Monday, November 28, 2011

The German Hour

by Jean Pisani-Ferry

Project Syndicate
November 28, 2011

A series of developments over the last few weeks have set in motion a downward spiral for the eurozone. Unless officials – especially German officials – act fast, the verdict of financial markets is bound to be ruthless.

First, the eurozone has failed to turn the tide. Mario Draghi, President of the European Central Bank, was right to note that, despite numerous ministerial meetings and three summits, implementation of the decision to increase significantly the firepower of the European Financial Stability Facility (EFSF) is still lacking. There are now growing doubts about the effectiveness of the EFSF.

Second, and partly as a consequence, virtually all eurozone countries’ debt is trading at a discount relative to German Bunds. While it was necessary to price risk more accurately, it is difficult to believe that the Netherlands, with a debt ratio nearly 20 percentage points lower than Germany’s, deserves to be assessed as a higher default risk. But now even the mighty Bund has started to suffer from heightened market anxiety.

Third, financial-market participants and, increasingly, real businesses are pricing in a possible breakup of the eurozone, if not the end of the euro itself. It is still difficult to think the unthinkable, let alone work out the details of it, but any rational player must now consider the possibility. If expectations of disaster build, and a growing number of players start positioning themselves to protect themselves, the consequences could become overwhelming. Not only the eurozone would suffer.

Fourth, Germany has become the eurozone’s undisputed leader. Although France continues to play its role as the other half of the European Union’s leading couple, it has lost influence and the ability to take the initiative. A weaker French economy, shakier public finances, and the coming presidential election are all combining to alter the balance with Germany. Political audacity can carry France only so far.


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