughly €100bn, if you think life insurers, pension funds, and others will "volunteer" to join banks in accepting their 50pc haircut.

This will leave Greece with a public debt of 120pc of GDP in 2020 after nine years of depression, if all goes perfectly, the same level that set off the crisis.

Fresh EU-IMF loans will once again finance Greece’s trade deficit and ratchet up its foreign debt. Europe is papering over the elemental fact that Greece has an over-valued currency, cannot compete within EMU, and should leave. But that is to disturb the sanctity of the Project.

In Spain, unemployment is within a whisker of five million, reaching a crisis-high of 21.5pc in September. There are 1.4m households where no member of the family has a job. Some 560,000 people have no support at all.

The latest job losses have been in health care and education, a foretaste of what will happen once the EU-imposed guillotine drops in earnest after this month's elections.

It is an unhappy starting point for an economy tipping back into a double-dip recession. The business federation (CEOE) said a credit crunch is already "strangling Spain's industry".

"We can't go on like this. It is impossible to get out this crisis with austerity alone," said Socialist leader Alfredo Rubalcaba, calling on Europe's Left to force a change in EU policy. Buena suerte, Señor, or rather Viel Glück.

Meanwhile, Germany's jobless rate has fallen dramatically over the last five years to just 6pc, and there lies the rub. The promised EMU convergence never happened. What exists instead is a 30pc or 40pc intra-EMU currency misalignment between North and South. This is Europe's cancer.

The two halves are locked together in a broken marriage. To pretend otherwise is no longer responsible. The structural gap cannot be closed by debt-deflation in the South – the current default setting of EU policy. It could arguably be closed if Germany were to let the European Central Bank reflate the whole eurozone system.

Instead, the ECB has done the opposite, opting to blight the chances that Spain might just be able to claw its way back to viability within the constraints of EMU.

Spain is tightening fiscal policy with heroic stoicism. The ECB did not have to have make matters worse by tightening monetary policy as well. It choose to do so, knowing that 98pc of Spanish mortgages are linked to floating Euribor rates.

It did so when money supply growth was minimal across the eurozone, and core inflation was tame, and knowing that Europe's banks are about to shrink their balance sheets drastically to meet capital rules. "In trying to keep its monetary virginity in tact, the bank threatens to destroy the eurozone," said Paul de Grauwe from Leuven University.

So, the ancient nation of Spain – whether you date it from Sancho III (Rex Hispaniarum) in 1035 or Los Reyes Catolicos in 1496 – was ordered by the EU summit to "strictly implement" fiscal retrenchment.

Spain will be subject to "rigorous surveillance" and "discipline", like all the other EMU victims of mispriced German, Dutch, Belgian, and French capital flows, and the ECB's (earlier) negative real interest rates.

Who will subject the excess savers and capital flooders to "surveillance" and hold them to account for destabilizing Southern Europe? Who will "discipline" Germany? Who will tell Berlin to cut VAT and reduce covert export subsidies in order to mitigate North-South imbalances? Yes, this is cheeky. I make the point only because the inexorable logic of EMU has reduced us to such discussions. If Germany and her satellites had their own Thaler, their currency would rise to reflect underlying economic strength. The underlying crisis would solve itself.

As for the ancient nation of Portugal – dating to Vimara Peres in 868 – it is already under EU-IMF administration, or a "state of occupation" in the words of labour leader Carvalho da Silva. The unions have called a general strike for November 24.

This honourable nation, which pays its debts, has been put in a position by the warped effects of EMU where its external capital accounts have swung from surplus to a deficit of 104pc of GDP. The current account deficit is still 8pc of GDP.

What Portugal needs is a 40pc devaluation against Germany. Instead, premier Pedro Passos Coelho is trying to regain competitiveness through an "internal devalution", with swingeing cuts to pay, pensions, welfare, and health. These reforms are necessary, but you cannot deflate an economy back to viability where (EMU-induced) total debt is around 350pc of GDP. It is mathematical suicide.

In Italy, the coalition of premier Silvio Berlusconi was given an ultimatum to submit concrete plans within 48 hours on how to reorganize Italy’s complex society, touching on the neuralgic issues of labour rights (Article 18 of the labour code) and how to treat the elderly.

Nobody tells us what to do,retorted a furious Mr Berlusconi, who then gave his first hint of revenge by calling the euro a strange hybrid creation that hasnt convinced anybody.

The country has been told to reach a balanced budget by 2013, even though it already has a primary surplus, and one of the lower debt levels (public and private) in the OECD club. This policy risks pushing Italy into a slump that could set off the destructive debt dynamic so feared, as has just occured in Greece.

It misdiagnoses the problem in any case. Italy is in crisis because it cannot compete, not because of debt. (The stess has revealed itself in the debt markets, but that is a different matter). Italy is simply in the wrong currency. It will languish in perma-slump until wage rates once again reflect global market reality.

The EU refuses to confront the core issue, instead seeking to buy time for Europe's South by conjuring a €1.2 trillion bail-out fund (EFSF) that seeks uber-leverage through "first loss" insurance of bonds.

This concentrates risk for creditors. It further endangers France's AAA rating, the foundation of the fund. It almost guarantees faster contagion to euroland’s core.

Europe has resorted to this twisted device because Germany has vetoed all moves to fiscal union, Eurobonds, debt-pooling, or ECB activism. It is a Hail Mary pass, a last gamble when all else fails.

Chancellor Angela Merkel warned last week that euro failure threatens a thousand plagues. "No one should think that another half-century of peace and prosperity is assured"

She has the matter backwards. The euro itself is has become an engine of destruction and bitter cross-border rancour.

Europe will not be whole and happy again until the currency is broken into workable parts, and this misguided experiment is shut down for ever.