Evercore Pan Asset

The Euro has always been a very political construction. The main governments of the EU have believed in the scheme, and have always pressed ahead whatever the technical difficulties or the market scepticism. In the early days the German people did not want or love the Euro, but the ruling elite did. Germany helped create it and joined it at the beginning.

Today the German people are still not reconciled to their single currency with the neighbours. There is a strong groundswell of opinion in Germany against common Euro area borrowing, against any bail outs, and against Germany paying more by way of transfers to help the poorer parts of the Union. Most of the German elite still think they are right to keep the Euro, but an increasingly reluctant people is opposing the transfers and higher taxes needed to make it work. A successful single currency area requires people in the richer parts like Germany to send money to the poorer parts like Greece.

In the last fortnight Mrs Merkel has had to rule out German support for any common Euro area borrowing, the favoured solution by France, the UK and others to the Euro’s main problem of sovereign debts. The German President has argued that the bail outs so far agreed are probably illegal. An important court case is pending on this issue. Mrs Merkel is having to move back to a position of not supporting the rest of the Euro area, as the pressure mounts from her own party against the costs of Euro membership. The Parliamentarians are beginning to reflect German popular doubts about the wisdom of Euro integration.

Even Finland has added to the difficulty by refusing to put up her share of the Greek loan without full collateral, leading many Germans to say if one gets collateral they all need collateral. That would undermine the Greek loan, as Greece probably cannot find all the collateral that would be needed. If Greece does not get her loan soon state bills go unpaid and Greece ends up reneging on her debts.

Mrs Merkel probably hopes she can use strong language against more bail outs and borrowing to steer her through, whilst facilitating back door means of doing it through the European Central Bank. The show has been kept narrowly on the road in the dog days of August by the European central Bank buying the bonds of Spain and Italy so they can still afford to borrow in the market to pay their bills. This is meant to be a temporary measure, pending sorting out the problems of the big Euro bail-out fund. No-one in the markets thinks they can agree a fund big enough to meet the needs of Spain and Italy. This week sees new issues by these two governments. The ECB has to stand ready to buy in the market to ensure these financings go smoothly. Some in Germany are worried about the extent of ECB buying.

The truth is a very political project, the Euro, is running into serious political danger. If Mrs Merkel is unable to move her voters and her party to agree to major financial support for other Euroland countries when they need it, the markets will push and push for the removal of weaker countries from the Euro by undermining the sovereign debts of the weaker countries.

I have always argued that because it is a political project the growing economic stresses and costs did not mean it was about the end. It is a different matter, however, if the political stresses for Germany become too great. Doubtless the German government still wants the Euro to work. Increasingly they have to take a hard line on no more bail outs, and on limiting the scope for the European central Bank to buy more bonds and create the money to do so. The Euro and some government bond markets in the EU will be nervous as German court judgements and Parliamentary votes come to play a more important role in the future of the currency. This very political currency will get into more trouble if German politics drifts against helping it succeed through a stronger economic government of Euroland matched with more loans and transfers. We continue to recommend avoiding Euro area investments as the crisis is not yet over.

As published in Investment Week