Europe Plays ‘Let’s Make a Deal’
06/26/2012 9:00 am EST
This week’s European summit could be the last gasp for the euro. We will undoubtedly see a deal—but the question is whether it will be strong enough to save the euro, writes MoneyShow’s Jim Jubak, also of Jubak’s Picks.
This week’s summit of European leaders is the last real chance to save the euro.
If this summit fails to produce a credible long-term plan for fiscal union, effective short-term policies to reduce interest rates in Italy and Spain, and at least hope for increased economic growth, then I think the momentum toward dissolution of the common currency will be irresistible.
The result won’t end the euro tomorrow, or even necessarily this year. 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 Thursday and Friday reverses the current course.
And I’m not optimistic about that. In its current form—after two years of promises, halfway efforts, and astonishing denial—I think the euro is cooked. Stick a fork in it.
Politics vs. the Euro
Why am I so pessimistic? In what has always been a political crisis, the euro has almost 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—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 only one direction, and that is toward the end of the euro.
The politics have taken a decided turn for the worse in countries such as Greece and Spain, which are at the heart of the Eurozone financial crisis.
At this week’s summit, Greece will ask for more time to meet the terms of its bailout deal. According to a draft proposal, the newly elected coalition headed by the New Democracy Party will ask for a two-year extension; an end to plans to cut 150,000 government jobs; reductions in required sales taxes on cafÃ©s, bars, and restaurants; and an increase in the income threshold that triggers higher taxes.
Think about the significance of the Greek request for the other countries facing austerity requirements. If Greece gets a break, why shouldn’t Portugal or Ireland? Any concessions to Greece will be hard to deny those two countries that have, by objective measures, tried harder to meet the terms of their bailout bargains.
But we should 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 in 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 will easily reach its budget target for 2012.
Unfortunately, that will leave Ireland looking at many more 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 gross domestic product. And, of course, that 8.6%-of-GDP budget deficit isn’t the end of austerity; it’s merely a signpost on the road of pain.
The big danger that looms is that the governments of Spain and Italy will lose so much political support that they won’t be able to implement promised austerity and necessary economic reforms.
The government of Mario Monti in Italy, indeed, seems headed 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 else they will be forced from power. And any likely replacement governments will be weaker—and therefore less able to deliver on austerity and reform promises—and will be likely 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 Eurozone debt crisis.
Favoring the Deutsche Mark
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 deutsche mark 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 German economy derives a considerable benefit from pricing exports using a weaker euro rather 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 have 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 plays into an increase in political sentiment against the euro and in favor of the deutsche mark.
The debate over the Greek request for more time and better terms, even if the Greek plan is shot down (and I expect it will be), feeds right into the political narrative in Germany. A significant number of German voters, evidence or no evidence, see the southern European countries as the home of lazy freeloaders who don’t work very hard (and then retire at 45).
Problems Deepen with Recession
Even German voters who don’t feel this way are likely to be dismayed when Greece, Portugal, Spain, France, and Italy all miss their budget deficit targets this year. And that is all but inevitable, since the Eurozone countries are all in or sinking toward recession.
Slower economic growth means 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 throwing good money after bad. If the austerity economies are 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 billions more 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 than to put billions more into rescue plans that are doomed—and will leave Germany 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 key to any solution, and if important German institutions weren’t opposed to the aggressive moves that are needed to save the euro. But Germany has the financial firepower to make the difference in the crisis.
The Bundesbank, Germany’s central bank, has opposed actions including the purchase of Italian and Spanish debt in the secondary markets, the European Central Bank’s decision to open a huge lending facility for European banks, and recent suggestions to use that European Financial Stability Facility to directly capitalize Spanish banks.
Politicians in the opposition—but also and more critically, inside Chancellor Angela 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, Merkel sounds increasingly as if she fears sentiment among German voters could quite easily turn against her.
There’s a Deal to Be Made
I know I sound pessimistic, but I’m not without hope. There is a deal out there that could put brakes on the momentum now pushing toward a breakup of the Eurozone.
It’s a potential deal that’s been on the table for months. That is one thing that worries me: If the Eurozone hasn’t seized on this potential escape before now, why be hopeful about the likelihood that European leaders will do it now?
The broad outlines of such a deal would trade a long-term path toward greater Eurozone integration—the German goal—for convincing short-term measures directed at increasing growth and putting Eurozone-wide guarantees behind bank deposits.
A clearly articulated path toward integration—Merkel has proposed something like this in her ten-year plan—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 be shut down.)
The measures would have to include something like the fiscal-discipline pact that seems to be moving toward approval. It would also include some limited kind of eurobond, perhaps along the lines of proposals for bonds that would finance the "excess" debt of countries working to reduce their budget deficits. (This is the carrot to balance the sticks.)
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 plan 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.
At the least, the package would need to include the targeted European investment bonds proposed by France’s FranÃ§ois 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 a 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 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 also be part of the package.)
Consider this my checklist for judging what comes out of the European summit later this week.
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 the Asian 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.
But if the package announced by the summit doesn’t measure up reasonably well against the standards I’ve outlined, 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.