Industrial production Unemployment rates - core vs. periphery Index, 100 = January 2007 Percent, Peripheral rates weighted by population mg ies Greece, Ireland, Spain & Portugal 105 ia ; Germany 14% "00 12% a Europe 10% on 8% BS ; sad Germany a0 - eriphery 4% 5 —_ aq wqei ce a 2007 2008 2009 2010 2011 0% —— ae ad - Source: INE, CSO, ISTAT,NSS, Eurostat, Bundesbank, J.P. Morgan Ue Securities LLC, J.P. Morgan Private Bank. Periphery =Portugal, Ireland, lialy, Source: J.P. Morgan Private Bank, Bankof Spain, Bankof Portugal, OECD, Greece, Spain. CSO, N55, Bundesbank The third concern: Germany as paymaster. We are often told that Germans across both major parties are unflinching supporters of the European project, and will do whatever it takes to prevent a break-up. The objections from members of the Bundesbank are described as lonely voices of opposition that carry no weight [a]. But how large are the costs going to be? German politicians and voters may see current circumstances as exceptional, and that if they just agree to one more package, the problem will go away. However, we are starting to see analyses of how costly a permanent transfer union may be for Germany. Bernard Connolly at Hamiltonian Advisors sent me a recent paper from the Centrum fur Europaische Politik in Freiburg, which provides some clues. They see three alternatives for the deficit countries: ** massive reduction in regulations and unit labor costs to regain competitiveness ** exit from the EMU, re-introduction of national currencies ** nermanent transfer union from surplus countries to deficit ones On the last option, they estimate a “creditworthiness gap” in European deficit countries of Eur 108 billion in 2010. The gap measures how much European deficit countries rely on capital inflows to fund consumption, rather than investment (which contributes to future GDP). Germany’s share of the European surplus is around ™%, so let’s assume a pro-rata burden on Germany to maintain the transfer union. As