Open Europe Berlin interviews Prof. Bernd Lucke, leader of Germany's anti-euro party AfD

Our German-based partner organisation Open Europe Berlin has published on its blog an exclusive interview with Professor Bernd Lucke - founder and leader of Germany's new anti-euro party Alternative für Deutschland (AfD). We have translated some of the most interesting bits.

On the topic of design flaws in the European Monetary Union (EMU)...

Bernd Lucke (BL): The root of all evil is, in my assessment, the fact that the European Treaties did not provide, and do not provide until today, for the possibility to withdraw from the eurozone...Since leaving [the euro] as a last resort was excluded from the outset, the possibility of exerting political pressure on member states was also limited.

[…]

Despite non-sustainable economic development in some countries, the financial markets obviously did not pick up on the large differences [between eurozone countries], which affected the risk of credit default. In turn, the low interest rates 'funded' these developments.  Actually, the alarm bells should have been ringing in view of the different developments in country-specific inflation rates, unit labour costs and trade balances. Also, the housing bubbles in Ireland or Spain should have been recognised and counteracted upon by politicians. However, warning systems were not available. It was revealed how ill-conceived the introduction of the euro was, under all aspects.

On the role of the ECB in the crisis...

BL: The ECB is not directly to blame because it was simply a part of the poorly constructed euro system...In the time before the crisis, the ECB could have been blamed at most for not pointing out the dangers associated with different inflation rates in the euro countries...Just a note: an independent central bank is good. But a central bank – like the ECB – that is no longer subject to state or democratic control and has switched to self-preservation mode is extremely dangerous.

On using tools such as the ESM and OMT to stabilise the eurozone...

BL: The ESM is ultimately a giant institutionalised eurobond, and therefore a form of debt mutualisation...What we want as AfD is...the return to the Maastricht criteria, and in particular the re-introduction and strict compliance with the no-bailout clause. No country shall be liable for the debts of other countries...Countries should and would go bankrupt, which would reduce the partly unbearable debt levels.

On how AfD sees a eurozone break-up...

BL: As an ‘immediate measure’, we demand the consequent compliance with the [existing] rules of the European Treaties as well as adding a euro-exit clause to the rules. If necessary, we want to force this right to exit by blocking future ESM loans with a German veto. Without further assistance loans, the crisis countries would decide that it is in their own interests to exit the monetary union. This should happen in an orderly and gradual [manner]. On the legal side, the European treaties need to be changed. We have parliaments and governments for that. And Germany has enough weight to push this through.

Mervyn King on the solutions to the eurozone crisis

The FT has just posted an interesting and lengthy interview with outgoing Bank of England Governor Mervyn King (pictured), conducted by the FT’s Martin Wolf. Many pressing topics are covered but the short discussion about the eurozone caught our eye (as might be expected).

When asked about the solutions to the eurozone crisis, King sums up the options very succinctly and without the usual qualifying statements needed by those directly involved in the crisis:

 “I think there are four [solutions]. One is to continue with mass unemployment in the south, in order to depress wages and prices until they’ve become competitive again. The second is to say, ‘Well, we have to get rid of this imbalance in competitiveness, so we need inflation in Germany.’ That seems unattractive, certainly to the Germans.

“The third is to give up on this question of restoring competitiveness quickly and accept that this is an indefinite transfer union. That requires two things: one is for people in the north to give money to people in the south; the other is for people in the south to accept the conditions imposed on them, which will limit the size of the transfer.

“The fourth is to change the membership. Now, I don’t know what the right answer is, and it will depend on their political objectives, but economics tells you that you have to have one or some combination of these.”

A very concise and accurate summary we’d say. Obviously each option can be tinkered and altered but the broad truth is all there.

However, we might go so far as to narrow the options down even further. Option one (which is currently being employed) seems unlikely to be politically or socially acceptable – countries such as Greece, Portugal and Cyprus in particular would struggle to regain competitiveness this way. It would also leave the structural flaws of the eurozone untouched, leaving it incredibly vulnerable to future crises.

Option two also seems unlikely to be sufficient, even if it were an option politically. We would say some element of it is probably necessary for the eurozone, but far from sufficient to solve the crisis. It could also create the ‘uncompetitive union’ which Germany fears most, as although internal imbalances in the eurozone may be eased the actual competitiveness of the bloc as a whole would be much worse than previously. There are also questions about how much such an approach would spillover into growth in the struggling eurozone countries - as we discussed in detail here. Again it also does not tackle the institutional flaws.

Therefore that leaves us with options three and four – something we have noted before.

Before the crisis can ever be solved the true choices facing the eurozone need to be realised. Let us hope that this weekend some of the eurozone leaders read King’s interview.

