President François Hollande of France and Chancellor Angela Merkel of Germany meet in Berlin, May 15 (Bundesregierung)

German chancellor Angela Merkel and newly elected French president François Hollande are bracing for their first proper fight. The debate between austerity and growth is expected to narrow to the question of whether countries in the eurozone should jointly issue sovereign bonds when leaders meet in Brussels on Wednesday.

Hollande, a socialist who became president this month, supports the creation of Eurobonds. So did his predecessor, the conservative Nicolas Sarkozy, but he was willing to drop the issue to allow France and Germany to combat the continent’s debt crisis together.

There was no such Franco-German unity on display in Camp David this weekend where leaders of the G8 countries met to discuss the global economic crisis.

American president Barack Obama embraced Hollande’s push for “growth”—which, to them, means more stimulus spending. He and other leaders paid lip service to fiscal consolidation but appear to have grown weary of austerity. Merkel insists that industrialized nations must get their fiscal houses in order to restore consumer and investor confidence.

British prime minister David Cameron, otherwise considered a champion of austerity, unexpectedly backed the creation of Eurobonds before the G8 summit. The United Kingdom, outside of the eurozone, wouldn’t have to participate. Italy’s Mario Monti also supports the idea. It left Merkel without allies at Camp David.

The European Commission floated the notion of creating Eurobonds last year as a way to stem Europe’s spiraling debt crisis. Joonatan Jakobs explained at the time how Eurobonds would work at the Atlantic Sentinel.

Since most countries in the single currency area are economically stable, a Eurobond would enable the least competitive among them to receive funding from the markets, substantially lowering the costs for countries that are currently in trouble.

Hence the German apprehension. Berlin fears that the creation of Eurobonds will ultimately lead to a “transferunion,” the permanent bailing out of weaker states in the single currency union at its expensive if they’re able to free ride on Germany’s pristine creditworthiness.

Spain endorses the proposal. Slovakia has come around to it. The previous conservative government was skeptical but left wing prime minister Robert Fico, who assumed office in April, told parliament on Monday that he would back the French position.

Finland and the Netherlands remain opposed. With Germany, they argue that more progress is needed on coordinating fiscal policies across the eurozone before members can consider jointly issuing sovereign bonds.

Prime Minister Mario Monti of Italy appears on CNN's GPS, May 20

Italian prime minister Mario Monti said the divide between proponents of austerity and growth in Europe “needs to be bridged.”

In an interview with CNN’s GPS that was broadcast on Sunday, the Italian leader said there could be effort to stimulate demand, “if it is demand to remove bottlenecks in the supply of goods and services, so broadly investment demand.”

Monti, a former European commissioner, was appointed in November of last year to save Italy from a Greek style debt crisis. Since putting government spending in his country on a sustainable trajectory, he has shifted his emphasis to improving Italian competitiveness and boosting growth.

He admitted that Italy is “destroying domestic demand through fiscal consolidation” but cautioned against runaway stimulus spending. “If it is an across the board crusade for more demand, then I believe that the German reluctance to that is not entirely unfounded,” he said.

Germany insists that eurozone nations must rein in public spending to restore consumer and investor confidence and further liberalize their economies to compete in a global market. Left wing leaders, including the newly elected French president François Hollande, believe in expansionary fiscal and monetary policies to prop up consumption.

Policy makers in Berlin are particularly wary of the European Central Bank printing money to finance government borrowing in the heavily indebted periphery of the single currency union.

As Monti put it, “The ECB in its autonomy has been able to find new techniques of intervention.” Indeed, it purchased some €1 trillion in Italian and Spanish bonds last year and loaned many billions more at virtually zero interest rates to weak European banks.

The Germans fear that this will cause inflation to rise and remove the incentive on the part of high debt nations to balance their budgets and reform. “It’s important that we get away from the idea that it always costs money to get economic growth,” said Chancellor Angela Merkel this month.

President Barack Obama and Angela Merkel discuss policy during the G20 summit in Seoul, South Korea, November 11, 2010

German chancellor Angela Merkel will likely be isolated among G8 leaders in Camp David this weekend. With the possible exception of Canada’s Stephen Harper, the leaders of the world’s other major industrial nations are all growing weary of austerity.

The divide is a familiar one. American president Barack Obama has urged his overseas counterparts to do more to stimulate economic recovery in the eurozone for two years while the Germans are adamantly opposed to more deficit spending as well as an expansionary monetary policy as has been pursued in the United States.

