The trouble with the Euro Zone is that the plan is a long term restructuring program with very few measures to help ease the pain in the short term. But as we all know, “We’re all dead in the long run.”
In the long run, the EZ will be much better structured as every time the crisis crescendos to the brink, the German’s agree to edge closer towards what needs to be done. The SPD, Germany’s main opposition, are more pro euro than Merkel and have a good chance of winning next year’s election. There’s a by-election in May in Germany’s biggest state and this could help push Merkel towards a more pro Euro stance if her coalition partners do badly and the SPD do well.
The decision to save the Euro has been delayed for the last couple of years because it is so unpalatable to the Germans. They do not want to be on the line for the rest of Europe’s mistakes and, therefore, Eurobonds and a central eurozone finance ministry have been dismissed. But when push comes to shove and the ground beneath the euro looks ominously unstable, the euro powers have converged towards a closer Euro, not a more disintegrated one. This will be the path that follows. Europe’s leaders have a high pain threshold and will not be forced into doing things they don’t want to do unless a gun is pointed at their heads. The euro crisis gun is reloading and eventually greater integration will follow.
I’m worried that too much austerity is driving the eurozone into a negative growth spiral and this is the biggest danger. If you have no growth, you can’t reduce your debt. Low interest rates are not sufficiently offsetting the fiscal tightening. But there are signs of hope. Ireland is doing a great job and is still growing. Spain’s exports are doing well and its competitiveness and productivity is very good compared with Germany. One of the reasons for such high unemployment is because its productivity is so good. But Spain’s problem is the housing market and how the rising number of dodgy loans has weakened the banking sector. France is a mess, resolute in the belief that it is different to all other countries and that its big, statist economy can continue to perform without undergoing reform.
Much is being done to deliver growth in future years in countries such as Spain, Italy, Portugal and even Greece, with labour market reforms while restructuring the big, overweight state-owned enterprises which have acted as a brake on the economy for years in Portugal, are an important part of the plan. But these reforms take time to take effect and there is very little being done to ease the pain as wages are squeezed to make these countries more competitive i.e. the internal devaluation.
In five years time I’m convinced these countries will be growing much more strongly but the question is will the Euro still be there. I think yes because it is too important and significant for German and French politicians to give up on. The peripheral countries want to stay part of the Euro still despite the tough measures being handed out because they realise that outside the euro, things would be much tougher. The Greeks have almost no exposure to the markets now and although another bailout is most likely, it’s not anything for the market to panic about. The Portuguese will need another bailout of about EUR30billion probably agreed sometime in the next 6 months. Portugal is due to return to the bond market in September 2013, at this point it’s unlikely this will happen because market rates will still be too high. But that’s only EUR8 billion so not much in the big picture, easily covered by the EC.
The core problems of the Euro are still there, i.e. no central ministry of finance but programs such as the European Stability Mechanism are bringing this closer. The IMF are telling Germany that eurobonds are needed. Will they listen? Unlikely but step by step we will get there.
It’s not a great time to be holding this Euro survival view at the moment with Spanish and Italian bonds selling off recently but these yields won’t go above 7%. The ECB made sure of that before Christmas and if nothing was done to support them at these levels then they would be wasting all the previous good work.
As I said in my earlier post ECB’s Rate Cut And Liquidity Analgesic, the LTROs acted like analgesics, taking the pain out of the crisis, easing the widening interbank rates allowing banks to finance themselves at more normal levels. They entered in carry trades on higher yielding Italian and Spanish bonds but unlike QE where new cash keeps coming month after month, the market was hit by a wall of money and the momentum has been lost, not helped by the German’s inability to agree to a bigger, more suitable firewall. A lot of what goes in the market is about maintaining the momentum but momentum has run out and has begun to go the other way until the policymakers again decide to take control of the situation and push momentum in the right direction.