The dispute matters because investors behaved as if fiscal union was already a done deal. This is reminiscent of assumptions at the height of the EMU bond bubble around 2007, when Club Med debt and German debt were considered interchangeable. Spanish spreads fell to four basis points.
The European cheerleaders who then ran European operations at Moody’s kept Greece’s rating at A1 until the bitter end, arguing that there was already an implicit debt union. It is worth recalling their exact words in December 2009 because I now detect the same kind of commentary on the Eurozone by market insiders.
“Moody’s believes that it is extremely unlikely that Greece will face short-term liquidity refinancing problems unless the ECB decides to take the unusual step of making a member state’s sovereign debt ineligible by guarantee…a risk that we consider to be very low,” he said. .
“Nor does Moody’s believe that the Greek government’s troubles represent a vital test for the future of the eurozone, but rather a reassessment of relative risks that had been concealed by years of abundant global liquidity.”
Investors woke up to find there was no such EU backstop. Northern creditor states were prepared to let Greece go bankrupt rather than give in to moral hazard. They allowed Italy, Spain, Portugal, Cyprus and Ireland to sink into systemic debt crises. It took three years before they let the ECB buy debt for good.
The contours are different today, but one thing seems familiar: the consensus could once again misjudge the mood in Germany, where inflation hit 8.2%, which was not the case amid of the 1970s. This tests patience: the sacred contract of monetary union is that the euro must be a hard D-Mark written in large, not a successor to the soft lira.
It is widely reported in the German press that Swiss inflation is only 3.4%, even though both countries have been hit by the same commodity shock. Confidence in the ECB’s monetary management and in the euro project is slowly eroding. “It will be ‘game over’ once Germany refuses to continue being Europe’s payer,” said Manuel Peiffer of asset manager GVS Financial Solutions.
We are not there yet but what ultimately determines the fate of the euro is not whether Italy chooses to leave: it is whether Germany chooses one day to leave.
This article is an excerpt from The Telegraph’s Economic Intelligence newsletter. register here to get exclusive insights from two of the UK’s leading economic commentators – Ambrose Evans-Pritchard and Jeremy Warner – delivered straight to your inbox every Tuesday.