Treasury secretary Timothy Geithner lamented Europe’s “negative spiral of growth killing austerity” this week. The German finance minister, Wolfgang Schäuble, was exasperated. “One cannot now seriously demand taking on even more debt to solve the crisis,” he told Focus magazine earlier in the month.

The Germans regard America’s nearly $1 trillion stimulus program with disbelief and insist that Europe’s approach should be different. Solid public finances, they say, is a key condition for consumer and investor confidence and therefore growth.

Transatlantic discord over austerity has become a recurring theme at international summits. President Obama urged Europe to do more stimulus at the G20 summit held in Toronto, Canada in 2010 and reiterated that call in Seoul the next year. The Germans opposed him both times and were able to sway other major powers their way.

In Toronto, the G20 countries agreed to cut their deficits in half by 2013, a targets which the Americans are almost certain to miss. Nations failed to reach agreement on monetary policy however. China and Germany remain critical of America’s willingness to print money, even if the European Central Bank has since done the same to finance Italian and Spanish deficit spending.

The difference for Merkel this weekend is that she has lost two allies. France’s Nicolas Sarkozy was replaced by socialist François Hollande this week who brings with him an agenda for “growth” (which means more public spending) while British prime minister David Cameron is now in favor of issuing Eurobonds or joint sovereign debt paper in the eurozone—so the United Kingdom wouldn’t have to participate.

The German high court preempted this proposal in September of last year when it decreed that parliament would have to consent to such a joint issuance of bonds. It is unlikely to. The Germans fear “transferunion,” the permanent bailing out of weaker states in the single currency union at Germany’s expensive if they’re able to free ride on Germany’s pristine creditworthiness.

Merkel is no stranger to isolation. She has few allies among Europe’s leaders. Italy’s Mario Monti and Spain’s Mariano Rajoy, both conservative prime ministers, try to reduce their deficits and introduce market reforms to make their nations more competitive relative to Germany—as Merkel put it in Seoul two years ago, “the benchmark has to be the countries that have been most competitive, not to reduce to the lowest common denominator”—but they also support a more expansionary monetary policy on the part of the European Central Banks which the German chancellor rejects for fear of inflation.

It may be convenient for the Germans if China were finally let into the G8. Until that happens, Merkel will stand her ground, alone.

House speaker John Boehner answers questions from reporters on Capitol Hill in Washington DC, February 2 (Bryant Avondoglio)

American president Barack Obama asked Republican leader John Boehner for a “clean” increase in the nation’s legal debt limit on Wednesday, one that is not conditioned on a plan for deficit reduction. The conservative House speaker said “no” but has also ruled out tax increases which the president believes must be part of a “balanced approach” to fiscal consolidation.

White House spokesman Jay Carney blamed Boehner and his Republican Party for jeopardizing the country’s financial credibility. “The president does not believe that the full faith and credit of the United States, its commitment to pay its bills and its obligations, should be held hostage to a political ideology,” he said after Wednesday’s meeting.

Republicans argue that they are looking for pragmatic solutions to solving the nation’s debt crisis when Democrats have rejected any proposed spending reductions and reforms.

To demonstrate Democrats’ intransigence, Republicans brought the president’s own budget proposal for fiscal year 2013 up for a vote again. As expected, it was overwhelmingly defeated in both the House and Senate.

The Democratic majority in the upper chamber hasn’t produced a proper budget throughout Barack Obama’s presidency. The conservative majority in the House of Representatives, this year and last, introduced budgets that were voted down in the Senate.

For three years, the United States have had to borrow more than $1 trillion annually to balance their budget. The national debt is approaching $16 trillion, several hundreds of billions of dollars short of the legal debt ceiling of $16.4 trillion.

The cap was most recently raised by $900 billion in July 2011 after weeks of strenuous negotiations between Democrats and Republicans. As part of their agreement, federal spending projections for the next ten years were reduced by $917 billion with $21 billion worth of cuts implemented in 2012.

A congressional committee was tasked with finding up to $1.2 trillion in additional savings over the 2013-2021 time period. Because the parties failed to reach a compromise, $1.2 trillion in cuts, split between defense and domestic spending, were automatically enacted. Republicans are now scrambling to avert those reductions in national security.

The battle lines for the upcoming debt debacle have already been drawn. Republicans don’t want to cut military spending nor raise taxes. Democrats don’t want to reform entitlement programs like Medicaid, which subsidizes health care for the poor, and Medicare, which pays medical care for seniors.

With Social Security pension payments, these mandatory spending outlays are mainly responsible for America’s ballooning deficit projections.

