Global Post-Crisis Economic Outlook
Henry C.K. Liu

Part I:      Crisis of Wealth Destruction   
Part II:     Two Different Banking Crises - 1929 and 2007
Part III:    The Fed’s No-Exit Strategy
Part IV:    The Fed’s Extraordinary Section 13(3) Programs
Part V:      Public Debt, Fiscal Deficit and Sovereign Insolvency
Part VI:     Public Debt and Other Issues
Part VII:
   Global Sovereign Debt Crisis
Part VIII:  Greek Tragedy

Part IX: Effect of the Greek Crisis on German Domestic Politics
This article appeared in AToL on  May 27, 2010


Germany had held the key to an orderly resolution of the EU’s sovereign debt crisis in its early stage. Yet Chancellor Angela Merkel’s government faced hostile questioning in the Bundestag, the German parliament, and even a legal challenge in the constitutional court, before it managed to finally sign off on the rescue package by Friday, April 30, 2010. Bundestag members were incensed over the government’s lack of transparency in negotiating the deal, and the rumored size of German commitment in the rescue package.
Defending her earlier posture in refusing to allow a timely bail-out plan for Greece without International Monetary Fund (IMF) involvement, Merkel said it would have been “unthinkable” that Athens would live up to such tough conditions three months ago without IMF discipline. She said that involvement of the IMF, the subject of strong disagreement within the German government, was necessary to give the program “maximum credibility” around the world, notwithstanding that IMF credibility in previous financial crises had fallen to junk staus.
The 16 Eurozone countries and the IMF on May 2, 2010 agreed to release €110 billion in “unprecedented” rescue loans to Greece, €1.3 billion of which will come even from cash-strapped little Ireland.
Irish Minister for Finance Brian Lenihan, who did not attend the meeting, said that Ireland stood ready to play its part, adding that the Government was preparing legislation to release bilateral loans to Greece. “Today’s decision will help safeguard the stability of the euro area as a whole and this stability will benefit all euro zone member states,” the Minister said of the €110 billion package.
Having agreed a fortnight earlier on April 25 to provide up to €45 billion to Greece in the first year of the rescue, the European and IMF authorities responded to extreme market pressure on Friday May 2 to set out for the first time the overall value of €110 billion ($146 billion) for the emergency package.
The deal to activate the rescue, struck at an extraordinary meeting of Eurozone finance ministers, came as Greece agreed to intensify efforts in the next three years to bring its budget deficit under control. Taxes will rise, public sector pay will be cut and pension age will also be increased under the plan.
The pact follows months of market pressure on Greek borrowing costs and mounting fear of financial market contagion bringing fiscally weak countries such as Spain, Portugal and Ireland under pressure on their sovereign debts.
Merkel’s Failed Leadership
While German Chancellor Angela Merkel had played for time during key talks in the previous 10 days, she changed stance on April 28, 2010 to call for a swift agreement, after market fell sharply in response to a rating downgrade of Greece sovereign debt on April 27.  Although most Germans were also opposed to the rescue and Merkel was facing a difficult regional election on Sunday, May 9, 2010, she characterized the rescue plan she now supported as an effort to secure monetary stability in the Eurozone. Berlin introduced legislation Friday, May 7, 2010 to facilitate German participation in the €110 billion ($146 billion) rescue package.
As it turned out, Merkel failed in her two prong objective. The market viewed the Sunday, May 2, €110 billion ($146 billion) rescue package as grossly inadequate and share prices fell sharply on the following Monday, May 3 and continued throughout the week.
Politically, Merkel also suffered a major setback in an important regional election. In the state election on Sunday, May 9, 2010 in Germany’s most populous state, North Rhine-Westphalia (NRW), a region of some 18 million people that includes Cologne and the industrial Ruhr area, voters dealt Chancellor Angela Merkel’ Christian Democrats a painful setback, erasing her government's majority in the upper house of parliament and curbing its power after a stumbling start and criticism over the Greek debt crisis. Merkel’s center-right alliance was voted out of power in a state election. It was the first electoral test since Merkel began her second term in October 2009.
