MacroScope

Germany back in business

By Mike Peacock
December 16, 2013

Germany’s Social Democrats voted overwhelmingly to join a “grand coalition” with Chancellor Angela Merkel’s conservatives. The government will offer broad continuity with some tweaks, the reappointment of Wolfgang Schaeuble as finance minister testifies to that. But could it unlock some euro zone policy doors after three months of limbo?

The big item on the agenda of an EU summit late this week is banking union. What results will dictate whether the seeds of a future financial crisis have been sown. Thanks to our exclusive at the weekend, we know that the latest proposal will see the cost of closing down a euro zone bank borne almost fully by its home country while a euro zone fund is built up over 10 years.

Key euro zone finance ministers will meet in Berlin today (as they did without success 10 days ago) to try and reach agreement in time for the summit. A full meeting of euro zone finance ministers is slated for Wednesday but it could take a bilateral meeting with the newly anointed Merkel and French President Francois Hollande to break the logjam.

Critics say the plan is a pale shadow of what was proposed in 2012 which, lest we forget, included a commonly funded backstop for failing banks and a mutual deposit guarantee which has long since bitten the dust.

Under this plan, the costs of closing a bank in year one would be fully covered by a fund set up by the home country where the bank resides. Such funds in every euro zone country would be paid for by the banks. The funds will reach a full size of 1 percent of all covered deposits after 10 years and at that point would be merged into a Single Resolution Fund which would finance all bank closures.

What eventually results would be significant, though whether the funds are sufficient is open to question. But for several years, the lion’s share of the cost of rescuing or closing a failing bank continues to fall nationally, so the notorious “doom loop” remains.

Further questions. Are the banks in a position, Europe-wide, to pay up? Is everyone confident that there will be no return to crisis in the next few years while indebted governments will ultimately remain on the hook? To what extent will powerful euro zone governments be able to influence or overrule the body tasked with bank wind-ups? And will even this blueprint be agreed given it’s just a proposal by the Lithuanians who hold the EU presidency?

By the end of the week, we should know.

With flash PMIs for the euro zone, Germany and France giving a late snapshot of another lacklustre year for the single currency bloc, European Central Bank chief Mario Draghi makes his last hurrah of 2013 with an extensive session in front of a European Parliament committee. With inflation forecast to remain well below target for the next two years, pressure is growing to act and the ECB has said a number of options were ready to be deployed.

The most likely – a repeat of the splurge of cheap, long-term money thrown at banks last year – has been saddled with a caveat. Draghi says the ECB would only sanction another “LTRO” if he was convinced banks would use it to lend into the real economy, which they didn’t last time, rather than as cheap money for a carry trade into government bonds giving a guaranteed return, which they did. The ECB is pondering how it might make that work.

Draghi will have to do without key lieutenant Joerg Asmussen who is quitting the ECB to return to a junior government job in Berlin for family reasons. No doubt his time will come again.

Given the Governing Council is a male-only body, it will be incumbent on the ECB to select a woman with Bundesbank number two Sabine Lautenschlaeger probably the favourite. Asmussen was important partly because he did not always adopt the German hard line. Lautenschlaeger is likely to be more orthodox and could marginally tilt the balance of opinion on the bank’s executive board.

For all the drama on the streets of Kiev, the money, or lack of it, tells us that a Ukrainian end game must be approaching. But which way will Kiev turn?

The European Union ratcheted up the pressure on Sunday, suspending further work with Ukraine on a trade and cooperation agreement because the government in Kiev had failed to give a clear commitment to the deal, that after Ukraine’s first deputy prime minister flew to Brussels last week seeking billions of euros of aid and saying Kiev would soon sign up to the accord which President Viktor Yanukovich rejected last month.

That throws Yanukovich’s visit to the Kremlin this week into very sharp relief. His opponents fear he will return having turned his back on the EU for good. And yet…

Kiev’s currency reserves are so depleted that they won’t even cover three months of imports. It is estimated to owe $7.5 billion to foreign creditors next year and while Russia could cut the cost of its gas and defer payments, it would probably have to do more than that to keep its neighbour afloat.

Can it and will it? Russia has big problems of its own having admitted its failure to diversify its economy will lead to a far lower level of growth than had been expected all the way out to 2030. Vladimir Putin has conceded for the first time that Russia’s economic problems were home-grown.

Admittedly, only a few hundred million euros of EU money is on the table for Ukraine  so far but we know the IMF and the World Bank are quietly watching too. Russian Foreign Minister Sergei Lavrov will meet EU foreign ministers in Brussels today.

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