The Congressional Budget Office estimates that by 2021, more than half of federal spending will have to be allocated to Medicaid, Medicare and Social Security. Along with defense, interest payments on the debt and unemployment insurance, it would be nigh impossible for the Federal Government to continue to fund education and other domestic programs unless taxes are raised substantially.

Republicans have proposed to privatize Medicare and reduce Medicaid payments. Democrats have ruled out such reforms. As Nancy Pelosi, the left’s leader in the House of Representatives, put it, they will not “reduce the deficit or subsidize tax cuts for the rich on the backs of America’s seniors and working families.”

On Wednesday, Pelosi accused Republicans of “manufacturing” a crisis by demanding spending cuts for more borrowing.

“Cuts” aren’t really cuts though. They are reductions in projected spending increases. In real terms, public spending will grow every year—under the Republican plan, by 4 percent on average; under the president’s plan, by 5 percent. Republicans would spend roughly $40 trillion over the next ten years; Obama would spend $45 trillion. If neither plan is enacted, the CBO estimates outlays worth $47 trillion over the same period.

Athens, Greece, December 10, 2011 (Helen Sotiriadis)

With the collapse of multiparty talks to form a new government in Greece, the country’s future in Europe’s single currency area is seen as highly precarious.

Ordinary Greeks are pulling their deposits out of local banks in anticipation of a eurozone exit which could trigger a currency devaluation. The country’s president said on Tuesday that at least €700 million in savings had been withdrawn before day’s end.

Investment bank JPMorgan Chase raised the odds of Greece leaving the euro to 30 to 50 percent. It predicts a “massive capital flight” to escape capital controls and the printing of IOUs (“I owe you”) debt papers which would temporarily serve as alternative currency while Greece prints new drachmas.

Worse for the rest of Europe, a Greek exit and likely sovereign default—as it would lack the international financial aid necessary to make payments—could trigger a “capital flight from [the] rest of [the] periphery.”

If periphery countries then impose capital controls, the monetary union is effectively dead, as one country’s euros are then not the same as another country’s euros.

The precedent is Argentina which defaulted on its debt obligations in 2001 and simultaneously depegged the peso from the dollar. Dollar deposits became peso deposits and it was illegal to make any more payments in dollars.

As a result of the peso‘s subsequent devaluation relative to the dollar, ordinary Argentinians effectively lost up to 80 percent of the value of their savings.

The policy was designed to prevent a collapse of Argentina’s banks and would likely have to be replicated in Greece if its financial institutions also lose access to European Central Bank funding.

The danger is that savers in other heavily indebted eurozone nations, including Italy, Portugal and Spain, fearing default and devaluation in their own countries, will pull their money out of the banks and drive it to Germany or Switzerland. Such a bank run could herald the collapse of the currency union.

Some are willing to risk it. German weekly Der Spiegel says Greece must leave the euro. “The attempt to retroactively bring the country up to speed through reforms has failed.” If the Greeks have their own currency again and devalue it, exports would be cheaper. “The Greek economy could become competitive again.”

This would be true if Greece were an exporting nation but as Der Spiegel also notes, it has actually a tiny industrial base and is (or was) hugely dependent on public spending. The total value of its imports is twice the size of its exports.

The costs of imports would skyrocket if Greece left the euro, deepening a recession that has already shrunk the country’s economy by nearly a fifth since the beginning of the financial crisis in 2008.

One out of five Greeks is out of work. The youth unemployment rate is over 50 percent. Changing the currency won’t change any of that unless market reforms are simultaneously implemented to make the Greek economy more competitive.

Greece was supposed to implement liberalizations in the last two years as a condition for the financial support it received from its European partners and the International Monetary Fund but progress has been markedly slow. If the government in Athens—possibly a left wing government that doesn’t believe in austerity—is no longer under pressure from the specter of default, there will only be less incentive to rein in public spending and reform.

What is more, if Greece regains its own currency, it also regains the ability to print money to try to inflate its debt away. An expanding money supply would no longer be offset by growth elsewhere as is the case in the eurozone. The value of Greeks’ money would first decrease as a result of switching to the drachma and possibly again as a result of hyperinflation.

So for Greece, there is no easy way out. If it tries nonetheless, the rest of Europe can only hope that investors and savers don’t expect other countries will follow.

Pipeline construction in the Black Sea (Gazprom)

Compromise is needed between the European Union and Russia regarding the Trans Caspian Pipeline to ensure regional energy security.

Believing the European Union’s 2009 Third Energy Package was designed to undermine Russian and Gazprom’s interests, the current discussions concerning the Trans Caspian Pipeline, the third round of negotiations, have stalled with neither side willing to relinquish to the demands of the other.

