international analysis and commentary

The White House tries to dodge eurozone bullets

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At the start of the debates and with both conventions over, the race for the presidency is roughly back where it was before political people got together wearing silly hats; the President is ahead by just inside the margin of error. At his convention, President Obama gave a good if not great speech, laying out the perfectly plausible case that without him the American recession that followed the collapse of Lehman Brothers could easily have morphed into a fully-fledged depression. While that is a quite sensible reading of events, it is also painfully unprovable, both factually and certainly electorally. In the end, the White House has to count on the scared, dispirited, and economically hurting American people just taking its word for it.

Given present polling, this seems something (just) that they are prepared to do. However, this is only the first monster President Obama must slay, the second is equally daunting and equally important; nothing new must upset this razor’s edge victory-in-the-making. There are at least three ghosts that could upset the apple cart: The American economy could get worse; The Iranian crisis could explode due to an Israeli bombing (please see my last Aspen Italy piece: The coming Iranian shock to the American election, September 2012); or the slow-drip euro crisis could finally turn septic.

As for the latter, European Central Bank (ECB) Chief Mario Draghi has brilliantly managed to keep the bond vigilantes at the door, by drawing up a battle plan that tactically might just shield Spain and Italy (and hence the currency as a whole) from falling off the table. Frankly, he has done as much and more than can be expected. But the autumn gauntlet that Draghi has so far run remains formidable, with a slew of factors posing a grave risk to the European edifice as a whole. And all President Obama can do is passively watch and hope for the best.

First, the German Constitutional Court ruled on the legality of the European Stability Mechanism (ESM), the crucial 700 billion euros bailout backstop Draghi hopes to deploy to save the currency. Simply put, without German involvement in the ESM there would have been no euro left to save. Given these impossibly high stakes, it was always highly likely the German Court approved the legality of Chancellor Merkel’s involvement in ESM, but also predictable that they did so with caveats.

These new restrictions give the Bundestag even greater democratic accountability over all the bailouts to follow. Any increase in German liability above the already agreed 190 billion euros for the ESM, must be met with another parliamentary vote. That is, if the new piggy bank does not do the trick, the German voter and his wary representatives must agree to more aid. Given German donor fatigue, this means that every successive transfer from the prosperous north to the desperate south will become ever more politically difficult. While the court bullet has been dodged, in the medium term, it is certainly an open question as to whether Germany has a limitless tolerance for further bailouts. The euro’s survival hinges on a “yes” to this vital query.

Second, also in early September, the heretofore trusty Dutch held parliamentary elections, triggered by the embarrassing reality that these up-to-now staunch believers in austerity (the Dutch have been more German than the Germans) find themselves in the mortifying position of needing budget cuts of 16 billion euros next year to meet their own budget deficit targets, agreed to with Brussels. The idea that this bailout donor must now engage in austerity on its own made the situation ripe for populist opportunists of both the left and the right.

On the left, the formerly Maoist and until recently electorally irrelevant Socialist Party looked set to dramatically increase its seats, all on the back of stating that budgetary rigor for Holland has been overdone. On the far right the Freedom Party of Geert Wilders campaigned to leave the euro altogether, and return the Dutch to the seemingly halcyon days of the guilder. Shrewdly exploiting the populist link, Wilders demanded to know why Dutch pensioners’ savings (through austerity) should be sacrificed, all to bail out profligate Greeks.

But in the end, a pro-European grouping, headed by the center-right Dutch liberals and the center-left Labour Party, came from behind and decisively won the election. However to regain lost ground, both pro-European parties more than nodded at euroskepticism, in order to poach votes from the extremes. The best example of this is outgoing liberal Prime Minister Mark Rutte’s startling pledge during a recent television debate not to give the Greeks another euro of Dutch taxpayers’ money. While tactically this seems to have played very well with angry voters, it leaves the Netherlands – until now a pro-European, rock solid, AAA creditor nation – the on-the-record enemy of the very measures we all know are coming to save the euro itself. So bullet dodged, but again, there seem to be accumulating political hostages to fortune.

Third comes Greece, the once and future crisis. It is the worst kept secret in the world that even after the commitment of 240 billion euros in aid, Greece continues sinking like a stone. Taxes remain uncollected, the massive cuts in the public sector remain unmade, and privatizations remain almost at a standstill. Whatever one thinks of why this is so, these facts are simply beyond dispute.

But also beyond the point of arguing is that Greece is locked in a death spiral. For example, the troika (comprised of ECB, IMF, and European Commission officials) demands a further 13.5 billion euros in cuts from a country that has already endured five years of severe recession. If the Greek government continues to ignore its people and agrees, it will then receive the next 31.5 billion euros tranche of aid, which will largely go to recapitalize its tottering banking system. While this is necessary, it is obviously not very popular.

In turn the new government of Prime Minister Samaras has pleaded with its European creditors to give Greece an extra two years to meet its onerous budget deficit goals, allowing them to smooth the pace of draconian cuts. For once at one, President Hollande of France and Chancellor Merkel have said there will be no concessions made until further cuts are in place and acted upon. As little has been acted on up until now, how this will happen is anyone’s guess. Greece remains nothing less than a ticking time bomb, a place – despite excruciating pain – whose problems have not really been addressed, let alone dealt with.

Fourth is the big event. When will Spain and Italy (both too big to fail) ask for bailouts and on what terms? First the good news; Draghi has made it abundantly clear that he is willing to turn the spigots loose to save both, as failure to do so would doubtless doom the whole euro edifice anyway. The ECB has declared it is willing to purchase colossal quantities of Spanish and Italian bonds to prevent their respective borrowing costs reaching the point of no return. But the devil – as ever in Europe – is in the details. The ECB fine print makes clear that both Madrid and Rome have to actively request a bailout, in effect signing over their economic sovereignty, going through the ESM route, and then have new and more onerous conditions imposed on them by the outside powers, clustered around the troika, as is the case for humiliated Greece.

This is politically killing for both governments. Up until now, Prime Minister Rajoy of Spain has foolishly made a mantra of the fact that Spain would never have to go cap in hand to Brussels; he famously harrumphed, “Spain is not Uganda.” But to save itself, Rajoy will have to fall on his sword over this devastating U-turn.

Far more adroit Mario Monti of Italy has just offered a similar hostage to fortune. While accepting that a bailout of Italy may be on the cards, he just as clearly has said he expects no new austerity conditions to be asked of Rome for the money, beyond what his government is already doing. But Draghi has made it clear that you don’t get the money, without giving up a good deal of economic control. The Germans simply will not accept anything short of this faustian bargain. So, as is true for Rajoy, Monti has laid himself open to the charge of backing down to the increasingly disliked dictates of Europe.

So as was great fun during the Harry Potter series, a euro-collapse is so powerful, so overwhelming, and so scary that its very name dare not be mentioned. And in fact this is what has happened – or more accurately not happened – on the American campaign trail. Mitt Romney has talked of Europe as a fate to be avoided; Barack Obama has intoned it as a reason his recovery is taking longer than he’d like. Neither has addressed anything like what is really going on here, or how it would impact an economically fragile America.

But in reading over the meat of this piece – looking at the bullets that need dodging to give the Draghi plan time to work – one name is conspicuous in its absence…that of Barack Obama. America, no longer basking in a unipolar world, is greatly affected by whatever ultimately happens in Europe, but is now powerless to have much to do with that outcome. It is the rudest possible awakening for Washington to the new multipolar world; America’s election result may well hinge on whether Europeans dodge these economic bullets between now and early November. And there is nothing they can do about it.