The eurozone’s attempts to defend itself against the spread of contagion are showing signs of failure on almost every front, putting a global financial crisis originating in Europe back on the table.
Political divisions between the core and the periphery increasingly threaten the emergency measures keeping the region afloat, making an orderly solution to the sovereign debt crisis look increasingly doubtful.
“Our new baseline outlook includes widespread bank and financial institution failures in Euroland,” Carl Weinberg, chief economist at High Frequency Economics, said in a note.
“We fear a global economic depression — less severe in North America — originating in Euroland’s sovereign debt crisis and banking sector fragility,” he said.
What began as a problem of excessive debt and unsustainable finances in Greece, a nation of only 11 million accounting for a paltry share of the region’s output, is now showing troubling similarities to 2008, when risky mortgage-backed securities in the United States set off a financial cataclysm.
The eurozone’s peripheral countries are surviving on emergency financing extended primarily by the region’s twin powers — Germany and France — as well as the European Central Bank. That support has been made conditional on the enactment of fiscal austerity.
But that arrangement now appears on the verge of collapse, with citizens of the core countries resentful of bankrolling bailouts and taxpayers in the periphery lashing out against drastic budget cuts and reduced entitlements.
German Chancellor Angela Merkel paid a steep political price for her support of bailouts, having suffered her fifth election loss this year in a regional vote over the weekend.
“The vote sends out a very clear message,” Lena Komileva, global head of G10 strategy at Brown Brothers Harriman, said in a note. “German taxpayers refuse to leverage their future pensions to protect the euro in its current 17-member form, and they are not alone.”
Opposition to additional aid brings into question the viability of future emergency funding designed to stem contagion, a point of concern exacerbated by Finland’s demand for collateral as a condition for further loans to Greece.
Meanwhile, resistance is gaining potency for those on the receiving end of aid as well.
Italian Prime Minister Silvio Berlusconi has signalled a tenuous commitment to austerity after refusing to legislate all the deficit-cutting measures he promised last month in return for support for its bond market by the ECB.
Still, Mr. Berlusconi’s revised plan sparked a general strike Tuesday in Italy, setting the stage for a confidence vote in the Italian Parliament on Wednesday.
Greek austerity, meanwhile, has proven ineffective, with its projected deficit for 2011 of up to 9%, well in excess of its 7.6% target, a miss some economists attribute to the austerity measures themselves.
“The slash-and-burn austerity programme has hammered demand and incomes, so that tax receipts are falling, despite the attempt to collect more,” Charles Dumas, chief economist at Lombard Street Research, said in a note. “No amount of austerity will put this right — GDP will simply slide away from under, destroying revenue, boosting relief expenditure and cutting the GDP denominator of all the relevant ratios.”
Collectively, the deteriorating relationship between the core and the periphery strained European equities, government bonds and the euro this week. The German benchmark DAX index, for example, plunged 5.3% on Monday, and a further 1% on Tuesday.
The possibility of the crisis getting away from policy makers has the region’s bankers openly contemplating the worst.
This “is not just a financial crisis,” Federico Ghizzoni, the head UniCredit, Italy’s largest bank, said in Frankfurt Tuesday. “For the first time, the European system is really at stake.”
To preserve the currency union, limit contagion and keep banks functioning, EU officials need to implement the €440-billion joint rescue fund agreed to in July as soon as possible, said Mark McCormick, currency strategist at Brown Brothers Harriman.
The ECB needs to keep buying up the bonds of peripheral countries, he said. “I think it’s possible they can still muddle through this.”
Financial Post
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