Merkel’s Christian Democrats Union (CDU) party plunged to its worst election result since World War II in Germany's most populous state, losing control of parliament's upper house in Berlin, as voters punished her reversal on aid for Greece. The result in a regional election in NRW may cost Merkel’s CDU its hold on power in the large state, and deprive CDU of its majority in the upper chamber, the Bundesrat, undermining the prospect of legislative approval of tax cuts and extension of the lifespan of nuclear-power plants.
Officials in Merkel’s CDU blamed the party’s poor showing in the election on the large German loans for Greece (€22.4 billion valued at $28.8 billion) passed by parliament on May 7 in the face of broad public opposition. Merkel was widely criticized at home and abroad for first refusing to support aid to Greece, taking the position that the crisis in Greece was a local problem, and then pressing German lawmakers to back Germany’s contribution to a €110 billion lifeline as the fear of contagion outpaced other concerns.
Almut Moeller, head of European policy at the German Council on Foreign Relations in Berlin said in a press interview that Merkel has become vulnerable politically, adding: “After her record of dithering over help for Greece, she really needs to make a show now of strong, resolute policy in Brussels to help stem the crisis from spreading further. The last thing the Eurozone needs at this point is weak German leadership.”
Yet, the election defeat weakened Merkel’s ability to exert strong leadership both at home and abroad. Foreign Minister Guido Westerwelle, the vice chancellor and leader of the Free Democrats, Merkel’s junior coalition partner, said after the election: “This is of course a warning shot for the governing parties, and the people should know that it has been heard. We must make an effort to win back lost trust.” 
Merkel’s conservative CDU won 34.5% of the vote — more than 10 points fewer than five years ago — and the Free Democrats 6.8%. The coalition, whose makeup mirrors that of the national government, finished well short of a majority in the state legislature.
The main opposition Social Democrats finished with 34.5% and the Greens 12.1%. A hard-left rival, the Left Party, won 5.6%. A coalition of the three minority parties is not a particularly likely prospect except under conditions of strong public discontent in the event of further economic deterioration of the EU. 
It was not immediately clear who would run North Rhine-Westphalia and whether conservative Juergen Ruettgers could cling onto the governor’s office in Duesseldorf. The Social Democrats hoped to run the state with the Greens, but it wasn’t clear whether they had won enough seats to gain control.
Merkel’s conservative Christian Democrats will have less political space to run Germany - the EU’s biggest economy - without a majority in the upper house, which represents Germany’s 16 states and must approve major legislation. To govern, Merkel will have to compromise with the opposition policy positions and accept diminishing ability to push through tax cuts as a means of stimulating the economy and to carry out significant reform to the health-insurance system, the implementation of both being part of the core positions of the Free Democrats whose support Merkel needs.
Merkel's federal government currently controls 37 of the 69 upper-house votes, including six from North Rhine-Westphalia. Its stock has slid following a poor start, constant squabbling over key policies and the challenge from the Greek crisis and its effect on the euro. A senior Merkel aide said after the election that the setback had many causes — among them local problems and “too much unnecessary arguing on the public stage.” German democracy has reduced the strength of German leadership at a time when such strength is imperative. The Christian Democrats’ general secretary, Hermann Groehe, also pointed to “the general uncertainty, people’s concerns with a view to the stability of the euro, the situation in Greece.”
Merkel initially held out on agreeing to aid for the nearly insolvent and liquidity-starved Greece, prompting German opposition parties to accuse her of avoiding an unpopular decision in the election run-up. Two days before the Sunday, May 9 election, at the desperate urging of Merkel, parliament approved on Friday, May 7, two days after the violent demonstration in Athens, a bill allowing Germany to grant as much as €22.4 billion ($28.6 billion) in credit over three years as part of a wider rescue plan to Greece.