The Southern Gas Corridor has not been a contentious topic in the past. However, the Third Energy Project has created a rift between Europe and Russia on energy security.

Under the agreement, Russia demands that Gazprom should receive the entire supply chain while the EU would receive energy supplies from Turkmenistan. Concerns have arisen regarding Russia’s eventual attempts to use supply routes as a “weapon,” and the Europeans do not believe that Turkmenistan will be able to remain stable without diversifying the nation’s export portfolio, so supplies over the long term may not be realistic.

Russia’s pressure to hand Gazprom the entire supply chain has pushed the EU to attempt to negotiate with Azerbaijan and Turkmenistan directly. Russia has attacked this approach citing unresolved claims of energy supplies throughout the Caspian Sea basin.

Analysis

The European-Russian spat over the latter’s gas monopoly is a classic example of one international player willing to counter the other’s attempt to tighten its control of energy supply routes to wield more influence.

Russia’s bet on energy has been more of a necessity than of a premeditated policy choice. In the absence of structural economic reforms capable of strengthening Russia’s competitiveness in world markets and bringing it closer to the technological edge, its only hope is to use abundant mineral resources to generate long term revenue.

The volatility of energy prices has long been a scourge for those countries which are overly dependent on their oil and gas. Thus, by maintaining its monopoly in Europe, still Russia’s main client, Gazprom is trying to ensure a stable price level and consequently, a source of stable income for the Russian Government.

With the Third Energy Package gradually implemented, Gazprom risks losing its transit role, one which promises in this energy equation the biggest margin of influence.

As long as the EU is ready to tolerate exceptions for the Russian gas company, Moscow will be willing to let the Trans Caspian Pipeline move closer toward completion. This is because the pipeline is not capable of becoming a credible substitute for Russian imports in the near future—-considerable is investment needed and tehre are legal problems to resolve—and because Russia will still maintain some control over it by using its influence in the Caucasus and Central Asia.

Wikistrat Bottom Lines

Steven Aiello, Michael Breen, Tatyana Bolton, Patrick Hall, Miguel Nunes Silva and Georgiy Voloshin contributed to this analysis.

Greek leftist leader Alexis Tsipras arrives at the presidential palace in Athens for coalition talks, May 13 (AP/Kostas Tsironis)

Greek left wing parties rejected proposals to support a technocratic government on Tuesday, a last ditch effort by Greece’s president to avert new elections and possibly bankruptcy.

“We don’t want to consent to any kind of bailout policies, even if they are implemented by nonpolitical personalities,” a spokesman for the far left alliance SYRIZA said. Party leader Alexis Tsipras earlier ruled out any coalition that adheres to the conditions of Greece’s two international bailouts.

The southern European country’s traditional ruling parties have supported a technocratic government for the last six months but were punished in last week’s election, falling two seats short of a majority between them.

The conservatives and socialists have since been in talks with parties that campaigned against austerity. If they cannot agree to form a government, there will likely be new elections in June. SYRIZA would come out the strongest, according to opinion polls, and may be able to form a coalition with the communists and other left wing parties.

June is also when the latest tranche in European and international financial support is due. If Greece does not advance its program of fiscal consolidation and market reforms, its European Union and International Monetary Fund paymasters could withhold bailout funds, raising the specter of a Greek sovereign default.

Greece received €110 billion in financial assistance in 2010 and was promised a second bailout worth €130 billion in February. More than half of Greece’s €350 billion debt was subject to “haircuts” at the time. Banks and private investors were forced to write off billions in Greek bonds.

Jean-Claude Juncker, Luxembourg’s prime minister and head of the group of eurozone finance ministers, insisted on Monday that talk of Greece leaving the currency union is “nonsense” and “propaganda” but German finance minister Wolfgang Schäuble told the Welt am Sonntag newspaper that, “We cannot force a country to stay in the euro.” He added, “Questions have to be asked in a European context—what is the best for Europe? As a rule, that is the best for Germany, too.”

Last week, European Commission president José Manuel Barroso suggested in an interview with Italian television that Greece could be made to withdraw from the euro if it rejected the bailout agreement. “Of course, the agreements have to be respected,” he said, “and if they are not respected, it means that the conditions do not exist to continue with a country.”

European Commissioner for Economic and Financial Affairs Olli Rehn, January 10 (ALDEADLE)

Both Europe’s top economic official and German chancellor Angela Merkel warned eurozone governments this week against further borrowing to pay for stimulus measures.

