"Real Politik" : A German Pre-emptive strike ?

Courtesy of Zerohedge and if they are right with their scope, we still can't say that we hadn't seen this one coming : Apparently Germany is silently preparing a "tabula rasa" and "cut the crap". In Thursday's Handelsblatt edition, it would appear that the following simple question would be raised : those who can and willing to play by the rules are welcome, those who can't, "schade", whilst staying in the EU.

So German "grundlichkeit" and "common sense" are increasingly taking the upper hand. And at hindsight, you can't really blame them, even in the light of so-called absence of altruism or social empathy for the euro-zone members. Enough is enough, basta cosi ! Why ?

1) Having a look at political games in Greece (who will preside parliament etc) and Italy over the past couple of days and weeks, no wonder Frau Angela and Herr Schauble are fed up. And also with France and their hidden agenda for that matter but we come to that later on (we Belgians with Dexia have already experienced a piece of that).

2) EFSF and market reaction : EFSF bonds are not performing very well lately and the latest auction was a disaster. So blame the market speculators ? No, not really. It's not that I am shorting the stuff, it's just that I am not buying the story, nor is the majority of Mr Market. It just doesn't add up and the Germans are pretty well aware of this. How can a leveraged fund of which almost half of the guarantors are in trouble be credible and by this be a credible threat towards the market sharks ? Italy and Spain would have to guarantee 1/3 while they are both in serious trouble. France almost 20% and not really being the most pro-active well-behaved student of the class. And Germany would have to guarantee almost 30% of this "brave endavour". In case of a 1 trillion eur equivalent rescue mission, 300 bio eur is a lot of money.

3) So for those who think a German exit or mini-EMU with or without Germany is a no-go because the opportunity cost for Germany is too big, I think you should reconsider. Guaranteeing EUR 300 bio is not small either. And the way things are proceeding right now, these guarantees will be called upon one day or another. Germany will always survive, they did so pre-EMU and they will continue to do so post-EMU. Their international trade by the way is not restricted to Europe and as far as I can tell, it's the sole country in the world registering a trade balance surplus with China. Apparently, German engineers and capital goods still rule.

4) On the ECB : first of all, never change a winning team and the Bundesbank for that matter have 50 years of credentials to lean upon. In their days, decision time was when it came to revalue or not. So the fact that a lot of Germans have abandoned ship the past couple of months should have been a writing on the wall. Not much honor to be gained around here. And for those interested, I would highly recommend 2 books from David Marsh : "The Bundesbank - the bank that rules Europe" (1992) and "The EURO - the politics of the new global currency" (2009). Briefly, post factum no surprise here.

5) On the ECB finally : so the ECB should follow the path of Benny and the ink-jets and buy bonds ad infinitum. A "Great" and very short term strategy but the incentive is wrong. Apart from moral hazard and potential difficulties in the field of money supply/inflation, it seems that once again the ECB should act as last resort for French banks. Because once again after the Greek catastrophe, French banks are the first in line to take a hit if this Italian job fails. And it doesn't stop here. Suppose the ECB should intervene and neutralize the operations by withdrawing liquidity from the market as it did at previous occasions (unlike the FED where it's pure money printing). A dead end street once again because interbank money market liquidity will dry up and the ECB will have to come again to the rescue by injecting tons of liquidity. And guess which banks will knock on the door big time ? Exactly, domestic colleagues from Dexia. Finally, the argument that the ECB should play "all in" because they blundered some months ago by hiking interest rates (see Krugman on his latest blogs) is for me pure nonsense. An economy "doomed" because short term rates go up from 1.25% to 1.50% ? If that's the case, we should all go home now and read a comic book.

So as far as Germany is concerned, time's up. Simple rules and a well defined crossing line between politics and monetary policy (Maastricht spirit, at least on paper). You do your job and if so, I adjust monetary policy. But Monetary policy should never become a vestal virgin. And simple well defined rules usually stand the test of time.