Any Commission changes to the eurozone crisis policy are largely semantic as the bloc continues to shy away from the tough choices

Building on our blog from yesterday, Open Europe’s Raoul Ruparel has an article in City AM today discussing the Commission’s country specific recommendations. Raoul argues that, despite protestations to the contrary, this is far from a wholesale change in policy but only a small change in the pace of policy implementation. Raoul also brings in an earlier discussion from this blog regarding the nature of the austerity vs. growth debate in Europe – fundamentally the real choice remains between creating a new eurozone architecture or breaking up.

See below for the full piece:

A REVOLT against austerity. A shift to growth. A new policy for the Eurozone. The supposed new approach, symbolised by yesterday’s European Commission economic recommendations for each Eurozone country, has been called many things. But once the rhetoric is stripped away, any changes that remain are largely semantic. The Eurozone remains on the same policy path; at most, it is just progressing along it at a more leisurely pace.

Let me quickly recap yesterday’s recommendations. Spain, France and the Netherlands were all given more time to meet their deficit targets, albeit in exchange for more open-ended commitments to deep structural reform. Don’t forget that this is far from a new precedent; Greece, Portugal and Spain have all received numerous extensions over the past few years.

Meanwhile, Italy exited the proverbial EU economic dog house known as the “Excessive Deficit Procedure”, a move which in normal times would allow it more economic freedom. Unfortunately, these remain far from normal times, and few doubt that those in charge of the purse strings in stronger Eurozone economies will continue to scrutinise every Italian policy move as if it were their own. Countries like Belgium and Slovenia got some leeway, but were also on the receiving end of a textbook scalding for a lack of structural and financial market reform – the type of which most Commission officials could probably dole out from memory by now.

For all the fanfare over the past months and weeks, this “new path” seems very much par for the course. Yes, there is a tweak here and there, but much in the same way a football manager might bring on a defender when his team is getting thrashed – it’s more about saving face than making a sizeable impact on the course of the game.

The first question to ask is, despite this not being the wholesale change it was cracked up to be, will it have any impact on the crisis?

In a word: unlikely. It’s clear that the current policy approach is not working, and in many cases a slowdown in the pace of cuts will be helpful – at least in political and social terms – as it allows a slower pace of wage and jobs cuts. That said, the amount of additional fiscal spending to be allocated to boosting the real economy remains a pittance in comparison to collapsing domestic demand and falling investment in many of the struggling countries. Further, it’s worth noting that, although some spending cuts have been slowed, the flip side of this will be deeper and faster structural reform. In many cases this falls heavily on the labour market. Unfortunately the short-term impact of such reforms, no matter how necessary, is often increased unemployment.

The second and more interesting question is, what more could actually be done on this front?

This brings us, inevitably, to the broader question of austerity versus growth. This has become a key debate during the crisis, but it fails to capture the key question in the Eurozone. It is clear to everyone that Greece, Portugal and Ireland were insolvent, and it was market pressure that pushed them into bailouts. Reducing debt levels is a vital part of their reform, while also serving to counter the significant moral hazard that comes with a bailout. Similar constraints apply in Spain, Italy, Cyprus and Slovenia in terms of expanding spending in the short run.

Therefore, asking to end austerity in much of the Eurozone is akin to asking for greater transfers from the stronger countries – whether direct, through fiscal union, or indirect, through banking union or much higher inflation.

This provides us with a clearer picture of the situation. First, the widely mooted change in Eurozone economic policy actually amounts to little more than a small adjustment, slathered in a thick coating of political rhetoric. Secondly, in reality there was little room for adjustment to this policy. This is mostly because many states have little room for further spending, but also because the decisions lie with national governments and parliaments, not the Commission.

This brings us to the conclusion that, rather than discussing whether or not to change austerity, there should be more focus on solutions that can really solve the crisis. The fundamental choice for the Eurozone remains the same as it always has been: the creation of the necessary architecture to deal with a widespread economic crisis, or face a break-up.

You want contagion…I’ll show you contagion…

Everyone, including us, has commented at some point this week about how calmly markets have reacted to the situation in Cyprus.

Cue Dutch Finance Minister Jeroen Dijsselbloem.

From his interview with Reuters:

"What we've done last night is what I call pushing back the risks…If there is a risk in a bank, our first question should be 'Okay, what are you in the bank going to do about that? What can you do to recapitalise yourself?'… If the bank can't do it, then we'll talk to the shareholders and the bondholders, we'll ask them to contribute in recapitalising the bank, and if necessary the uninsured deposit holders."

