Euro zone advancing through obstacle course
Paris, September 13, 2012
Europe has cleared more obstacles on the road to containing its sovereign debt crisis and stabilising the euro zone after Germany's constitutional court allowed a permanent bailout fund to go ahead and the Dutch voted for pro-European parties.
Coupled with a European Central Bank decision to buy short-term bonds of states that apply for assistance and abide by strict conditions, and with EU proposals for a single euro zone banking supervisor, Wednesday's ruling clears the way for a concerted effort to draw a line under the crisis.
However, there are still risks on the way to repairing the flawed euro construct, and Europe has yet to find a strategy to revive economic growth that would enable highly indebted states to reduce debt burdens and put the jobless back to work.
Among the bailed-out euro zone countries, Ireland is inching its way back towards the capital markets and Portugal is doggedly implementing a tough austerity programme, and has just been granted an extra year to achieve its fiscal targets.
Greece, where the crisis began, remains an exception to the general mood of cautious optimism, but talk of forcing Athens out of the euro zone has abated for now.
"If you look at the ongoing few weeks, I would say we see a light at the end of the tunnel," Finnish Europe Minister Alexander Stubb said.
He cited last week's ECB decision as well as the proposed banking union, the German court ruling and the triumph of pro-European centrists in Wednesday's Dutch general election.
"If we get the next few weeks right we'll have turned a corner," Stubb said.
Enthusiastic market reaction after the German ruling, with Spanish and Italian bonds rallying, shares rising and the euro hitting a four-month high, showed many investors believe the euro zone is finally starting to get on top of the crisis.
The next hurdle is Spain. Prime Minister Mariano Rajoy is under pressure to apply for a limited assistance programme that would allow the rescue fund to buy Spanish bonds upon issue, and the ECB to intervene to bring down shorter-term borrowing costs, while keeping Spain in capital markets.
Rajoy took another half-step this week by saying he was considering requesting ECB support and would not object to IMF involvement in monitoring Madrid's public finances.
Whether for tactical reasons, out of national pride or fear of the political consequences, he is holding back on an application, possibly hoping he can get past Oct. 21 regional elections and a late-October funding hump without outside aid.
Rajoy is resisting German pressure for tougher additional policy conditions to be attached to any aid programme, refusing to consider cutting pensions, a key drag on Spanish finances.
If Spain tries to tough it out, its risk premium over safe-haven German bonds could spike again as investors take fright.
Buyer of last resort
With the ECB effectively declaring itself a buyer of last resort for troubled governments' debt, provided they maintain fiscal discipline and implement economic reforms, predictions of a euro zone breakup have become less imminent.
Even New York University economist Nouriel Roubini, who has called the euro crisis a "slow motion trainwreck", said the ECB had bought politicians time to fix the euro's design faults.
Indeed the prophets of doom are now to be found more among the guardians of German central banking orthodoxy, who fear the bailout strategy will lead to moral hazard, loose fiscal policy, inflation and eventually a collapse of the euro, than among Anglo-Saxon critics of the single currency.
"We will get a liability union which will change the character of the monetary union towards an Italian-style monetary union. It will have parallels with the Italy of the 1970s and 1980s," said Joerg Kraemer, chief economist at Commerzbank, reflecting the jaundiced view of many in Germany's conservative financial establishment.
The Bundesbank, Germany's respected central bank, was isolated in opposing the ECB bond-buying decision, and its criticism was widely echoed in the German media.
Yet one of the lessons of the last week is that strident critics have failed to sway either Chancellor Angela Merkel, who has firmly backed the ECB, or the constitutional court judges, who are Germany's most respected watchdogs.
Indeed, the pro-European consensus in Berlin's political establishment seems to be strengthening, despite shrill warnings from Merkel's Bavarian sister party, the Christian Social Union, which fears voter retribution in next year's state elections.
The opposition Social Democrats and Greens support closer EU fiscal and economic union, including the eventual issuance of common euro zone bonds, giving Merkel potential alternative coalition partners after next year's German general election.
That may have emboldened usually cautious European Commission President Jose Manuel Barroso to call in his State of the Union address for a more far-reaching pooling of sovereignty to move towards a "democratic federation of nation states".
Yet there is little public appetite for deeper political integration in many countries, including France and the Netherlands which voted against a European constitution in 2005 referendums.
Other obstacles to a smooth resolution of the euro zone crisis include Greece's serial failure to meet its fiscal and economic reform targets, although there is no sign of the EU or the IMF preparing to pull the plug on Athens, and financial troubles among euro zone minnows Cyprus and Slovenia.
Economists are also worried that France, the euro zone's number two economy and a crucial contributor to the rescue fund, is failing to cut public spending or embark on structural economic reforms under way elsewhere in the euro zone.
For the moment, Paris remains a relative safe haven with record low borrowing costs, even though its public debt is nudging 90 percent of gross domestic product. But market sentiment can shift fast, as Spain and Italy have experienced.
Uncertainty shrouds Italy's prospects. Technocratic Prime Minister Mario Monti's term expires next April and a general election may produce political gridlock or a weak government unable or unwilling to pursue his reform course.
It is also unclear whether ECB support for Spain, assuming it requests assistance, will be enough to keep Italy's borrowing costs under control without Rome having to apply for a programme of its own.
"The euro crisis is not over yet. It comes in waves. Grave risks are still ahead," said Holger Schmieding, chief economist at Berenberg Bank.
"But between them, the German government, the German court and the ECB have over the last six weeks made it even more likely than before that future waves of turmoil will be less vicious than the ones before." – Reuters