Germany will shatter Europe's uneasy calm

The wave of relief that spilled through markets when the US Federal Reserve opted not to begin the ’tapering’ of its quantitative easing program has delayed one critical and ultra-sensitive turning point in the post financial crisis environment.

Another approaches this weekend.

At the weekend, Germany goes to the elections even as there are signs of a nascent recovery in the eurozone economies. While the outcome appears uncertain, it is likely that Chancellor Angela Merkel will probably retain her position and that Germany will remain committed to the eurozone.

With the election out of the way, there is an expectation that the effort to put the finances of the eurozone on a firmer footing – an effort that appears to have been largely on a backburner for the past year – will resume.

That probably means another restructuring of Greece’s debts, another bailout for Cyprus, perhaps more interventions in Portugal, perhaps credit support for Ireland and maybe even some assistance for Spain. The sovereign debt crisis in southern Europe has been dormant, but has yet to be resolved.

It also means that the shift towards a European Banking Union – and a belated ‘’proper’’ recapitalisation of Europe’s banking systems – will gather pace.

The European Central Bank will take over responsibility for supervising the eurozone’s banks next year. It is conducting what is expected to be the most credible stress tests of the sector and will inevitably force the weaker institutions to raise more capital.

While there have been some capital raising in anticipation of the new regime, there is a belief among some that the banks are short about $US1.5 billion of the capital required. There is also a conviction that some eurozone banks need to be wound up.

An effective banking union would require the transfer and centralisation of significant sovereign powers and controls to the ECB, which Germany has been resisting ahead of the election.

Post-election, a deal might be more practicable, although everything we’ve learned about the workings of the eurozone since 2008 suggests that achieving any kind of consensus and therefore any real concerted action is difficult.

The uneasy calm in the eurozone over the past year has been aided by the US Fed’s quantitative easing program and the continuing flood of cheap funds that have been pushed out to the corners of the globe searching for positive returns and chasing yield.

For the moment, the beginning of the end for that program has been delayed as the Fed waits for signs of stronger growth in the US economy, which means that the unintended consequences of the QE program – including its harmful impact on third-country currencies, like Australia’s, and in promoting speculative and risky behaviours – will continue.

At some point in the not-too-distant future, however, the program will have to be wound down which, as we’ve seen this week, could have quite widespread and extremely dislocative impacts across financial markets and economies.

If that were to coincide with an attempt by the European authorities to finally address the structural problems within the eurozone and its financial system, it could produce a quite volatile and dangerous moment – yet again – for global markets and the global economy.