"If we want to have a healthy, sound financial sector, the only way is to say, 'Look, there where you take on the risks, you must deal with them, and if you can't deal with them, then you shouldn't have taken them on’”.

"The consequences may be that it's the end of story, and that is an approach that I think, now that we are out of the heat of the crisis, we should take."

"We should aim at a situation where we will never need to even consider direct recapitalisation…If we have even more instruments in terms of bail-in and how far we can go on bail-in, the need for direct recap will become smaller and smaller.”

"Now we're going down the bail-in track and I'm pretty confident that the markets will see this as a sensible, very concentrated and direct approach instead of a more general approach".

We’ve bolded the key quote. Essentially, he saying the Cyprus deal might be a template for other bank restructurings across the eurozone (although he seems to be trying to row back from this a bit).

Now, we’re not saying we disagree with his points and we certainly agree with the sentiment of his comments – banks should be able to shoulder their own risks and if they can’t they should have plans for winding down and deleveraging. This is why we’ve long argued for things such as living wills for banks.

Let’s be clear, banks should be responsible for their own risks. That said, if you go round telling markets all week that Cyprus is unique and specific and all year that a banking union is on its way with an ESM backed recap fund, they aren’t going to take kindly to abruptly finding out otherwise.

It all just seems a bit strange and a bit clumsy - to put it mildly. Sometimes for better or worse, markets need to be handled with kid gloves.

Contrary to his expectation that markets would see it as “sensible”, they have reacted wildly. Spanish and Italian stock markets have swung into negative territory after being up for the day, led by their banks taking a hammering, figures via @suanzes:

Ibex35: -2,68%. BBVA (3.97%), Bankinter (-4%), CaixaBank (-2,44%), Banco Popular (-4.147%), Sabadell (-3,83), Santander (-3,27%)

As we have said before, we never quite bought that Greece, Cyprus or anyone was entirely unique, though with Greece eurozone leaders definitely could have got away with it.

Where does this leave plans for banking union and eurozone integration? We’re hesitant to say tatters, but it’s not looking great.

Let the guessing game continue: The Eurogroup's mixed messages on capital controls

As we have noted at length, the capital controls are a key part of the Cypriot deal and could have a huge bearing on how and when Cyprus recovers from this crisis. Unfortunately, as with almost all important eurozone decisions, this one lacks clarity.

The body of the Eurogroup statement said:

“The Eurogroup takes note of the authorities' decision to introduce administrative measures, appropriate in view of the present unique and exceptional situation of Cyprus' financial sector and to allow for a swift reopening of the banks. The Eurogroup stresses that these administrative measures will be temporary, proportionate and non-discriminatory, and subject to strict monitoring in terms of scope and duration in line with the Treaty.”

However, the Annex noted:

“Only uninsured deposits in BoC will remain frozen until recapitalisation has been effected, and may subsequently be subject to appropriate conditions.”

EU Internal Market Commissioner Michel Barnier added earlier today:

“Any measures to restrict or limit freedom of movement may only be enacted exceptionally and temporarily and that is what has been requested by the Cypriot authorities.”

Some pretty mixed messages. The first suggests that “administrative measures” (which is widely being taken as capital controls or related measures) will be generally applied. Bruegel suggests that this may not even need to take the form of full capital controls and could be limited to measures slowing down the movement of capital. This is contradicted by the second point which suggests they will only apply to the Bank of Cyprus uninsured depositors. Barnier’s point is closer to the first point but suggests actual controls will be needed.

FT Alphaville has an interesting run-down of the different type of capital controls and their implications. Paul Krugman makes the valid point that, if the trade-off of the single currency is reduced transaction costs in exchange for an overvalued currency, once capital controls are introduced, what is the motivation to stay inside? As he notes, wider points on the EU and access to ECB liquidity apply but it gets to the crux of the choice facing Cyprus.

As we have suggested, we find it hard to imagine that the banks could survive long without capital controls, while the economy would likely take an even bigger hit. As we have mentioned, it would fall on the ECB to continue to sanction ELA to keep banks afloat during deposit outflows, but this would amount to a large transfer of risk towards the Cypriot Central Bank (and therefore the Cypriot state, and therefore the eurozone). Meanwhile, access to the ELA is limited by the ECB’s view of bank solvency (one they have shown they may not stretch indefinitely) and assets which can be posted as collateral.

One thing that is for sure: this lack of clarity is certainly not helping an already messy situation.

Could Cyprus leave the Eurozone but stay in the EU?

Now, we're not necessarily saying that Cyprus should leave the eurozone.

