Fate of millions relies on eurozone balancing act

THE eurozone is like an elderly relative who takes suffers “turns” from time to time, and is rather poorly as a result, but somehow lives on to celebrate another Christmas.

Over the past year, the eurozone has been scratched badly by a bear (Russo-East Ukrainian in origin) while, at times, it has looked as if key parts (such as Catalonia) could start dropping off altogether. A couple of years back, people (the financial markets) almost stopped feeding her, but then a kindly Italian called Mario held a whip-around and the eurozone got plenty of food.

From autumn 2012, the eurozone crisis abated following the pledge by European Central Bank president Mario Draghi to “do whatever it takes” to prevent a meltdown in the sovereign debt markets. Draghi has not had to follow through on his pledge, but the long-awaited recovery in the eurozone largely petered out.

The financial markets are no longer hunting the peripherals to near extinction, but unemployment, particularly in Mediterranean countries, remains at acute levels, around one quarter of the workforce in Spain and in Greece. It is no coincidence that leftist parties Syriza and Podemos have come from near nowhere to top national polls in each nation. Average unemployment across the eurozone now exceeds 11% and among the youth, it can range as high as 50% in some countries. This represents a hammer blow to skill development and consumption in rapidly ageing societies.

At a more mundane level, at the heart of the eurozone, stagnation persists. The relationship between the eurozone’s lead economy, Germany, and the reluctant followers, principally France and Italy, could best viewed as a kind of Mexican stand-off, with occasional flare ups and moments of warmth.

A key development has been the shift in the focus of the crisis away from periphery countries Greece, Portugal, Ireland, and Spain towards the financially drifting core states, France and Italy. Since 2012, sovereign yields among eurozone states have converged dramatically, with the exception of Greece. The yield on Irish 10-year money has fallen to a record low. However, unemployment remains extremely high and growth in Italy turned negative, this year. Many in the markets are concerned about the state of affairs in Italy, with national debt approaching 133% of GDP. Since February, the country has had a new prime minister, the 39-year-old Matteo Renzi, a man who sees himself as the next Tony Blair. A strange ambition perhaps, but Renzi believes his country’s labour market needs shaking up. If he were to succeed, and this were to act as a template for other states which have been slow to meet German demands for economic restructuring, it could conceivably lead to a break in the impasse between the Germans and many other eurozone states.

As a result of this impasse, along with excessive German fears of inflation, the eurozone is perched perilously on the edge of deflation, with inflation — at 0.8% — well below the 2% target set in the treaty setting up the single financial market. This undershoot has persisted for years, contributing to the malaise. The challenges Renzi faces are considerable. He is seeking to push through legislation designed to overhaul unwieldy labour laws. In late October, the trade unions brought a million people out onto the streets of Rome.

The Scottish vote to remain in the UK may have taken some momentum away from independence movements across the eurozone, but the challenge to the authority of Madrid remains. It could spill over to the bond markets and to the wider economy, threatening Spain’s real but fragile nascent recovery. While Morgan Stanley, in a recent note to investors, predicted that the real outcome of all this will be a reduction in transfer payments from Catalonia to the central government, there is still a possibility that this could spin out of control. The new Spanish king is untested, the monarchy in serious trouble. The prime minister, Mariano Rajoy, appears rigid and unyielding. Much may depend on the political skills of the Catalan regional leader, Artur Mas.

Watch out to for lawyers and judges wearing robes, particularly pernickety German ones. In March, the German federal constitutional court threw something of a curved ball in the direction of the Court of Justice. While the court ruled that the eurozone crisis fund was legal, it did so with deep misgivings. Their concern is that the €700bn European Stability Mechanism fund leaves the German taxpayer on the hook to the tune of almost €200bn. The court also referred the so-called OMT or “outright monetary transaction” programme unveiled by Draghi as part of the effort to battle deflation, to the Court of Justice for consideration. Pointedly, the court asked the Court of Justice to “clarify why the measures proposed in the OMT programme are not in violation of European primary law”.

The German court clearly is seeking to ensure that any interventions by Draghi are of the more restrictive kind, something which runs counter to the advice of most economists. A Court of Justice response could come late in 2015 and the ball will be back in the German court. In the view of jurist Rene Smit, the German court has made it clear that it considers that the ECB acted beyond its powers in pushing forward monetary transactions.

All of this puts the brakes on any really ambitious programme of quantitative easing at a time when fiscal tools are apparently unavailable. People call on the Germans to reflate their economy, but such calls are falling on deaf ears. The country’s current account surplus has reached record levels despite the damage to exports caused by the stand- off with the Kremlin.

The standoff between the eurozone’s lead protagonists, supporters of growth and inflation hawks, continues, but will the patience of Europe’s electorates and in particular, of its underemployed and poorly paid youth, persist. If it does snap, this could serve as a trigger for a new phase in the ongoing eurozone crisis.

The euro patient could yet find itself back in intensive care, surrounded by anxious medic considering all possible treatments.

With a population of 334m, the single currency area is riven is internal and external pressures, including German inflation fears and growing nationalist movements, says Kyran Fitzgerald.

Average unemployment across the eurozone now exceeds 11%