Greece Only a Headline Issue
While Greece was the headline issue, a more fundamental problem with German voters was the Merkel government’s stumbling start in dealing with problems at home. Freed last year from a “grand coalition” with the opposition Social Democrats in which she shone as a consensus-builder, Merkel then got bogged down in internal divisions — notably about the controversial proposal of big tax cuts in a recession that will add to the government’s fiscal deficit.  In response to the spreading and deepening Eurozone sovereign debt crisis and a resounding election defeat for the ruling coalition in North Rhine-Westphalia, the Merkel government has since removed tax cuts indefinitely from its agenda. The last thing Germany needs now is to increase her public debt.
Without an upper-house majority, Merkel may be forced to again focus on consensus-building, a regular fixture in post WWII German politics. Merkel’s first term had been consumed with consensus-building. Opposition parties are against tax cuts and other controversial plans such as extending self life of nuclear power stations. Social Democratic opposition leader Sigmar Gabriel told the press that the election setback was “a good signal ... that North-Rhine Westphalia has declared by popular vote that this isn’t how we want to live in Germany.” Gabriel said it was a “turning point” for the Social Democrats, who are still recovering from a heavy national election defeat in September 2009. They led North Rhine-Westphalia for nearly four decades until losing it in 2005 amid discontent over then-Chancellor Gerhard Schroeder’s efforts to trim the welfare state.
Merkel lost her important state election not because of voter anger over the Greek bailout. Mr Ruettgers, the CDU prime minister of North Rhine-Westphalia, was trailing in the polls long before the Greek crisis broke, primarily because of a party financing scandal. Also, Merkel’s coalition partner, the FDP, has dramatically lost in popularity for insisting on unpopular tax-cuts that will threaten Germany’s long welfare state tradition and balanced budgets.

The outcome of a dramatic weekend for German Chancellor Angela Merkel is a near disaster for Europe’s most powerful leader. She missed a great opportunity for assuming the leadership needed to steer the EU out of its most difficult crisis.
Haunted by the potential adverse impact of Greece’s near insolvency on the EU leaders put together a €750 billion (nearly $1 trillion) rescue package in long nightly negotiations on Sunday May 9 that lasted in to the morning hours of Monday, May 10, to try to stabilize the teetering economies of the euro-using nations heavily burdened by debt - but the driving force behind that package was French President Nicolas Sarkozy, not German Chancellor Angela Merkel.
Merkel’s CDU, fresh from a heavy defeat in North Rhine-Westphalia's regional elections, was a wounded participant in the meeting of EU leaders as election results came in while the final decision was approaching. The NRW Bundesland (state government), Germany’s economic powerhouse, was no longer in the hands of the same conservative and liberal coalition that had ruled the federal government in Berlin. This change will make governing a lot more difficult for Merkel and her liberal partners because they have lost the majority in Germany’s secondary political chamber, the Bundesrat. Germany was no longer represented in the crucial EU meeting by a leader who enjoys the undivided support of her people.
The linkage between the Greek crisis and turmoil in German domestic politics is indirect but significant. The failure of German leadership in the EU was publicly demonstrated as events unfolded. 
Three months earlier, it already was clear that Greece was unable to handle its exploding budget deficit without help. The other Eurozone member states discussed for more than a month what was needed to be done to help Greece and, by March 25, put forth a mix bag of financial aid with the International Monetary Fund agreeing to step in as the emergency relief team. At that point, Merkel squandered the chance to take the stage to be the strong political leader of the hour. She failed to tell the German people that helping Greece financially before the situation got out of control would prevent deep losses to all within Eurozone, particularly Germany.
Germany had a €4.8 billion ($6.1 billion) trade surplus with Greece in 2009. Greece is Germany’s second biggest customer in military export. German private banks have acquired Greek government loans worth €30 billion to €40 billion ($38.3 billion to $51 billion). Thus a collapsing Greek market would hit Germany’s economy hard even without the inevitable effect of contagion to other Eurozone member states to which Germany also enjoyed trade surpluses.  Most significantly, Merkel failed to tell German voters that the Greek sovereign debt crisis is a critical test for the euro’s future. International market confidence on the commitment of the 16 euro-zone countries to defend the stability of their common currency will be shaken by a failure to bail out Greece’s euro debts.
