Analysis: Euro zone advancing through obstacle course

PARIS Wed Sep 12, 2012 3:08pm EDT

A Euro currency sign is seen in front of the European Central Bank (ECB) headquarters in Frankfurt September 6, 2012. REUTERS/Alex Domanski

A Euro currency sign is seen in front of the European Central Bank (ECB) headquarters in Frankfurt September 6, 2012.

Credit: Reuters/Alex Domanski

PARIS (Reuters) - Europe has cleared more key obstacles on the road to containing its sovereign debt crisis and stabilizing the euro zone after Germany's constitutional court allowed a permanent bailout fund to go ahead.

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, political risks still lurk on the path 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 program, and has just been granted an extra year to achieve its fiscal targets.

"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 told Reuters.

He cited last week's ECB decision as well as the proposed banking union, the German court ruling and expectations of a pro-European result in Wednesday's Dutch general election.

"If we get the next few weeks right we'll have turned a corner," Stubb said in a television interview.

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 strong pressure to apply for a limited assistance program 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 October 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 rescue program, refusing to even 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.

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 trouble 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, 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 also shrouds Italy's position. 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 applies for a assistance, will be enough to keep Italy's borrowing costs under control without Rome having to apply for a program 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 Berenburg 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."

(Additional reporting by Ritsuko Ando in Helsinki,; Writing by Paul Taylor)

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Comments (1)
dareconomics wrote:
Analysis: Euro zone advancing through obstacle course | Reuters.

This is typical mainstream media analysis of the eurocrisis. It is long on spin and short on facts and numbers.

The actions recently taken by Europe are mere window dressing. Dramatic reforms are necessary. The writer at least gets that much,

…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.

This is the whole problem in a nutshell. Europe cannot afford its present lifestyle. The failing states need to make dramatic budget cuts, and they need to remove all of the red tape that profits a few at the expense of the many.

Whenever a government starts makings these changes, it gets voted out of office. Since the onset of the eurocrisis, not one government has succeeded in winning elections. The opposition has taken power in each case. It doesn’t matter if the country is basket case Greece or supposedly rich France.

The article points out that Ireland is inching its way back to the capital markets and Portugal has continued to implement a ruinous austerity program. So what? Each country is still in the midst of a depression with unemployment touching 15%.

The article then uses a couple of quotes from the Finnish finance minister to show that things are looking up. The Finnish finance minister is a politician, and politicians love to spin things and take the credit.

What was he going to say? Could you imagine,

The Finnish Finance Minister was quoted as saying that with demographic pressures and uncompetitive economies, it looks like the rich, Northern countries are entering a de facto fiscal union with the poorer Southern one.

During a recent interview, he said, “It looks like Finnish taxpayers will be footing the bill for the PIIGS indefinitely. Please make sure you vote Stubbs in the next election.”

Then, good news is made of the fact that Rajoy is maybe sort of considering a bailout. How is it good news that the fourth largest Eurozone economy needs to be bailed out? Spain is in a lot of trouble. Its bailout has the potential of sopping up the resources of the ECB and ESM all by itself:

http://dareconomics.wordpress.com/2012/09/06/actual-spanish-financing-needs/

http://dareconomics.wordpress.com/2012/09/08/actual-spanish-financing-needs-part-2/

This is my favorite line from the article:

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 conclusion of market euphoria is incorrect. It does not show that many investors believe that the eurozone is finally starting to get on top of the crisis. It means that investors think that they can make money buying stuff and selling it later. That’s it.

The problem with all of these articles that talk about saving the euro is that the euro is the problem for the PIIGS. A country with its own currency would have been well on the way to a sustained recovery by now. Check out what happened in Iceland and Argentina over the last few years.

Once you make the assumption that the euro should be saved, your analysis is already incorrect. The politicians of Spain, Italy, Portugal, Greece and Ireland should stop trying to save the euro and start trying to save their own countries. A good start would be readopting a national currency.

Sep 12, 2012 4:30pm EDT  --  Report as abuse
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