|Can Merkozy deliver?|
|Wednesday, 07 December 2011 00:53|
S&P threat adds to pressure. 72 critical hours left
The sharp fall in yields on Italian bonds after Mario Monti announced a euro 30bn austerity package—including a hike in the retirement age and a tax on property—indicates what we’ve known for a long time, that the markets are looking forward to austerity measures in troubled European countries. To that extent, the Merkel-Sarkozy austerity pact, which they will present at the eurozone summit later this week, is just what the markets need since it will automatically pass sanctions against governments that breach a 3% fiscal deficit target. But it’s a bit more complicated, and that’s why S&P has threatened a full-scale downgrade of 15 members of the eurozone, including Germany, if they don’t arrive at a workable solution in Friday’s critical debt summit—a collective downgrade though is a bit of an oxymoron since it leaves all countries in the same relative position. The problem with the Merkozy solution is that while European nations are almost certain to embrace it given the alternative is an unimaginable chaos, a solution which takes away national autonomy—in deference to French pride, Merkel has come around to the view that the European Court of Justice would just rule on whether member states had met the fiscal conditions and would not be able to reject their budgets!—is unlikely to work in the long run. Certainly, member states need to discuss it at length, to weigh the cost of a strong euro (assuming the plan works) versus the benefits they will get from being part of a no-exit eurozone. None of this can happen in the next few days—Wolfgang Münchau quoted a member of the European Parliament, in the FT, as saying a fiscal union of the type envisaged could take up to 10 years!
There is also the question of whether extreme austerity of the type being proposed for all of Europe is the solution since it will drive Europe into a deeper recession and worsen the current crisis, even the ability to repay debt. The immediate issue, however, is that Europe needs the ECB to act as a banker of last resort because that is the only way markets will stop pushing up bond yields—but until the market senses German support is conditional, bond yields will keep rising. That’s why, from just a problem on the periphery, the crisis has rapidly spread to, if S&P’s warning is to be taken seriously, even Germany. It is obvious, from the softening of positions by Germany and the various statements emanating from Europe, that some kind of a solution will be arrived at over the weekend. But if it is the half-way house that most expect, we’ll be looking for another solution at another crisis summit a few weeks down the road.