Europe ’s Best-Case Scenario

03/01/2012 9:15 am EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

If Germany is forced to put more of its money on the line, it might start caring about the economic toll of austerity, writes senior editor Igor Greenwald.

Plop. That was an extra €530 billion leaping into the global liquidity pool, courtesy of the European Central Bank and its offer of super-cheap three-year loans, taken up this time by 800 needy European banks.

The amount dispensed was only slightly larger than the first such liquidity injection in December, which coincided (perhaps not so coincidentally) with the start of the global equity rally still with us today.

As of now, no further booster shots are scheduled. All that’s left now is to see how much the medicine will dull austerity’s self-inflicted pain.

So far so good: the euro dipped from the vicinity of an eight-week high, but that might have also been because Federal Reserve Chairman Ben Bernanke acknowledged the recent pickup in US employment in congressional testimony.

Gold prices fell, and whether you’d care to credit Bernanke or blame concerns about global liquidity now that the ECB is on hold, that’s hardly a sign of impending apocalypse. Italian and Spanish long-term yields slipped as well, pointing to the likelihood that at least some of the proceeds from the ECB refinancing will be reinvested in sovereign debt.

The rest will almost certainly be earmarked on propping up shaky bank balance sheets, leaving many would-be borrowers out of luck.

Meanwhile, as the European recession grinds on, austerity’s twisted logic dictates that governments keep slashing spending just to offset the shortfalls in revenue caused by previous budget cutting, a vicious circle that has now ensnared Spain.

The good news is that Spain isn’t Greece, and can’t simply be written off as a backsliding basket case, like Greece. The conservative Spanish government has made genuine cuts, and Spain’s economic struggles have more to do with a real-estate bubble (inflated by the ill-fated monetary union) than any history of government profligacy.

Spain can’t simply be forced into a depression like Greece—that would do too much collateral damage to the European economy.

It’s also no longer 2010. The official European doctrine that austerity will rebuild confidence has had two years to show that it’s not working. The facts on the ground have weakened the position of austerity’s proponents. At some point, even Germany might realize that austerity is actually undermining the budget discipline it craves.

At last weekend’s summit of G20 ministers in Mexico, Germany sought increased support for Europe via the International Monetary Fund. It was not so politely told that Europe should help itself first by increasing the size of its new financial backstop.

US Treasury Secretary Timothy Geithner demanded “a stronger and more credible firewall.” His UK counterpart George Osborne said the world wanted “to see the color of their money” before contributing their own.

It’s possible that once Germany puts more of its money on the line, it will become less willing to force the economies it’s backing to self-destruct in exchange for the assistance. That would constitute genuine progress.

And common sense suggests that common sense will win out, eventually.

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