Instead of strong and timely leadership, Merkel acted like a opportunistic politician and tried to buy time by downplaying the gravity of the crisis and the probability and importance of the need for Germany to help bail out Greece for Germany’s own sake. She allowed popular dislike among the conservative majority of German voters on the idea of aiding a socialist EU member nation that has been squandering borrowed money since joining the EMU, and had openly betrayed EU institutions with false budget accounts, notwithstanding that many other Eurozone member states were also guilty of the same sins.
Merkel wanted to delay her decision on Greece until after the CDU fanned off challenges in May 9 regional elections. She tried to play for time instead of acting as a decisive political leader of a critically needed and well-orchestrated pan-European defense of the euro.  Merkel’s reluctance to take up the role of decisive leadership damaged the euro, her coalition government in Germany and, ultimately, herself as an effective leader in world affairs.
The Issue of a Transfer Union
Chancellor Angela Merkel’s closest advisers are adamant that they took the lead in drafting the rescue plan and that no lasting defeat has been suffered. Yet since the finance ministers of the Eurozone signed off on their €750 billion stabilization package in the early hours on Monday, May 10, members of the German government and senior officials have been fighting a desperate rearguard action to deny they have allowed the European Union to become a “transfer union”, a term to mean the EU could become little more than a transfer mechanism to switch money from rich taxpayers in Germany to poorer ones in southern and eastern Europe. The term has become part of the political lexicon in the debate over massive credit guarantees for members of the Eurozone.
“We will not allow any transfer union,” asserted Ulrich Wilhelm, state secretary and chief spokesman for Chancellor Merkel, in his official account of the massive Brussels deal. “We achieved that goal,” pointing out that the €440 billion in credit guarantees would not come from any EU fund, but from national governments.
The Rise of France’s Economic Government
France has won” was the common reaction in Europe on the day the deal to save the Eurozone was done. Recapturing the leadership role for Europe from Germany has been the goal of France since the end of the Cold War.
Behind the loaded German domestic political debate sits a deep suspicion that France Germany’s closest ally and greatest rival in the EU, has finally achieved its goal of creating of an “economic government” which subordinates the independence of the European Central Bank to political imperatives.
Instead, the German emphasis is all about “stability” of the euro, and with it, the German economic structure. Merkel insists that she is only prepared to lend German money, whether to Greece or any other needy Eurozone member state, to preserve the stability of the common currency. “I have made it clear that for us in the federal government, the most important thing is the stability of the currency,” she said on Monday night. “I am very proud of our German culture of stability.”
This fixation on the German culture of stability is behind Germany’s insistence on all Eurozone member-states to commit themselves to tough austerity programs, and to promise to accelerate action to regulate market speculators.
The Issue of Regulatory Reform – A Long Range Policy Split between US-UK-EU
On the question of regulations, Merkel and Luxembourg Prime Minister Jean-Claude Juncker called for urgent regulation of credit-default swaps (CDS) to shore up financial stability in the euro area and prevent a rerun of the Greek financial crisis which still threatens to spring up like wild flower after a spring rain all over Eurozone.
Merkel, speaking to reporters in Luxembourg on March 9, moments before Greek Prime Minister Papandreou met President Obama in Washington, said the EU must take the lead in curbing the “very speculative elements” of derivatives trading, going beyond previous Group of 20 agreements. “We’re of the opinion that a quick implementation of actions in the area of CDS has to happen,” Merkel said. Citing “ongoing speculation against euro-region countries,” she called for the “fastest possible” implementation of new rules.
Europe must “do everything to avoid unhealthy speculation,” said Luxembourg Prime Minister Juncker, who heads the euro-area finance ministers group. European leaders are ratcheting up the pressure for tighter global regulation of derivatives as they seek to learn the lessons of the Greek fiscal crisis. Papandreou was expected to press Obama to help combat the “unprincipled speculators” that threaten a new global financial crisis. “Europe and America must say ‘enough is enough’ to those speculators who only place value on immediate returns, with utter disregard for the consequences on the larger economic system,” Papandreou said in a speech in Washington.
