The Euro is Still Alive...
… For the time being … but in the high dependency unit! European leaders have agreed a basis to ‘resolve’ the crisis posed by the high levels of debt in Greece. Under the deal, Greek debt would drop from 160% of its GDP to 120% by 2020. That would still be a very high level of debt – about the position that Italy is in now.
The news has been received positively with the main Eurozone markets up by over 3.5% at the time of writing and the FTSE 100 up by around 2% with banks sharply up: some uncertainty has been removed and the news could have been worse!
The key elements of the agreement are that holders of Greek debt have had to take a loss of 50% ; the ‘bail out’ fund, the European Financial Stability Facility (‘EFSF’), is being increased to one trillion euros; there will be greater budgetary ‘co-operation’ between the members of the Eurozone; banks will be required to raise additional capital.
The requirement for banks to raise additional capital is to give them greater resilience against future defaults and to build confidence in the banking system. If they cannot raise the required funds in the markets, there may be a need for further government funds to recapitalise the banking sector.
The greater budgetary co-operation is clearly a centralisation of control. The stronger countries, such as Germany, will see this as necessary if they are to limit future calls on the EFSF. The weaker economies such as Greece and Italy will see this as an unwelcome interference in their financial management and, as we have already seen in Athens, the necessary austerity measures will not be well received.
A fund of one trillion Euros is widely seen as being insufficient to meet the likely calls. There remain doubts about the ability of other Eurozone countries to manage their debt problems and avoid default. Italy’s economy, and debt, is very much larger than that of Greece. It will find it difficult to manage its debt without a significant return to growth.
The debt laden economies of Greece and Italy need the freedom to manage their own interest rates, currency issuance and exchange rates. They cannot do that whilst remaining in the Euro. Germany vetoed using the European Central Bank to create money on the grounds that it would be inflationary. The financial circumstances and needs of Germany and of Greece could hardly be more different.
The break up of the Euro has been avoided for now. This is a move in the direction of a Federal Europe with centralised budgetary control. It may prove to be a ‘sticking plaster’ solution as the underlying problems remain. It should at least buy time and avoid the immediate crisis. Markets have been calmed. Nevertheless, without a return to economic growth, we can only expect further problems.
See also Can the Euro survive