Foreign and Defense Policy, Europe and Russia

New euro zone agreement is a ‘great leap sideways’

Given when ECB president Mario Draghi said earlier this week, I just don’t see why this euro zone “compact” will inevitably result in massive ECB bond buying. This sounds about right (via Reuters):

“This is a great leap sideways,” said Daniel Gros, director of the Centre for European Policy Studies think tank in Brussels, referring to the new fiscal rules. “We now have a framework that in 10 years time could restore a degree of fiscal order to the euro zone. The German view is that this is all that is needed to convince markets to buy Spanish and Italian debt. I have my doubts that it will be enough. I think the tensions continue.”

And IHS Global Insight (bold for emphasis) also seems dubious:

The question is whether such an agreement will ensure observance of the new fiscal rules as effectively as treaty change. The legal details of the new agreement remain sketchy and will be discussed today (9 December). Of particular importance will be the role of the European Court of Justice (ECJ) in enforcing fiscal rules, and to what extent the European Commission and European Parliament will play a role. Another factor to consider is how far member states will be able to implement debt brake laws into their constitutions, as called for in the agreement. Already, such proposals have floundered in the Austrian parliament, where a large majority is required to make constitutional changes.

Although greater fiscal and economic discipline and co-ordination is likely to be welcomed by the markets, the agreement is unlikely to ease Europe’s chronic debt and liquidity problems in the short term. Moreover, a commitment to austerity across Europe is likely to further depress aggregate demand in the short and medium term, further damaging the continent’s growth prospects. Of greater importance is the reaction of the European Central Bank (ECB), seen by many as holding the key to easing the Eurozone’s short-term liquidity crisis.

So you still have big issues in the short term. And big questions about the willingness of voters to endure years of austerity. As AEI’s Desmond Lachman explains:

1. The essence of the European periphery’s present economic predicament is that it is proving extraordinarily difficult to reduce these countries’ still outsized budget deficits without the benefit of having their own separate domestic currencies.

2. Stuck within the Euro-zone straightjacket, these countries cannot devalue their currencies to boost exports as a cushion to offset the highly negative impact on their economies from the major fiscal retrenchment that the IMF and the EU are requiring as a condition for their financial support.

3. As Greece and Ireland have found out, attempting to adjust under these conditions must be expected to entail many years of painful deflationary and recessionary conditions that will only compound their indebtedness problems

4. Compounding the periphery’s adjustment problems is the fact that the European core economies are already slowing abruptly. In addition, European banks are already cutting back on lending in an effort to shore up their balance sheet positions, which are threatened by large loan losses on their peripheral lending. This makes it all too likely that Europe as a whole will move into a meaningful and prolonged recession, which will make it even more difficult for the peripheral countries to meet their budget deficit targets.

5. With countries in Europe’s periphery highly unlikely to be able to reduce their large imbalances, the only thing that could realistically hold the Euro together over the longer-run would be for countries in Europe’s North to willingly write large checks year-in-year out to finance the deficits of the countries in Europe’s South.

And who thinks that is going to happen? Well, at least my pal Felix Salmon at Reuters is happy about it all. Oh, actually he’s not:

It all adds up to one of the most disastrous summits imaginable. A continent which has risen to multiple occasions over the past 66 years has, in 2011, decided to implode in a spectacle of pathetic ignominy. Its individual countries will survive, of course, albeit in unnecessarily straitened circumstances. But the dream of European unity is dissolving in real time, as the eyes of the world look on in disbelief.

Europe’s leaders have set a course which leads directly to a gruesome global recession, before we’ve even recovered from the last one. Europe can’t afford that; America can’t afford that; the world can’t afford that. But the hopes of arriving anywhere else have never been dimmer.


Desmond Lachman, hot off the presses:

• “If we look down the road…in 6 months…you won’t have Greece in the Union.…It’s difficult to see how Portugal, Ireland, and possibly Spain are going to stay in the euro for very long.”

• “The summit…does nothing to address the credit crunch that is developing in Europe. Policymakers once again have demonstrated an inability to get ahead of the crisis. Their failure today to agree on Treaty change to include legally binding rules for budget deficit reduction, leaves the European Central Bank (ECB) with little cover to support the Italian and Spanish bond markets.”

• “What’s going on in Europe is of fundamental importance to the United States…because most equity markets and risk markets are interconnected, and so when we see things getting out of hand in Europe, we will see markets dislocated globally.”

John Makin (former consultant to the US Treasury Department, the Congressional Budget Office, and the International Monetary Fund):

• “This European banking crisis is on a parallel with our Lehman crisis in 2008.”

• “ECB President Draghi did not pledge any further buying of sovereign government bonds. The outcome was less than markets had hoped for but about what they expected–just enough to contain the ongoing European crisis but not a clear roadmap to a solution.”


One thought on “New euro zone agreement is a ‘great leap sideways’

  1. You can sum up the Euro train wreck in one sentence from Felix Salmon’s article:

    “The fundamental problem is that there isn’t enough money to go around”

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