But with eurozone finance ministers set for a pretty long and rough night of talks, trying to reach a compromise that will allow Cyprus to live another day inside the eurozone, the question is, if it came to it (i.e. if a deal can't be agreed and ECB turns off the taps), could the country leave the euro but stay in the EU? As we note here and here, due to Cyprus' geopolitical importance, if it did ditch the Single Currency it would be vital that it stayed in the EU.

Leaving aside the question of how Cyprus would be ring-fenced and given a reasonable chance of bouncing back with its own currency (a big one to leave aside admittedly), what would the legal and political mechanics look like?

There is currently no mechanism for a country to leave the eurozone. However, there is a provision (article 50 TEU) that allows for a negotiated exit from the EU. This has lead some analysts to conclude that a country has to leave the EU if it left the euro. We disagree.

As so often in the EU, this will come down to political negotiations. The below analysis is based on our paper from last year on a possible Greek euro exit (which, incidentally, we said was unlikely to happen in the short-term). The line of reasoning very much applies to Cyprus. 

Given the absence of a specific euro exit article, there are two ways in which a country can leave the Single Currency.

• Changing the EU treaties to allow for a euro exit mechanism, perhaps modelled around article 50 (possibly even simply extending the article to refer to a euro exit) or the idea – floated by German politicians – to automatically trigger an exit if a state is unwilling or unable to comply with the rules governing the single currency. This would require agreement amongst all 27 member states and would essentially be a treaty renegotiation (making it complex and long winded). 

• Using existing articles in the treaties which provide flexibility to address a number of issues, such as article 352, to legally facilitate withdrawal from the euro but not the EU. This would also require agreement amongst all 27 member states and the European Parliament. Per definition, a decision for Cyprus to leave the euro has to happen essentially overnight (some estimates have put the real time available at 46 hours). This is problematic as a treaty change could take months, even using the fastest track (the simplified revision procedure, which needs to go through at least some national parliaments). 

Historically, political expediency has trumped EU law. Although it would not be clear cut or easy – and involve a legal stretch – we believe that in order to take a swift decision and avoid a Treaty change EU leaders could (and most likely would) use existing provisions in the EU treaties to allow for a Cyprus euro exit. In particular Article 352 TFEU – sometimes referred to as “the flexibility clause” – allows member states to take measures to achieve EU “objectives” (subject to unanimity and consent of the European Parliament but not ratifications in parliaments), when those are not already provided for in the EU Treaties. Article 352 states,

“If action by the Union should prove necessary, within the framework of the policies defined in the Treaties, to attain one of the objectives set out in the Treaties, and the Treaties have not provided the necessary powers, the Council, acting unanimously on a proposal from the Commission and after obtaining the consent of the European Parliament, shall adopt the appropriate measures."

This article could be used to provide a legal temporary avenue for Cyprus to leave the euro within the framework of the EU treaties. This would be far from an easy process; there would likely be numerous legal challenges against the move, while the negotiations would be hazardous and subject to domestic political constraints.

Precisely for this reason, a full treaty change would almost certainly be necessary very soon after the actual Cyprus exit (and use of article 352), which would change Cyprus status under the EU treaties from a euro member to a non-euro one and recognise, at least in retrospect, that there is a way for a country to leave the euro (under an expanded article 50 for example). Such a Treaty change would, at least in theory, go some way to counter some of the political uncertainty and legal ambiguity around the status of Cyprus’s EU membership and therefore reduce the risk of legal challenges. However, a full treaty change would come with its own set of political and legal complications. As with Article 352, a treaty change could only happen if all member states agreed. In addition, the changes would most likely have to be ratified in national parliaments.

So far from straightforward, but still plausible.  

What to expect from the EU in 2013

As 2012 draws to a close Open Europe has put out its take on what to expect from 2013. Reviewing our (admittedly milder) effort at this last year, shows that we didn’t do too badly, especially for what turned out to be a very volatile and difficult year for Europe (with plenty of government interventions, which are notoriously hard to predict).

See here for the full report where we lay out our view on three key topics to watch in 2013 – discussions of a ‘Brixit’, the formulation of the new eurozone banking union and, of course, the continuation or otherwise of the eurozone crisis.

Section 1: The eurozone crisis – survival but stagnation

2013 looks likely to be a calmer, but still painful year for the eurozone, with several political flashpoints (notably German, Italian and Austrian elections) that could quickly trigger a fresh flare-up in the crisis – particularly as many of the campaigns could become de factor judgements on the eurozone crisis and the bailouts. The eurozone is unlikely to fully turn the corner, with low growth and high unemployment continuing to plague many countries. Activism from the ECB is likely to help ease concerns, with its new bond buying programme the OMT potentially activated to aid Spain at some point. This will be needed as markets will still be on edge with Italy, Spain and France face funding costs of €332bn, €195bn and €243bn respectively.