“We cannot solve this crisis by piling new debt on top of old debt which is already damaging our economic growth prospects,” Olli Rehn, Europe’s commissioner for economic and monetary affairs, said in panel presentation at a conference in Tallinn, the capital of Estonia which adopted the common currency in January of this year.

Merkel told the Hamburger Abendblatt earlier in the week that Europe had to “get away from the idea that it always costs money to get economic growth.”

She reiterated that sentiment in parliament in Thursday. “Growth through structural reforms is sensible, important and necessary,” according to Merkel.

Growth on credit would just push us right back to the beginning of the crisis and that is why we should not and will not do it.

The German leader suffered a setback the next day when the left wing majority in the upper chamber of parliament rejected her plan to reduce income taxes by €6 billion next year.

The ruling German conservative and liberal parties have not had a majority in the Bundesrat since May 2010. Socialist and Green parties in opposition are increasingly critical of their austerity agenda. Social Democratic Party leader Frank-Walter Steinmeier urged the government two months ago to enact “additional measures to promote economic growth.” His party has been emboldened by socialist François Hollande’s election win in France.

Merkel’s and Rehn’s warnings were clearly aimed at preempting the newly elected French president’s push for a growth pact that would enable national governments to spend more freely to stimulate economic activity. Hollande has been critical of the strict fiscal rules that were enshrined in a European treaty in December.

Eurozone governments have now to submit their spending plans to the European Commission for approval. If they fail to adhere to the deficit cap of 3 percent of gross domestic product, the Commission drafts an alternative budget. Countries that do not implement it could be subject to a fine.

Rehn, whose department is the recipient of governments’ budget proposals, insisted that Europe stays the course. He added, “we are suffering from a very high level of public debt which has increased from 60 percent on average to 90 percent in Europe.” Particularly in the periphery of the single currency area, countries have racked up enormous debts.

“The only sustainable path,” said Merkel, “is to accept that getting over the crisis is a long, strenuous process which will only succeed if we tackle the causes of the crisis which are the horrendous debt and the lack of competitiveness of some eurozone states.”

In conjunction with debt and deficit limits, the Germans have sought to enhance competitiveness across the eurozone with lower taxes, liberalizations and labor market reforms.

Greece, Italy and Spain have made progress in these areas but say that they need more time for fiscal consolidation and more flexibility on the part of the European Central Bank to finance their deficit spending before they’re able to balance their budgets. The Germans are highly critical of this proposition because it would drive up inflation.

Business leaders meet during an Asian Development Bank summit in Manila, the capital of the Philippines, May 4

In order to insulate their economies from the continuing financial uncertainty in Europe, the Association of Southeast Asian Nations along with China, Japan, and South Korea, known as ASEAN+3, announced steps last Thursday to enhance economic cooperation between Asian states.

The countries will double the size of a liquidity fund that member states can tap into to $240 billion. They also increased the quota of unconditional funds each country can access from 20 to 30 percent before triggering an International Monetary Fund program as well as an extension of the maturity of currency swaps from ninety days to twelve months.

Officials are particularly optimistic about the economic prospects for ASEAN. At the Asian Development Bank’s board of governors meeting in Manila last week, chief economist Rhee Changyong was extolling on the future of ASEAN, stating that “a new growth force is coming in Asia, one that would come to match the economic growth seen in China and India.”

Rhee’s confidence was reflective of the widespread enthusiasm over the expected beginning of the ASEAN economic bloc in 2015. If all goes as planned, the bloc will eliminate most tariffs and promote the free flow of labor and goods within its borders. There is even talk of a common currency. ASEAN, with an area encompassing six hundred million people, will be the next frontier for economic growth.

Many economists have predicted that as China’s competitive advantage in labor costs recedes relative to other developing countries, there will be a gradual migration of manufacturing plants to lower cost countries like Indonesia and Vietnam in addition to other areas in Southeast Asia. Recent developments in China seem to bear this out.

A few months ago, Chinese officials were pressured into raising wages by striking workers at Apple supplier Foxconn in addition to other factories in the country.

However, ASEAN must proceed cautiously on economic integration because, as seen in the eurozone, a step toward monetary union without the concurrent fiscal agreements in place is a recipe for instability.

The European Union is grappling with member countries stricken with slow or negative growth. Unemployment is increasing and production declining but countries cannot take the sort of measures they likely would have had if they still controlled their currencies.

For now, ASEAN’s plans for an economic bloc that encourages trade by reducing barriers, such as tariffs and quotas, is materializing. The adoption of a common ASEAN currency is still very much a long term vision.