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The euro has run out of time; the political tides say it's produce a fix at this week's summit or the common currency is done
06/26/2012 8:30 am EST
If this summit fails to produce 1) a credible long-term plan for fiscal union AND 2) effective short-term policies to reduce interest rates in Italy and Spain and to, at least, create the hope of increased economic growth, then I think the momentum towards a dissolution of the common currency will be resistible.
The result won’t be an end to the euro tomorrow or even necessarily in 2012. Given the costs of ending the euro, I expect any path toward the end of the currency to be long and messy. The euro won’t go easily. But kicking and screaming, it will go unless the summit scheduled for June 28 and 29 reverses the current course.
And I’m not optimistic about that. On current form—after two years of promises, halfway efforts, and astonishing denial—I think the euro is cooked. Stick a fork in it.
Why am I so pessimistic now? In what has always been a political crisis, the euro has run out of political room. I think there’s just enough space for one more try—but if this attempt at the European summit doesn't work, I think the euro is out of time. Politics from both ends of the crisis—in both the weak economies of the periphery and the strong economies of the center—will soon have built enough momentum that this crisis will be able to move in just one direction and that is toward the end of the euro.
The politics of this crisis have take a decided turn for the worse in countries like Greece and Spain that are at the heart of the financial crisis of the euro.
At this week’s summit Greece will ask for more time to meet the terms of its bailout deal. (That is if any Greek leader will be healthy enough to attend.) According to a draft proposal, the newly elected coalition headed by the New Democracy Party will ask for a two-year extension, for an end of plans to cut 150,000 government jobs, for reductions in sales taxes on cafes, bars and restaurants, and for an increase in the threshold that triggers income tax.
And think about the significance of the Greek request for the “austerity” countries besides Greece. If Greece gets a break, then why shouldn’t Portugal or Ireland? Any concessions to Greece will make it hard to deny similar measures to those two countries that have, by objective measures, tried harder than Greece to meet the terms of their bailout bargains.
But then also think about the effect on the euro crisis if European leaders don’t offer any carrot to go with the stick. The “austerity” countries are headed toward a series of political crises on the Greek model because voters can’t see any light at the end of the tunnel on a tolerable time frame. Even the good stories aren’t likely to raise anyone’s spirits. On June 19 the Irish government said that it would easily reach its budget target for 2012. Unfortunately, that will leave Ireland looking at years more of austerity before it can return to financing its borrowings in the financial markets. The 2012 budget target is, after all, a deficit of 8.6% of GDP.
And, of course, an 8.6% of GDP budget deficit isn’t the end of austerity but merely a signpost on the road of pain.
The big danger that looms is that the governments of Spain and Italy will lose enough political support so that they won’t be able to implement promised austerity and necessary economic reforms. The government of Mario Monti in Italy indeed seems headed relatively quickly in that direction—which is why, in my opinion, Monti has recently become so vocal about the need for the EuroZone to implement a bigger program aimed at increasing economic growth.
The hard-pressed governments in the “austerity” group need to show something or they will be forced from power. And any replacement government will be weaker—and therefore less able to deliver on austerity and reform promises—and will be likely, as in Greece, to have won power on the basis of promises to negotiate a better deal.
But this is only half of the deterioration in the politics of the euro debt crisis.
The politics of this crisis have taken a decided turn for the worse in the country that effectively holds the veto power right now—Germany.
A June poll for ARD public television showed that 55% of Germans want the Deutschmark back. That’s up 9 percentage points since the May survey in this poll.
I find two things disturbing about this poll.
First, despite significant evidence showing that the Germany economy derives a considerable benefit from pricing exports using a weaker euro than a stronger Deutschmark, a majority of Germans want their old currency back. In the same survey 56% of Germans say they’re worried about their savings. Weighing the advantages of the euro against the potential threat from the single currency, a majority has decided that the threat outweighs the advantages.
Second, the deteriorating politics of the “austerity” countries and their need to ask for either more time or more bailout funding as their economies contract with the EuroZone recession plays into an increase in political sentiment against the euro and in favor of the Deutschmark.
The debate over the Greek request for more time and better terms, even if the Greek plan is shot down (which I expect it will be), feeds right into the political narrative in Germany where a significant number of German voters, evidence or no evidence, see the southern European countries as the home of lazy free loaders who don’t work very hard (and then retire at 45.)
Even German voters who don’t feel this way are likely to feel stunned if Greece, Portugal, Spain, France, and Italy all miss their budget deficit targets this year. It’s just about inevitable since the EuroZone countries are all in or sinking toward recession. Slower economic growth means that budget cuts and tax increases made to date won’t reduce budget deficits as much as projected because tax revenues sink with slowing economic growth. If Germans have euro bailout fatigue now, think of the politics as this crisis drags on into 2013 and beyond. (And 2013 is an election year in Germany.)