Section 2: Banking union – slow or even slower?
A decision on the second step of the banking union – a joint fiscal backstop – is unlikely to be taken amid continued disagreements and domestic pressures. Even plans to have the ESM recapitalise banks already look to have been pushed back to 2014. During the year it may become increasingly apparent that, as is, the banking union does not represent a solution to the crisis.

Section 3: Britain in the EU – a mid-life crisis or full divorce?

We don’t see any fundamental changes to the relationship, but positioning and political manoeuvring will set the stage for the 2014 (European Parliament) and 2015 (General) elections – that in turn could decide the exact nature of the EU-UK relationship in the future. Two important issues to watch will be the opt out (and back into) EU crime and policing laws as well as the negotiations on the EU budget. The general tone of the debate within the government and Conservative party will be an important test ahead of the elections.

Obviously then, this is far from an exhaustive list but simply represents our thoughts on some key points of interest to watch in 2013. Feel free to share your thoughts for 2013 in the comments below!

A big week for Greece - but still few answers

As we noted in our press summary today, this week is lining up to be another big one for Greece.

The Greek government faces two crucial votes in parliament – first on Wednesday to push through the latest package of structural reforms (as demanded by the EU/IMF/ECB) troika and second on Sunday to approve the latest and, according to Greek PM Antonis Samaras, the last austerity budget for next year.

Since the governing coalition was formed after the second summer elections, such votes have usually passed without much fanfare. However, this time around the Democratic Left (which holds 16 seats in parliament) has said it will not vote with the its coalition partners. Pasok (which holds 31 seats) is also facing a period of internal strife with one MP already leaving and up to five others threatening to at least vote against the government. New Democracy (127 seats) should have an easier job pulling its MPs together.

The votes should pass but the margin for error is tiny, possibly only two or three votes, notably provoking unrest amongst financial markets and other eurozone leaders. In the end, given that the end of the government would very possibly signal the end of Greece as eurozone member, the (perceived) fear factor is likely to be enough to once again push the vote through.

This clears the way for the release of the next €31.5bn tranche of bailout funds and a potential two year extension to the Greek bailout. Today’s FT notes that the extra funding for the extension is likely to come from an increase in short term debt issuance by Greece and possibly a reduction in interest rates on eurozone loans to Greece – exactly as Open Europe predicted in its recent flash analysis on the issue.

The FT article also includes a potential plan for the ECB to return profits from its purchases of Greek bonds to Greece via eurozone governments to avoid the thorny issue of the central bank directly financing a state. This sounds plausible on the surface since the returning of profits to national governments should happen naturally anyway under the ECB rules. The only issue being that this can only happen overtime as the profits accrue as the bonds are paid off, so its unlikely to be paid out in a single chunk at one time (as is needed here).

One final point on the cost of the extension. We put it at around €28.5bn, although estimates range from €15bn to €40bn. We didn’t include a delay in Greece’s return to borrowing from the markets, which is looking increasingly likely. If Greece doesn’t return to borrowing until after 2016 it could add a further €10.6bn to the cost of an extension.

So although this is a big week for Greece, even a clear government win in both votes will do little to answer questions over Greece’s future in the eurozone.

Draghi's incomplete vision for the future

ECB President Mario Draghi had a long and interesting op-ed in Die Zeit yesterday morning, titled ‘The future of the euro: stability through change’. Interestingly, the piece seems specifically targeted at gaining support in Germany, not unlike Greek PM Antonis Samaras' charm offensive last week. For example:

“Countries must be able to generate sustainable growth and high employment without excessive imbalances. The euro area is not a nation-state where persistent cross-regional subsidies have sufficient popular support. Therefore, we cannot afford a situation where some regions run permanently large deficits vis-à-vis others.”

“Yet citizens can be certain that three elements will remain constant. The ECB will do what is necessary to ensure price stability. It will remain independent. And it will always act within the limits of its mandate.” 

The main thrust of the piece is that Draghi dismisses the option of a United States of Europe as well as the prospect of returning to the previous setup. Instead, Draghi focuses on a 'third way', a slightly vague proposition built upon combined economic and fiscal policies and greater financial oversight – again a picture which is likely to appeal to the traditional (ordo-liberal) German economic approach. Draghi sees the political and economic developments moving in tandem over time rather than through giant leaps and grand agreements.

