Every time the eurozone holds a summit, markets become optimistic that “this time – finally – leaders will manufacture a solution to the debt crisis”, says The Economist. Then they realise that nothing has really changed. By Monday, optimism over last Friday’s accord had dwindled. Italian and Spanish government bond yields rose again (reflecting falling prices) and stocks tumbled.
The flurry of ideas, along with the fuss over Britain’s veto obscured the basic problem: the summit won’t stop investors asking whether euro area governments are going to default on their debt, says Karen Olney of investment bank UBS. The summit’s centrepiece was the Merkel-Sarkozy plan to improve the eurozone’s fiscal discipline. Governments will limit themselves to budget deficits of 3% of GDP or face automatic sanctions. There will be stricter surveillance of national policymaking at the European level.
No real progress on fiscal union
But this ‘fiscal compact’ doesn’t amount to anything, says FxPro.com. It falls “far short of what the Germans wanted, namely an EC veto on unacceptable national budgets”. Without truly strong external oversight, “eurozone governments will always do what their national electorates want, rather than following Brussels”, says Liam Halligan in The Sunday Telegraph. That’s what happened to the Stability and Growth Pact, a collection of similar proposals to ensure fiscal discipline at the time of the euro’s inception. Moreover, that was in a growth environment. So the new measures are unlikely even to prevent a future crisis and do nothing to fix the current one.
Markets had hoped for “a degree of common tax or spending… undertaken by something akin to a eurozone Treasury”, says FxPro.com. The Treasury would eventually issue joint eurozone bonds. In short, fiscal union, with the core subsidising the south. However, fiscal union is being resisted in the core. The other potential game-changer in this crisis – the European Central Bank (ECB) printing money and buying enough peripheral bonds to keep yields at affordable levels for indebted states – has been vetoed by Germany.
At least the ECB has substantially reduced “the possibility of a Lehman moment”, says Jacob Kirkegaard of the Peterson Institute for International Economics, a research body. The bank has tried to ensure that funding doesn’t suddenly dry up in the wholesale market by extending unlimited credit to banks for up to three years and allowing them to borrow against a wider range of collateral. But banks are still obliged to improve their capital ratios, which implies that they are shrinking their balance sheets and reducing lending. So the credit squeeze that has helped send Europe into recession isn’t over.
What about the rescue fund?
Hopes that the eurozone’s rescue fund, the European Financial Stability Facility (EFSF), could muster enough cash to end the crisis by funding Italy and Spain look unlikely to be fulfilled. There is little money in the EFSF, and plans to leverage it have become bogged down. The basic problem, says Halligan, is that nobody is likely to lend money “to an entity with no obvious income stream”.
The EFSF’s planned permanent replacement, the European Stability Mechanism (ESM), is now being brought forward to July 2012. It is supposed to wield €500bn, though again it’s hard to see who in Europe is in a position to fund it. In the meantime, a plan for eurozone central banks to give the International Monetary Fund a mere €200bn, which could then lend it to member states, has run into German objections. The bottom line: Europe’s “financial fire wall” remains “inadequate”, says Richard Barley in The Wall Street Journal.
With no real progress made last week, the chances are that “the crisis will continue at varying levels of intensity throughout 2012”, ratings agency Fitch has warned. With a bit of luck, reckons Barley, “the situation may hold until Christmas”.