After shooting itself in both feet, EuroZone aims a gun at its own head

07/18/2011 4:57 pm EST


Jim Jubak

Founder and Editor,

Huge progress on the euro debt crisis this weekend. German Chancellor Angela Merkel and European Central Bank head Jean-Claude Trichet dug in their heels on apparently irreconcilable positions inching the monetary union closer to total political failure.

That’s one way, I guess, to end the lingering euro debt crisis.

Merkel, who has repeatedly said that bondholders must share the pain in any new Greek rescue plan, repeated her call for bondholders to share the pain in any new Greek rescue plan.

Trichet, who has repeatedly said that the European Central Bank won’t participate in any mandatory or voluntary plan that stipulated that bondholders take losses or extend the maturities of the debt they held, repeated his position that the bank would not accept any defaulted Greek bonds as collateral. Ratings companies such as Moody’s Investor’s Service have said they would regard even a voluntary plan to extend the maturities of Greek government bonds as a default. “The governments would then have to step in to put things right,” Trichet said in an interview with the German edition of the Financial Times.  (Don’t think the placement of that interview wasn’t intentional: Take that Angela.)  Which, of course, is exactly what Merkel’s government refuses to do.

On Thursday EuroZone leaders are scheduled to begin a summit that’s supposed to produce a new Greek bailout package. Merkel has indicated that she may not attend unless there’s a good chance of an actual agreement.

It’s not at all clear to me that a rescue package for Greece would now end the crisis. By dithering in disagreement for weeks, European political and financial leaders have let the crisis move far ahead of their discussions. Last week Italy, which has a lower budget deficit as a percentage of GDP than France, was dragged into the morass when yields on Italian government bonds popped above 6%.

With the expansion to Italy, the crisis has moved from the peripheral economies of Portugal, Ireland, and Greece, to the center of the EuroZone. And the steep climb in Italian yields is an indication that financial markets have begun to focus on the need for a more far-reaching restructuring of the euro system. If Italy doesn’t grow by at least 2%--and its economy is growing by just 1%--then the country can’t afford to pay current high interest rates. Austerity packages aren’t going to fix that problem. (They might even make it worse by slowing economic growth.) Italy needs either a way to grow faster—by leaving the euro and devaluing a revived lira—or to pay lower interest rates—by financing some of its debt through EuroZone bonds.

Neither of those items, as far as I can tell, is on the agenda for the upcoming summit. European leaders seem to still believe that they can “solve” the crisis by kicking the Greek debt problem down the road into 2014. After the crisis spread to Italy last week that cynical approach has been superseded by events.

I think this all means that any relief rally from a new Greek debt package is likely to be short-lived. The summit could indeed produce nothing and, with Greece able to finance its debts through mid-August at least thanks to a $17 billion payment from the first rescue package, the stalemate could extend into September. That will keep pressure on the euro—especially if the U.S. government comes up with its own Potemkin village scheme to raise the debt ceiling—against the U.S. dollar. A rising dollar isn’t good for the prices of commodities such as oil and copper. A continued euro crisis, though, would be good for gold and silver—especially if Standard & Poor’s and other ratings companies review a U.S. debt ceiling deal and find it a sham.

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