There are a couple of key issues that Draghi fails to address:

• There is no real explanation of how his proposed 'third way' would address the internal eurozone imbalances he correctly identifies as a cause of the crisis, other than some loose talk of competitiveness, (i.e. there is no mention of fully-fledged fiscal union that goes down so badly in Germany).
• How will the eurozone find the time to make the piecemeal changes he suggests? Greater fiscal and financial oversight takes time to set up and organise. He also fails to mention the political/democratic implications of pooling greater economic powers at the eurozone level. Again no mention of potential ECB spending or bailouts to buy time for these changes.
• Ignoring these issues makes the prospect of a eurozone solution without a political union sound easy, but in reality ensuring that conditions are enforced and that money is well spent may well require such a set up. This also avoids the thorny questions of democratic accountability which follow on from political union.

Ultimately, Draghi's unwillingness to put a price tag on any of his suggestions or explain how they can be delivered in a democratic manner makes them hard to believe. The German public deserve better 'solutions' than this.

While everyone is talking about Greece...

It may sound incredibly obvious, but the eurozone crisis is not only about Greece. Yes, Athens may be facing its "last chance" (Juncker dixit) to save its euro membership. And yes, the diplomatic offensive launched by Greek Prime Minister Antonis Samaras (see picture) to obtain a two-year extension to the EU-IMF adjustment programme clearly deserves attention.

However, while everyone is talking about Greece, quite important (and not necessarily good) news is coming out of other eurozone countries - of which, as usual, we also offer a comprehensive overview in our daily press summary.

In particular:

• According to sources quoted by Reuters, the Spanish government is in talks with its eurozone partners about the eurozone’s temporary bailout fund, the EFSF, buying Spanish bonds – but has made no final decision over whether to request the assistance. Unsurprisingly, the European Commission said that there are no negotiations under way, and a bailout request from Spain is not expected "any time soon". Right...

• According to a high-ranking official at the Portuguese Finance Ministry quoted by Jornal de Negócios, Portugal (the 'forgotten man' of the euro crisis) will not be able to meet the EU-mandated deficit target of 4.5% of GDP for this year unless new austerity measures are adopted. The main reason seems to be the sharp fall in tax revenue: -3.6% during the first seven months of the year, as opposed to the 2.6% increase the Portuguese government was betting on for 2012. The alternative, the Portuguese press suggests, would be asking the EU-IMF-ECB Troika to relax the target. Boa sorte with that one, especially since in September we will hit the point where Portugal is within one year of being expected to return to the markets. Remember how the IMF's requirement for a country to be funded for twelve months played out in Greece... 

• A Cypriot government spokesman told reporters yesterday that the island's public deficit at the end of the year will be around 4.5% of GDP – significantly higher than the 3.5% of GDP initially forecast. Clearly not good news, as this will almost certainly increase the EU-IMF bailout Cyprus is currently negotiating. Another headache for the Troika, which is due to visit the island again shortly (although no clear date has been specified yet).

• New figures published by the Irish Central Bank show that €30.5 billion or 27.2% of the €112 billion outstanding in owner-occupier mortgages at banks in Ireland was in arrears or had been restructured at the end of June, up from €29.5 billion (26%) in March. Furthermore, German Finance Minister Wolfgang Schäuble told the Irish Times that he will oppose any debt-relief plan for Ireland that “generates new uncertainty on the financial markets and lose trust, which Ireland is just at the point of winning back.”

Add the German Constitutional Court ruling on the ESM treaty along with the Dutch general elections (with the EU-critic Socialist Party led by Emile Roemer ahead in the polls) into the mix and it really looks like there will be little room for boredom in September.

Showdowns that will define Europe's future

In today's Telegraph, we argue:

'It will not be the case that the south will get the so-called wealthy states to pay. Because then Europe would fall apart.” Thus spoke Horst Köhler, former German president, finance secretary and IMF head, almost two decades ago. 

Köhler’s remarks are worth pondering. A series of multi-billion-euro bail-outs – and more to come – have now planted a north-south political divide at the heart of the European project. Taxpayers in Europe’s north resent underwriting their southern neighbours, while voters in the south are equally frustrated at having austerity imposed upon them from abroad. As has been noted repeatedly, this is the greatest tragedy of this crisis: a project that was meant to bring people together, now risks driving them further apart. Alas, events in the eurozone this autumn could further exacerbate this tension. There are at least five key stand-offs to watch over the next few months:

Greece v Germany: Greece managed narrowly to escape running out of money today by raising almost 4 billion euros in short-term debt. But Athens will face an excruciating autumn. On almost every count, Greece is miles away from meeting its EU-mandated austerity targets, which raises the questionof whether Germany – or the IMF – will pull the plug on the country in October when its next progress report is due.

