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Re-elected Obama may take the gloves off with Europe

Re-elected Obama may take the gloves off with Europe

Stern words likely with Berlin
Phoney war over ECB bond-buying to continue

by David Marsh

Tue 13 Nov 2012

US frustration with Europe’s inability to solve the euro crisis is likely to come increasingly to the fore after Barack Obama’s re-election, spelling bad news for relations with Germany in particular. The US president’s victory will have three effects on economic and monetary union (EMU), none of them particularly rosy.

Underlining the new, more worrying turn on EMU, the figures for the European Central Bank’s intra-euro area Target-2 payments imbalances, which were relatively positive for September, turned slightly negative again in October. The Bundesbank’s claims on the ECB rose to €719bn from €695bn in September, although this was still below the record €751bn for August.

What are the effects of Obama’s win on Europe?

First, after months in which the White House and Treasury made clear their wish for Greece to stay in EMU to prevent a damaging pre-election financial collapse, the re-elected president will now have a much freer hand to say what he thinks about Europe’s irresolution. If Obama decides to take the gloves off with the Old Continent, this could lead to some wounding exchanges with Berlin. Obama will probably side more overtly with France and Italy to rail against alleged German intransigence on helping Greece and other problem-hit countries.

This will not go down well with Chancellor Angela Merkel. Significantly, the most resounding approval in Europe for Obama’s win came from France’s president François Hollande, who sees the US as an ally in his anti-austerity campaign.

Second, now that the election is out of the way, greater optimism about US economic growth may start to take hold internationally – depending on whether the so far intractable issue of the US fiscal cliff can be resolved. This coincides with steadily worsening economic news from Europe. The gap between US and euro area GDP growth could widen next year to nearly 3 percentage points, the largest since the euro began. On past form, this will weaken the euro. Good news for southern Europe, bad for resolve and morale in Germany and the other creditor countries.

Third, despite the pressure, German unwillingness to agree to more generous action over Greece, Spain and the others is likely to increase, not diminish, as the timetable moves into gear for next year’s German federal elections. A strong reason why the European Central Bank’s much-trumped-up bond-buying plans are on hold is because the Bundesbank’s negative views on the matter have already been well-circulated in political circles and in the marketplace.

The ‘phoney war’ on the ECB’s so-called Outright Monetary Transactions (OMT) programme could continue until the New Year. In terms of the impact on Spanish and Italian bond yields, we may have already seen the best of the OMT’s impact.

As the French 18th century philosopher Voltaire opined about the Holy Roman Empire (‘neither holy, nor Roman, nor an empire’), future historians may say that the OMT was neither outright, nor monetary nor a transaction. It is certainly taking a long time to get going. This reflects the harrowing contradictions of the conditionality that requires the Spanish government to approach Europe for a further bailout deal without being able to tell Madrid parliamentarians what it will get in return.

The Bundesbank’s conditions for a successful OMT are the same as it habitually applied to past foreign exchange market intervention. Action should be powerful, coordinated and in line with fundamental market trends. It’s unclear whether these preconditions are in place.

The longer the delay in implementing the OMT, the greater will be the resolve of its opponents. And the larger will be the reluctance to break the seals on a Pandora’s box that, once opened, can be closed only with the greatest difficulty.

All this is compounded by further euro area brinkmanship on Greece after international lenders failed to bridge differences on how to reduce Athens’ still-disastrous debt levels, bringing the country close to defaulting on a €5bn debt payment due at the end of this week. Only nine months ago, Greece benefited from by far the greatest sovereign debt restructuring in history. Yet it is further away than ever in solving its debt problems, since austerity, as many people predicted, has simply made the debt problem worse.

This calamitous outcome occurred under the aegis of the International Monetary Fund. The combination of circumstances makes the IMF much less likely to get involved in further bailout packages, whether for Greece or for other struggling states like Spain.

In his new steely post-election mood, Obama will join with leading emerging market economies such as Brazil, China and India in declaring Europe must sort out its mess by itself. This can only mean more money from the Germans. Hardly likely to help Merkel’s popularity, less than a year before her own elections.

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