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Political stubbornness could spell end of euro
By Jim Power
Market conditions in the eurozone continue to be characterised by weakness, volatility and intense uncertainty.
The dreadful plight of the Spanish banking system is the immediate concern this week, but the Greek situation is continuing to bubble away in the background.The euro fell to its lowest level in over two years against the dollar this week and European equity markets are taking a real hammering. The weaker euro is obviously good news for exports from the eurozone, but the weakness is being fuelled by intense uncertainties in the zone and the future of the currency project is still sitting on a precipice. Reflecting this intense state of nervousness, bond yields in what are regarded as the safer sovereign bond markets have fallen to ridiculously low levels.
For example, 5-year bond yields have fallen to 0.37% in Germany, 0.26% in Denmark and are slightly negative in Switzerland. If one assumes that inflation is likely to average around 2% per annum in those countries over the next five years, then investors are prepared to accept substantially negative real returns in those markets in return for a lack of currency and default risk.
This is a truly bizarre situation and is indicative of just how dysfunctional markets have become in the eurozone, and with good reason.
The economic and financial problems are mounting by the day and yet the political leadership is behaving like a rabbit stuck in the headlights. On Wednesday, the EU Commission issued the results of its latest in-depth review of the member states and issued some very mixed messages.
At one level, it suggests that good progress is being made in rebalancing the European economy and in sorting out public finances and other imbalances. It believes that its policies are contributing to this improvement, but warns that efforts need to be redoubled to move faster and further.
It is recommending that a closer integration in the euro countries is required in areas such as cross-border crisis management and burden sharing to move towards a “banking union”. It suggests the links between banks and sovereigns be severed and direct recapitalisation of banks by the yet to be formed, European Stability Mechanism (ESM) might be envisaged. From Ireland’s perspective, the latter suggestion rings very hollow.
The whole approach towards the banks in Ireland has been based on linking bank debt and sovereign debt in a very explicit manner. The powers that be in Europe have opposed any change to this situation in Ireland at every step of the way and life for the Irish Government and more importantly the Irish economy has been seriously complicated by this state of affairs.
Thanks to the Spanish banking crisis coming to the fore in recent weeks, there appears to be recognition at EU leadership level, that Spain should not be forced to turn its bank debt into sovereign debt. One assumes that if the Spanish get such treatment, then Ireland will have to retrospectively get the same treatment.
The powers that be will have to recognise the current policy is placing an unbearable burden on the Irish economy. They will also have to realise that the euro area is as strong or as weak as its weakest member, and so every attempt will have to be made to ease the burden on the most vulnerable economies and get meaningful growth moving again. If this approach is not faced up to, due to political stubbornness, then they will have to face up to the reality that the most seriously affected economies will find it impossible to remain part of the currency union.
The EU Commission appears, at last, to recognise this reality, and, hopefully, this will represent a turning point in the general political approach to the crisis that is engulfing the eurozone. We must hope sanity rather than ideological orthodoxy wins out at the end of the day.
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