Though there is still scope for muddling through, almost any outcome will lead to rising political tensions. If Germany sticks to its guns, the popular disillusion in Greece will grow massively. If Berlin gives in, it faces a serious backlash from the country’s public – a majority of which wants to kick Greece out.

Spain v the North: Amid continued problems, Spain could possibly request EU cash as early as September. But the country is simply too big for a Greece-style bail-out, while Madrid would not accept having its economic policies fully decided in Brussels and Berlin. Instead a third way must be found involving less money and softer conditions, probably with heavy and controversial ECB involvement. The North will dislike such an arrangement – particularly cheap ECB money going to Spain – but may give in for fear of worse.

The bail-out funds v national democracy: On September 12, Germany’s constitutional court will rule on whether the eurozone’s permanent bail-out fund – the European Stability Mechanism (ESM) – is compatible with the country’s “basic law’, following a host of complaints. Though unlikely, should it strike it down, the markets will go absolutely crazy. Regardless, the ruling will leave a bad taste in Germany and shows how the ESM is becoming an increasingly toxic issue, with southern and northern politicians disagreeing fundamentally on its size and whether it should be given a direct credit line to the ECB.

The Dutch v Europe: September 12 will also see another example of national democracy reasserting itself: the Dutch elections. Geert Wilders, leader of the super-populist PVV, is seeking to turn the campaign into a referendum on Europe, hoping to tap into the Dutch anti-bail-out mood. At the same time, the Dutch socialists – currently leading in the polls – have vowed to resist both the EU fiscal treaty and further transfers of power to the EU without approval in referendums. A divided Dutch parliament and more assertive government will almost certainly make eurozone politics even more complicated.

Germany v France: This autumn will also see negotiations over whether the eurozone will take the next big leap towards an economic union, with an October EU summit tasked with providing a “road map” for more integration. Ideas include a banking union (with a single supervisor and joint backstop) and collective government borrowing in the form of eurobonds. The issues are tremendously complicated, subject to a cobweb of disagreements and will take years to clear away. But importantly, this could widen the gap between Germany and France, with the two disagreeing fundamentally on the order of events. Berlin wants a political union first, meaning greater German control over others’ finances in return for underwriting them – while Paris wants to press ahead with stronger bail-out mechanisms, via the ECB and others, leaving the oversight for later. The Franco-German axis is not about to break, but maintaining it will become increasingly difficult.

So how should Britain respond to all of this? Simple: try to control what it can control and leave the rest behind. The UK is right to seek to buffer up against a potential euro meltdown. It is also right to look for ways to ensure that further eurozone integration – such as a banking union – is not detrimental to Britain or the single market. But the UK government needs to stop giving unwelcome advice on the need to turn the eurozone into a “debt union” or for the ECB to start spraying the Continent with cheap money – both options effectively involving Angela Merkel completely running over her own voters.

The eurozone crisis has unleashed some seriously unpredictable political forces. EU leaders may have to choose between maintaining the euro and maintaining national democracy as we know it. In either case, we have no idea how voters – in the North and South alike – will respond.

 

Berlusconi's comeback: What could it mean for Italy's future in the eurozone?

In today's City AM, we argue:

The jubilant chanting and cork-popping in Rome last November now looks premature. In a sensational U-turn, Silvio Berlusconi has decided to run for Prime Minister in next year’s elections. 

His comeback may have huge implications for Italy’s future in the single currency. Over the past few weeks, the 75-year-old former Italian Prime Minister has outlined his personal way forward for Italy in the Eurozone crisis – quite revolutionary compared to Italy’s traditional view of its euro membership. 

He has made clear that the solution to the Eurozone crisis is for the European Central Bank (ECB) to become the ultimate backstop for struggling Eurozone countries. If this scenario fails to materialise, there are only two alternatives left. The first, in Berlusconi’s own words, would be Italy and other peripheral euro members saying “ciao ciao” to the single currency. The other would be Germany leaving instead – clearing the way for the ECB to act as the Eurozone’s lender of last resort. Pouring more fuel on the fire, Berlusconi described the prospect of a future outside the single currency as “no blasphemy” and “not the end of the world” for Italy. 

Those remarks were by no means the swan song of a disgraced leader. If there is one thing Berlusconi knows better than many Italian and European politicians, it is how to tell people exactly what they want to hear. And you can bet that he is well aware that riding the anti-euro (and anti-austerity) tiger can pay off in votes these days – as the apparently unstoppable rise in the polls of comedian Beppe Grillo’s Five Star Movement shows. 

Italy leaving the euro remains a distant prospect. Yet, if Berlusconi’s new line of thinking becomes official party policy, the result would be one of the largest political parties in Italy openly saying that the country’s support for the single currency should no longer be unconditional. Add Lega Nord and the Five Star Movement, and the number of anti-euro voices across the political spectrum starts to look worrying. 

