Tuesday, July 3, 2012

"Europe – A Band-Aid, Not a Panacea”

Sydney M. Williams

Thought of the Day
"Europe – A Band-Aid, Not a Panacea”
July 3, 2012

An editorial in Saturday’s Financial Times stated, cautiously but optimistically, that last week’s meeting in Brussels “may not have resulted in a false dawn.” However, they also added that the test will be whether last week’s European Council “could forge a political agreement to use the policy tools that exist to stabilize the eurozone’s financial markets.” Good luck with that!

There is an irony in that the market breathed a sigh of relief when Angela Merkel appeared to blink, when it has been she who has presided over the fiscally most responsible of the major Eurozone countries.

While I profess no expertise in European matters, it strikes me that the statement implying that direct loans of about €100 billion to Spanish banks by the European Central Bank (ECB) will not increase sovereign debt are as disingenuous as those that frequently emanate from Washington. It is true that the Spanish government will not be the intermediary, and so theoretically not responsible for the loans. Nevertheless, on its face, the comment is a fallacy, for who provides funding to the ECB, or the European Stability Mechanism (ESM) other than sovereign nations? Regardless, a sovereign nation may let one or two smaller banks fail, but can they afford to let their bigger banks collapse? Digby Larner, writing in Barron’s, quotes Gustavo Bagattini, European economist for RBC Capital Markets: “The key problem remains the unanswered question: From where does the money come?”

The proposal apparently requires that any recapitalization of struggling banks through the European Stability Mechanism be supervised by an independent control authority, an office yet to be created. That would be a positive, but it remains to be seen if that happens and it is unknown what power the supervisor will have. In a concession to existing bondholders, the new loans will not be considered senior to existing bonds.

The leaders also agreed on a €120 billion “growth pact” package and “closer fiscal and economic cooperation.” A “growth pact”, in ‘Europeanese’, means increased government spending, which most governments cannot afford, and the words “closer fiscal and economic cooperation” are ones we have been hearing for years. In fact, it seems to me that, instead of breaking “the vicious cycle” of a convergence of banking and sovereign debt, as many have suggested, the cycle continues.

It sounds like the can has been kicked farther down the road. Guy Verhofstadt, former Belgian Prime Minister and now leader of the Liberals in the European Parliament had this to say: “Together with the growth measures decided at the summit, this should buy us several months, months we need to use to really tackle the crisis by establishing a fiscal union and by mutualizing debt.” A fiscal union would be a good thing, assuming it is politically feasible, but mutualizing debt implies a return to open-checkbook politics – an unlikely eventuality, as it is something Germany’s Angela Merkel has vehemently opposed.

François Hollande, Socialist President of France, joined President Mariano Rajoy of Spain and Italian President Mario Monti in lining up against Angela Merkel. Germany has a lot at stake. As the largest and wealthiest country in Europe, Germany is now facing fading optimism, weakening manufacturing and declining retail sales. Germany has to worry about Germany.

The FT opines that the European problem was a consequence of “reckless private lending from surplus countries to reckless borrowers in the periphery.” All of that may be true, but I would suggest that those activities only facilitated what was (and is) the real problem – spending and promising what you do not have and cannot reasonably provide. There was nothing that I read that would suggest putting a governor on reckless spending. The bleeding has been temporarily stemmed, but the wound has not healed. For example, Didier Migaud, who heads the audit body in France where government spending represents 56% of GDP, suggests the country needs to find €43 billion in savings – about 3.6% of their 2012 budget. (The deficit this year is expected to be about 7% of this year’s budget.) President Hollande of France has suggested that he will try to close his country’s budget gap, not by reducing services, but by raising taxes on the wealthy. In other words, ideology again trumps practical economics.

Perhaps skepticism colors what I consider my disinterestedness in this issue. Perhaps Europe will solve its problems with little pain. Perhaps the FT will prove prescient when they conclude their editorial: “But the steps taken this week show that pessimism may be overdone. Perhaps it could one day be morning in Europe again.” I don’t know. Someday morning will return to Europe, but I suspect it will arrive in a revolutionary whirl, accompanied by a Margaret Thatcher or a Ronald Reagan, not a François Hollande, a Mariano Rajoy, a Mario Monti, or even an Angela Merkel.

Nevertheless, European stock and bond markets rallied enthusiastically on Friday and again on Monday. However, I suspect the jury is still out on the Continent’s emergence from the problems that confront them – problems many Europeans have yet to admit. A panacea cannot be applied if the disease has not been acknowledged.

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Before you head off for what is America’s greatest holiday, read the piece in yesterday’s Wall Street Journal by David Gelernter, professor of computer science at Yale. His op-ed is entitled “What is the American Creed?” Professor Gelernter writes, “We should always be marching toward the American ideals of freedom, equality and democracy, as we did when we ended slavery, granted women the right to vote and finally buried Jim Crow.” The Fourth of July is a time to reflect on the principles on which this nation was founded, and those simple words – freedom, equality, democracy – words which are easy to say, yet often difficult to honor. They represent the goals toward which we should always strive, individually and as a nation. Happy Fourth!

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