European leaders on Friday failed to deliver the sort of comprehensive reform package that markets had longed for. Without Britain’s consent, the countries in the single currency union agreed to push ahead with a fiscal compact that aims to prevent debt crises in the future but it wasn’t clear what immediate relief eurozone governments could offer banks and investors who fear for the future of Greece, Italy and Spain.
The European leaders did agree to replace their temporary bailout fund with a permanent rescue body six months ahead of schedule. The European Stability Mechanism is now set to come into force in July of next year.
Markets may be assured by the move because it should prevent a eurozone member from ever teetering on the brink of bankruptcy again as happened with Greece, Ireland and Portugal which have all had to request European financial support. The mechanism may not be powerful enough to bail out bigger euro nations like France and Italy though nor could it halt a financial meltdown if French banks, which are heavily exposed to Greek debt, require state intervention in the event that Greek bonds need to be written off despite various rescue attempts.
There is another obstacle in the way. German chancellor Angela Merkel’s coalition partners have said to oppose the very creation of the ESM. They fear permanent bailouts for the weaker eurozone nations at Germany’s expense.
Germany opposes collateralization of European sovereign debt in the form of eurobonds for the same reason. Fiscal union, however, does appear imminent if the euro area moves to enforce semi-automatic sanctions for budget profligators in the future — a German demand on Friday.
Especially in other northern member states, there is political resistance to surrendering further sovereignty to Brussels. Yet the consensus among observers is that “Europe will need to deepen economic integration and find a politically acceptable form of collateralized debt,” as Fabian Zuleeg, chief economist with the European Policy Center think tank, put it.
“Helping the IMF to increase its lending can help tide things over for the countries which struggle to access financial markets at reasonable interest rates but it will not be the end of the crisis,” he added.
The International Monetary Fund is called in to provide short-term relief to peripheral European economies with national central banks expected to loan it up to €200 billion ($270 billion) next week. It could subsequently loan the money to troubled euro nations. The IMF can condition this lending on fiscal reforms which is deemed preferable to central banks or European governments acting bilaterally without any formal conditions attached.
Ahead of the summit, European Central Bank president Mario Draghi expressed reservation about this move because it raises questions about the independence of the central banks.
Frankfurt slashed interest rates by a quarter percentage point to 1 percent and eased rules on the collateral it asks from banks to borrow from the ECB. The policy is designed to boost liquidity in financial markets. A critical move, said Zuleeg, in counteracting the downturn because European firms rely significantly on bank financing rather than equity.
The main problem, though, argued Karel Lannoo of the Center for European Policy Studies, is not a lack of money as much as a lack of confidence in Europe’s banking sector. “Before the crisis, there was ample liquidity,” he pointed out, “with low level of capital in the banking system, and much higher levels of central bank interest rates.” Increased liquidity will do little to aid Europe’s weaker economies if it is all deposited at the central bank to draw interest.
According to Detlev Schlichter, author of Paper Money Collapse, in which he advocates a return to the gold standard, those years of ample liquidity were at the root of the crisis. “After decades of constant expansion of the fiat money supply, of low interest rates and cheap credit, banks are massively overstretched and the state, everywhere, is overburdened with debt.”
Schlichter argues that economies need to contract and banks need to deleverage to return to a growth path. “Even more money printing and attempted debt monetization” will ultimately lead to an “inflationary meltdown,” he fears and it seems that markets are increasingly worried about the prospect as well.
As long as politicians insist that “this time it is different,” investors will remain wary of lending to nations that are perceived as least creditworthy and the ECB will continue to buy peripheral bonds to prevent these countries from going under — thus prolonging the current predicament until they cut spending significantly.
Draghi on Thursday announced no change in his bond purchase operation which is capped at €20 billion per week and keeping Italy and Spain on life support.