The German press has reacted to Berlusconi’s comeback in a particularly telling fashion – with headlines ranging from centre-left Süddeutsche Zeitung’s “The candidacy of a nightmare” to centre-right Die Welt’s “The Godfather, Part IV”. 

Nonetheless, Berlusconi’s return could paradoxically turn out to be good news for Germany. Italy’s centre-left Democratic Party – currently the most popular in opinion polls – could be encouraged to form an anti-Berlusconi coalition with other moderate centre parties. This would break its tradition of seeking allies among the far-left, whose ideological background is incompatible with many of the reforms initiated by Mario Monti’s technocratic cabinet. Despite consistently rejecting the idea so far, Monti might then be willing to stay on as the head of this reformist coalition, provided that it receives broad support in next year’s elections. Unlike with Berlusconi, many Italians would probably forgive him for the U-turn.

 

Perhaps Il Cavaliere wasn't joking, after all...

Italy's former Prime Minister Silvio Berlusconi claimed he was "joking" when he suggested, earlier this month, that Italy should consider saying "ciao ciao" to the euro if the ECB is not allowed to print money and become the single currency's ultimate backstop. However, jokes aside, he made very similar remarks at a book launch yesterday. He said,

"I don’t think the hypothesis of leaving the euro and using competitive devaluation is blasphemy." 

"The best solution is to convince Germany that the ECB must act as [the eurozone’s] lender of last resort…What could happen otherwise? Some people expect Germany to leave the euro. I have spoken to several German financial experts who think [Germany’s] euro exit is not such an odd idea, after all." 

"If Germany sticks to its negative positions, it can either happen that individual [eurozone] countries return to national currencies, or that Germany leaves the euro." 

Italy leaving the euro remains a distant prospect. But as we noted before, Berlusconi's influence on his political creature - the People of Freedom party - remains huge, even if he is not going to run for Prime Minister in next year's general election. Should Il Cavaliere's new line of thinking become party policy, we may well have one of the mainstream political parties in Italy (most likely in the opposition, but still) saying that the country's support for the single currency is not unconditional.

After the rise of anti-euro comedian Beppe Grillo, this would be another sign that support for the euro can no longer be taken for granted in Italy.

Do the election results mark a turning point for Greece? Think again...

Over on the Spectator's Coffee House blog, we argue,

Things in Greece could have been worse after the election, but that fact can’t be hailed as a ‘turning point’. Assuming that Greek political leaders form a coalition and push ahead with EU-mandated reforms, which is a very likely outcome given that Greece may only have enough cash in its coffers to soldier on for another month, any such government will inevitably include parties that completely disagree on how to resolve the crisis. The only glue would be the fear of economic catastrophe.

This uneasy government would be ill-suited to withstand pressure from Syriza and the rest, who will spare no effort in blaming it for the inevitable economic pain. The threat of new elections, which would probably lead to Greece's exit from the Eurozone, will constantly hang over the country’s head like the famous sword of Damocles.

A great deal of hope is being placed on the new government’s ability to renegotiate the terms of the EU-IMF bailout programme. At the G20 summit in Mexico, Angela Merkel went a long way to play down these expectations. This suggests that the upcoming revision will largely be a superficial exercise. Greece may obtain a slight reduction in the interest rates, an extension of the debt repayment deadlines, a few billion for investment, and perhaps even be given some slack on its deficit reduction targets. However, the thrust of the bailout agreement will stay the same — and many of the conditions will remain unachievable and poorly targeted at the substance of Greece’s problems, such as the dramatic loss of competitiveness since it joined the euro, and a number of systemic flaws in the country’s administration.    

So should Greece leave the Eurozone as fast as it can? The euro crisis has proved that Greece should never have joined the single currency in the first place, and the benefits of Greece trying to re-build its economy outside the Eurozone are well-documented. However, if Greece left the euro now, the risks involved would very likely outweigh these benefits in the short term. Our estimate is that, if Greece exited today, it would need external financial assistance worth up to €259 billion — or else face the serious threat of hyperinflation and a banking sector collapse. Given the blind alley down which Europe has led Greece, this is the unfortunate reality, failing to take these issues into consideration could lead to a terrible outcome for all, including the UK. 

Having said that, the key question about the future of Greece’s euro membership will not go away; and it will have to be answered, sooner or later. The impression is that, once Greece manages to balance its budget and put its ailing banking sector back in decent shape, dropping the euro will look a more sensible, even desirable, alternative — especially if the Greek budget is to be drafted in Brussels on a permanent basis.