Germany forces deflationary policies

Evans-Pritchard of the conservative Telegraph has been one of the best journalists for the euro crisis..

Another fine piece:

German austerity drive risks Euro-slump
German finance minister Wolfgang Schäuble has vowed to halt rescue payments to Greece unless the country complies totally with the EU-IMF demands, brushing aside warnings that a Greek collapse would set off a disastrous chain reaction and a global banking crisis.

“The next tranche can be paid only when the conditions have been met. There is no room for manouvre here,” he told the Bundestag. Yields on 10-year Greek debt spiked to a fresh record of 19.8pc on fears of a disorderly default.

The tough words reflect sentiment in Berlin that Greece should be left to its fate or even be ejected from the monetary union, even though the chief reason Greece has failed to meet its deficit target is the crushing effect of recession. The economy will have shrunk by 12pc by the end of this year, playing havoc with debt dynamics.

Mr Schäuble rebuffed calls from the International Monetary Fund for a softening of Europe’s austerity drive. “Piling on more debt now will stunt rather than stimulate growth in the long run. Highly indebted Western democracies need to cut expenditures, increase revenues and remove structural hindrances in their economies, however politically painful,” he wrote.

German insistence on deflation polices is causing near universal despair. Spain’s leader Jose Luis Zapatero – who told union leaders at a closed-door gathering that the economy was “sliding into the abyss” – called for global action “through the G7 or the G20” to shore up Europe’s financial system.

Berkeley professor Barry Eichengreen said Europe’s rescue fund (EFSF) is too small to save the eurozone, leaving the creditor powers of Asia as the last hope. “Europe’s leaders have shown themselves incapable of breaking the vicious cycle, raising the danger of the European crisis becoming a global crisis. It is now past due time for the IMF and G20 to intervene,” he said.

“Asia’s own stability hinges on the stability of the world economy,” he said, callling for a variant of the “Brady bond” plan used in Latin America.

Charles Dumas from Lombard Street Research said German policies – enforced by EU bodies – will doom the eurozone to a slump. “Here is the stubborn folly of the sound-money men of the 1930s,” he said.

Pursuit of debt reduction by deflation only – in a world whose savings rate is already at an all-time high – means Euroland recession next year could well be prolonged and deepened into depression. At the root of this are fallacious and malignant policies,” he said.

Mr Dumas said Germany is not only pursuing a “predatory trade policy” within EMU through a misaligned currency but is also blindly forcing a downward slide for the whole system by compelling the deficit states to choke demand without offsetting stimulus in Germany and creditor states.

German factory orders fell 2.8pc in July and confidence indicators have plunged, suggesting that Germany itself may be near recession. Car parts giant Bosch said the economy was in an “extremely critical condition”.

Political pain was in evidence in cities across Italy on Tuesday as protesters scuffled with police and trade unions launched a general strike to protest austerity.

Italy’s cabinet agreed to further measures to stave off a spiralling debt crisis, accepting a rise in value added tax from 20pc to 21pc, a higher retirement age for women after 2014, and a 3pc wealth tax on those earning more than €500,000, on top of swingeing cuts to the regions.

Premier Silvio Berlusconi appeared to backslide last week. He was forced to submit after Italy’s 10-year yields surged to 5.57pc and spreads over Bunds hit fresh highs.

Yields had dropped earlier to 5pc after the European Central Bank launched mass bond purchases. However, the ECB is switching intervention on and off to pressure the government. Mario Draghi, the Bank of Italy’s governor and the ECB’s next chief, said Rome should not “count on” intervention.

Separately, Slovakia said its parliament would not ratify the July deal to boost the EFSF rescue fund before December, meaning that it will not be operational before February. It is unclear whether the ECB can step in to hold the line in Italy and Spain for that long.

An internal vote on the EFSF package by parties in Chancellor Angela Merkel’s coalition in Germany showed that 25 of her Bundestag deputies will vote against the measure or abstain, risking the downfall of the government.

Germany’s consitutional court is expected to demand further powers for the Bundestag when it rules on the legality of Europe’s bail-out machinery on Wednesday. There is an outside “tail risk” that it will go further, restricting Germany’s ability to participate in rescues until there is a fresh EU Treaty. That would be an earthquake.