German Chancellor Merkel and French President Sarkozy are turning to regulatory efforts to help tame the surge in Greek financing costs. Greece’s budget gap, at 12.7% of Greek GDP, the EMU’s biggest and more than four times EMU limits. Papandreou’s government last week outlined measures to save €4.8 billion ($6.5 billion), including higher fuel, tobacco and sales taxes, as it seeks to lop 4 percentage points off the budget deficit.
EU Economic and Monetary Affairs Commissioner Olli Rehn said in an interview in Strasbourg, France, that Greece is “on track” to achieve its deficit-cutting goals following the passage of extra austerity measures. The new measures put Greece “onto the path of fiscal adjustment for 2012 below 3%” of GDP, he said. The difference in yield, or spread, between the 10-year Greek bond and its German equivalent, the bund, rose 1 basis point to 307 basis points as of 12:42 p.m. on March 9 in London.
A European Monetary Fund
As Papandreou pushes ahead with deficit-cutting plans that set off deadly and massive protests in Greece, European leaders may be headed for a split over a proposal to set up a lender of last resort to bolster fiscally distressed euro-area countries. Merkel, whose finance minister Wolfgang Schaeuble champions the idea of a European Monetary Fund (EMF), said it would work as “a measure of last resort” and only after “a cascade of sanctions” against governments that break euro rules. A change of European treaties would be required, Merkel said.
French Finance Minister Christine Lagarde said an EMF may not be the best option: “Other ideas need to be studied and those that respect the Lisbon treaty are much preferable.”  Luxembourg’s Juncker said any such fund should not create an opening “for countries that don’t take budgetary discipline so seriously.”
Bundesbank President Axel Weber , a European Central Bank governing-council member, also questioned the fund proposal. He also said he sees the need for more transparency in the CDS market. “The CDS market has developed very strongly and drives prices in bond markets,” Weber told reporters in Frankfurt. “Not everybody who buys protection has an underlying exposure. It’s a very intransparent market, we need to have a much more transparency.”
While European leaders seek ways to limit CDS, Germany’s BaFin financial regulator said market data lack evidence that the instruments were used to speculate against Greek bonds. Data provided by the US Depository Trust & Clearing Corporation did not show that new open positions were built up and also does not indicate “massive speculative action,” BaFin said in a statement.   
Yet the German government is fighting an uphill battle against commentators and opposition politicians, even from the ranks of its own coalition, to persuade the public that the “special purpose vehicle” that will provide credit guarantees to Eurozone members is not a “transfer union” by another name.
Bild Zeitung, the mass-circulation newspaper that has been fighting a daily battle against the Greek bail-out, and now the wider €750 billion Eurozone stability plan, taunted the chancellor again on Tuesday, May 11: “The ‘safety parachute’ for the euro is the ultimate crime for Europe,” it declared. “We Germans have made sacrifices for a stable euro for the last 10 years, with wage restraint and sacrificing pension rises. We have paid the price while others have been partying at our expense . . . Europe’s path to a transfer union is simply a road to its ruin.”
The German taxpayers’ federation said on Tuesday, May 11, its members had been taken unawares by the government, which claimed there was no alternative to the package. “These decisions will cost us very dear,” said Reiner Holznagel, federation secretary.

As for Greece, there have been no further riots since Wednesday, May 5, 2010 when the public was shocked by three deaths that resulted from the fire bombing of a bank. Both in Greece and Germany, a slight majority was emerging in favor of the European bailout, while still 66% of Germans are favorably disposed towards the Euro, the fate for which is closely tied to the fate of sovereign debt of Eurozone member states.
Just as the Obama neoliberal centrist Democrats are facing electoral defeat by conservative right-of-center Republicans in the mid-term election because of theirs inept handling of the financial crisis, Merkel’s Conservative Christian Democrats experienced electoral defeat by a new coalition of left of center parties.
