French and German leaders made steps towards establishing an economic government in the eurozone on Tuesday, as the sovereign debt crisis once again claims the mantle as the world’s chief economic fixation.
The best efforts of Nicolas Sarkozy and Angela Merkel, however, only served to amplify fear and volatility, with the proposals falling short of what was needed to restore some confidence.
While the plan does acknowledge reforms needed to fix the economic union, the pace of change proposed is far too slow to address the urgent concerns of investors, said Craig Alexander, chief economist at Toronto-Dominion Bank.
“If Europe is committed to having the euro experiment survive, you’re going to have to have a fiscal union,” he said. “The problem is the political system in Europe can’t cope with the jump from the current system to a fiscal union in one go.”
Markets clearly favour such a jump, involving the issuance of “euro bonds,” to immediately stabilize weak peripheral economies.
Instead, the leaders laid out a more gradual groundwork for enhanced economic governance, including deficit limits on member countries, greater economic supervision, as well as a tax on financial transactions. Investors registered their disappointment on New York and Toronto stock markets, which fell by about 1% and 1.2%, respectively.
While joint euro-region bond sales may come eventually, their introduction now would put the “most stable countries of the euro zone in grave danger,” Mr. Sarkozy said, adding that euro bonds would be contemplated only “at the end of a process of integration, not the beginning.”
He reiterated the “absolute determination” of Germany and France to defend the euro.
Since the inception of the eurozone, the currency’s primary vulnerability has resided in the discrepancy between fiscal and monetary policy.
Economists have always had reservations about the viability of a currency union that lacked fiscal unity. Over the course of the last year and a half, the debt saga has laid bare that inherent weakness.
It appears as though the union’s big powers now recognize the need to patch that governance hole. But they are consistently criticized for lacking the appropriate urgency as called for by the severity of the crisis.
“This has been the story of this development for the last two years, that the leaders are somehow behind the markets,” said Stephen Lewis, chief economist at London’s Monument Securities.
Ms. Merkel, for example, on Tuesday cited the need for possible changes to the European Union treaty in the future as challenges demand.
“They’re having a few challenges already,” Mr. Lewis said.
Drastic action, however, may just not be viable.
While prodded into action by market swings, the region’s leaders are simultaneously restrained by political tensions, mainly within their own electorates.
German taxpayers, already embittered over having to bankroll seemingly ineffective bailouts for irresponsible borrowers, are stridently opposed to the introduction of euro bonds.
Letting those countries borrow with backing from Germany and France lets them off the hook, according to the perception, Mr. Alexander said.
“You create a free-rider problem. You could have a small country that behaves fiscally irresponsibly, but its bonds are backed by Germany and France,” he said.
Appeasement of taxpayers can also help explain the proposed financial-transaction tax, which, while probably not economically desirable, would at least appear to spread the burden to the financial sector, Mr. Alexander said.
However, while moving towards fiscal integration too quickly risks taxpayer backlash, moving too gradually risks allowing contagion to get out of hand.
The moment when a debt crisis becomes a financial crisis occurs when bank flows start to become seriously restricted. Already, European banks are proving reluctant to lend to one another. And the private sector within Europe’s core is certainly in favour of the issuance of euro bonds, Mr. Lewis said.
“That would provide financing for hard-pressed countries and enable them to continue buying from big business,” he said.
Additionally, there is yet another layer of political sensitivity which could delay the move towards fiscal governance, Mr. Lewis explained.
“They have to be very cautious about seeming to dictate how these problems should be solved,” he said. “There is a feeling in some parts of Europe that this Franco-German (leadership) is not fair and not a healthy development from the point of view of the eurozone’s future.”
Financial Post
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