Germans are already, justifiably, worried about the dangers of pouring good money after bad. If the “austerity” economies were going to go under anyway, the logic goes, wouldn’t it be better to let them go now rather than after Germany has sent them more billions of euros. I sense growing support for the not so easily refuted argument that it would be better to spend limited resources on an orderly wind down of the euro rather than putting more billions into rescue plans that will fail anyway—leaving the country still on the hook for further payments for dissolving the EuroZone.
Eroding German support for the euro wouldn’t matter quite so much if Germany weren't the key to any solution—only Germany has the financial firepower to make the difference in the crisis—and if important German institutions weren’t opposed to the aggressive moves that are needed to save the euro now. The Bundesbank, Germany’s central bank, has opposed everything from the purchase of Italian and Spanish debt in the secondary markets to the European Central Bank’s decision to open a huge lending facility for European banks in December and February to recent suggestions to use the European Financial Stability Facility to directly capitalize Spanish banks. Politicians in the opposition but also and more critically inside Merkel’s own coalition have succeeded in delaying Germany’s vote for the European Stability Mechanism, the permanent European bailout fund. Facing elections in 2013 and coming off a series of defeats in state elections, German Chancellor Merkel sounds increasingly like a politician boxed in by her fears that sentiment among German voters could quite easily turn against her.
I know I sound very pessimistic, but I’m not totally without hope. There is a deal out there that could brake the momentum now pushing toward a breakup of the euro. It’s a potential deal that’s been on the table for months. Which is one thing that worries me: If the EuroZone hasn’t seized on this potential escape for the euro before now, why would anyone be hopeful about the likelihood that European leaders will seize it now?
The broad outlines of such as deal would trade a long-term path toward greater EuroZone integration—the German goal, they say—for convincing short-term measures directed at increasing growth and putting EuroZone-wide guarantees behind bank deposits.
A clearly articulated path—something like Angela Merkel’s 10-year plan—toward integration would include making the European Central Bank the key regulator of all EuroZone banks. (Maybe then some of the zombie banks that national central banks have refused to shut down would get shut down.) The measures would have to include something like the fiscal discipline pact that seems to be moving toward approval. And it would also include some limited kind of Eurobond, perhaps on the lines of proposals for bonds that would finance the “excess” debt of countries working to reduce their budget deficits. (A carrot to balance the stick.) And integration would have to include some form of joint deposit insurance so that savers didn’t have an incentive to move their money out of stressed Spanish or Italian banks toward the safety of German institutions.
That wouldn’t give Merkel everything she wanted but it should be enough so that the platform could be sold to German voters as a good alternative to the current scheme of endless bailouts.
To sell this package to voters and governments in France, Spain, and Italy it would have to be joined to concrete measures to increase growth. By concrete, I mean something more than the vague promise that emerged from last week’s mini summit among Germany, France, Spain, and Italy to spend 1% of EuroZone GDP on investments in growth. (That 1% included a lot of money that as already been appropriated for growth.) At the least the package would need to include the targeted European investment bonds proposed by France’s Francois Hollande. But to be really convincing it has to go beyond that to include such measures as an interest rate cut from the European Central Bank and policies from the German government that would increase German consumer spending.
Without some two-part deal like this suggestions that the European Central Bank step in to buy Italian and Spanish debt are pretty much worthless. Unless they see a package like this, bond traders would know that they have the firepower to bet against the euro and eventually overwhelm the European Central Bank’s bond buying in the secondary market. (Some provision that would give the European bailout funds bank status so they can borrow directly from the European Central Bank should be part of the package.)
Consider this my checklist for judging what comes out of the European summit this Thursday and Friday.
Make no mistake; something will come out of that summit. The stakes are too high for European leaders not to put together something that they hope will end or postpone the crisis.
There’s the danger that the financial markets, which have become increasingly skeptical with each half-baked promise of a solution, will pass judgment on this newest plan with a sell off.
More likely, if the days before the summit continue with the kind of selling pressure that emerged on occasion last week and that markets exhibited at the start of this week, the markets will deliver a modest and not very sustained rally on the package. The hurdle for success has been set very low on this summit by last week’s meetings.
But if the package announced by the summit doesn’t measure up reasonably well against the standards I’ve outlined in this post, I’d use any rally to move more money to the sidelines or to any safe havens that I can identify.
I do think this summit is a last chance for the euro. And given the unpredictable, but I’m sure huge, consequences of the demise of that currency, I’ll be looking for as much safety as I can find if the summit fails to deliver.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did not own shares of any stock mentioned in this post as of the end of March. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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