Published in Business Spectator (Melbourne), 27 September 2012
After three years of the euro crisis, it is surprising how announcements still impress markets. The approval of the European Stability Mechanism by the German constitutional court and the plans of the European Central Bank to purchase unlimited quantities of government debt were enough to calm the markets and reduce yields on euro periphery debt. Some commentators are even wondering whether the euro crisis could be over by the end of the year.
The cautious optimism is surprising because we have been here before – not once but several times. In the past three years, there have been many such moments when the worst appeared to be over, when nerves were calmed and some observers thought they spotted green shoots. And then the crisis re-emerged elsewhere, usually more severely.
So is this time different? Can the combined firepower of the ESM and the ECB overcome the crisis and lead Europe onto a path of economic recovery? Or are we just witnessing another retarding moment before the next escalation?
It helps to ask what has actually materially changed since market sentiment turned. Only if the possibility of future ESM/ECB interventions substantially improved the situation would there be reason for optimism.
Unfortunately, the types of interventions signalled are only enough to buy more time and delay the inevitable. The underlying problems of monetary union remain untouched while signs of new crises abound.
For a start, the ECB/ESM interventions are highly unlikely to correct the balance of payments problems which show in central banks’ Target 2 positions. Last month, the Bundesbank’s claims against the rest of the eurozone exceeded €751 billion – up €24 billion from the previous month. As long as capital is fleeing from the euro periphery while trade deficits remain stubbornly high in the crisis countries, this problem will get worse. Bailing out governments via the ECB or the ESM does nothing to correct these payments and trade imbalances.
Then there is the Greek problem. The country is still small; its public debt is still gigantic (and growing); its economy is still collapsing; and its ‘austerity’ measures are still insufficient to put public finances on a more sustainable footing. If recent reports are to be believed, Greece is not fulfilling its obligations and will need, according to some estimates, up to €30 billion bailout money soon to avoid yet another default. Neither the ECB nor the ESM will be able to do much about any of that.
The ECB cannot just buy Greek government debt or it will lose face. After all, ECB president Mario Draghi promised money only in return for successful austerity policies. Yet nobody pretends that Greece is succeeding on this front. Clearly Greece will eventually need another formal bailout package, the country’s third in as many years. Equally clearly, there is not the slightest political will to provide this.
Greece is not the only persistent worry for European policymakers. Portugal, for a long time presented as a role model for economic reforms, looks shakier than ever.
True, the government of Prime Minister Pedro Passos Coelho has been one of the most reform-minded in the eurozone, no one can complain they haven’t tried hard enough. However, the Portuguese people have started to revolt against their government’s latest measures, forcing Passos Coelho into a humiliating U-turn over their planned Social Security tax increases.
If not even Portugal’s austerity measures can be relied upon, what are the chances that Spain and Italy will stay the course? It is far more likely that Portugal will be the next Greece as its public debt ratio is on course to rival that of Greece.
Then there is another small complication in Europe’s rescue policies: the ESM itself. It may be able to deploy the gigantic amount of €500 billion (although it first has to borrow most of this in capital markets). But even this sum is not enough to bail out countries the size of Spain, let alone Italy.
In essence, the Europeans are contemplating a crisis ‘solution’ to this problem which was previously tried under the ESM’s predecessor, the EFSF: leverage. By some financial alchemy, €500 billion might be turned into up to €2 trillion. This would require the ESM to raise even more money in capital markets, a feat the EFSF never managed. In other words, the leveraging plans for the ESM appear dead on arrival, leaving the ESM too small to do what was intended for it.
And just when it seemed news couldn’t get much worse, Germany’s economy is stuttering. September’s Ifo business confidence index unexpectedly fell for a fifth consecutive month.
There is now a question mark over whether the German economy will return to growth in the near future and leave its current period of stagnation behind. Needless to say that any deterioration in Germany’s economic performance leaves the whole edifice of eurozone bailout measures looking fragile.
The problems mentioned above are just some of the issues facing Europe today. But there are plenty of problems to add to the list: The increasingly eurosceptic stance of Finland; the stalled economic reform process in Italy; the erratic policy announcements of Spanish Prime Minister Mariano Rajoy. There is no shortage of problems in Europe with the potential to derail the eurozone and lead to a new stage of the crisis.
We are where we have constantly been in past three years: in a moment of deceptive tranquillity. It may take markets a little longer to examine the combined ESM/ECB measures, but they will find out soon enough that little has been solved. Crisis countries are still in a situation which does not allow them to recover and grow their economies.
The euro remains a zombie currency which condemns half of Europe to prolonged misery while locking the other half into a liability union it never signed up for. And with the ECB actively joining the currency debasement race, the euro also becomes more dangerous for global monetary stability.
Under all of these circumstances, how could anyone conclude that the crisis was more or less under control and that the worst might be over?