US Involvement
Obama consulted the leaders of Germany and France on Sunday, May 9, on jittery European financial markets and the need for European leaders to take steps to build confidence in the markets. Obama spoke first by phone with German Chancellor Merkel and later with French President Sarkozy.
It was his second conversation in three days with Merkel. White House spokesman Bill Burton said the phone conversation with Merkel was part of Obama’s “ongoing engagement with European leaders with regard to the economic situation there. … They discussed the importance of the members of the European Union taking resolute steps to build confidence in the markets.”
After the talks with Sarkozy, the White House issued a nearly identical statement describing the conversation, different only in saying that Obama and Sarkozy had “agreed” on the need for European steps to build confidence in the markets.

At one point during a call with Group of Seven officials at the weekend of May 7, Tim Geithner, US Treasury secretary, made it clear that the US was not pleased with the Eurozone rescue package as it stood.

A person with knowledge of the discussions told the press that Geithner was “very direct”, telling his counterparts the intervention was not in the “right order of magnitude” and should be increased, and more commitments were needed from struggling countries in terms of “fiscal credibility”.  Geithner himself has been criticized for the inadequate size of the US stimulus package.

Mr Geithner’s forcefulness highlights how US officials have stepped up their involvement in efforts to contain the European sovereign debt crisis in recent days, amid escalating fears within the Obama admin­istration and the Federal Reserve that the US ­recovery might be under threat. An apprehension that was justified by the sharp declines in US equity markets since the Greek crisis began. Even the trillion dollar stabilization package brought only two days of respite in a secular bear market that began in mid April, 2010. Concerns for financial stability in Europe had been at the top of Washington’s economic agenda for weeks, but a sharp drop in markets at the end of April put policymakers in crisis mode.  Obama intervened with calls to Merkel and Sarkozy on Sunday. Also, Mr Geithner discussed the eurozone rescue with the Group of 20 leading economies.
Fed-ECB Currency Swap Renewed
The Fed also began working with the European Central Bank and other central banks on ways to reinstate currency swap lines that were introduced during the financial crisis to help foreign banks gain access to dollar funding. The swap lines, which totaled nearly $600bn at the height of the meltdown, were wound down by the start of 2010.
The Federal open market committee, which sets US interest rates, held an emergency session on Sunday, May 9, to approve the swaps – a move supported by the Obama administration amid hopes it would provide another tool to ease the strain in the credit markets.
The decision to reinstate the currency swap facilities was seen within the Fed as a relatively risk-free way of helping out Europe: its counter­parties in the swaps are ­foreign central banks, not the financial institutions that primarily benefit from the deals, and there is no foreign exchange risk because the price of the swap is agreed at the outset.
Continuing Doubts on Recovery
Continuing doubts about the sustainability of the fragile recovery in the US and the potential for credit strains in Europe to cross the Atlantic meant US officials felt compelled to get more involved.
The European debt crisis has unfolded amid questionable growing optimism on the strength of the US recovery. Incurable optimists are pointing to the economy posting a 3.2% annualized growth rate in the first quarter of 2010 and four consecutive months of job creation as sign of a v-shape recovery.
Yet fundamental data show serious structural problems remain while reform activism has been ground to a halt. Structurally, the credit system remains hopelessly impaired, with stimulus money going to perpetuate the very same malpractices that have brought on the systemic crisis. Fiscal and public debt difficulties are demolishing many of the most productive states. Consumer spending cannot revive without a significant pick up in employment which is nowhere in sight. Most of the bailout money given to distressed banks has gone into carry trade for synthetic speculative profit from interest rate arbitrage in cyber finance, totally detached form the real economy where the creation of jobs and products counts. The entire financial sector, including all the too-big-to-fail banks, seems to be under indictment for criminal fraud that would take years to move through the courts, with decades of associated civil litigation that will leave lingering uncertainty in the market. The rise of the dollar against the euro and the yen will also torpedo hope of revival for the US export sector. The Federal Government is in danger of being turned into a partisan gridlock after the mid-term election next November, with the possibility of a premature lame-duck presidency two years ahead normal.
May 17, 2010
Next: The Trillion Dollar Failure