In 2011 the former Italian Prime Minister Romano Prodi described Germany in the German Newspaper “Der Spiegel” as “the new China”. By this, he meant that Germany had, as the most financially-stable eurozone country, become a political tour de force.
German chancellor Angela Merkel said recently that she would never go down the “euro bond” route – This means that the eurozone will never share debt between countries. Naturally, the leader of a country boasting a strong, healthy economy is reluctant to chequer its balance sheet by taking on 3rd party debt.
This isn’t the news the eurozone wants to hear; political stakeholders seem to be losing patience with the eurozone’s piecemeal ‘sticking plaster’ approach to managing the crisis. Rather than plug financial bleeding with bailout stoppers, many Eurozone leaders want a bigger change, and they want it sooner rather than later.
What kind of “big change” are we talking about? To recover eurozone finances, Governments need to move their attention to structural reform. This is just a fancy way of saying “they need to do things better”, but the “structural” element refers specifically to the way that a country is run; its laws, administrative processes and logistical architecture.
If we take Spain as an example; Spanish employment law leaves few rights to the majority of Spanish workers – this accounts (in part) for Spain’s high unemployment rate (24.6%). By changing these laws to protect the worker, Spain could improve its legal framework and make it more supportive for the Spanish citizen. Structural reforms such as these can make a huge difference to a country’s finances.
The Organisation for Economic Co-operation and Development (OECD) has said: “The crisis has acted as a catalyst for reforms… they are necessary to make longer term growth stronger, more sustainable and more equitable. We know that these efforts will pay dividends in the future, which is why governments must keep up the reform momentum”.
Reforms can include anything from reduced government spending (the “austerity” measures we mentioned), the privatisation of enterprise, the promotion of foreign investment to bring money into the country, improved governmental leadership, reduced state subsidies, and the devaluation of currency (a strategy to make investments, business opportunities, goods and services more attractive to the foreign investor).
And another thing: the eurozone needs to get behind Spanish and Italian banks. Entry into the euro currency hasn’t yet established an “all for one, and one for all” mentality. The question of whether Spain and Italy will be guided through the crisis is a real test of the eurozone as an institution.
Spain’s balance sheet shows that it is capable of financial sustainability, and Italy’s can be tackled through a combination of budgetary discipline and asset sales (the liquidation of goods, investment funds and other valuable holdings). The European Central bank (ECB) will only support these countries if eurozone politicians show public support for the cause.
In June, there were hopes that Italy’s prime minister, Mario Monti, and Spain’s prime minister, Mariano Rajoy, could coax Merkel to give Southern Europe her support. Even the investment markets persuaded themselves that Germany might be willing to compromise, by allowing the European Stability Mechanism (ESM) – the organisation that provides financial assistance to euro area countries – to pay out direct aid to banks. This aid would be “direct” in the sense that it would go directly to the banks (rather than the government), and would not be proffered in exchange for austerity commitments.
Germany isn’t going to go for this. It fears that reforms and budget cuts will be put on ice, just as they were in Italy and Spain when the European Central Bank ECB implemented its long term refinancing operation (LTRO). If reforms aren’t on the horizon, Germany doesn’t see any “positives” to come from bailing out flailing eurozone finances.
ECB president, Mario Draghi, has promised to do “whatever it takes to preserve the euro”. The ECB strategy for preservation hinges on one thing: unlimited bond purchases (eurobonds). The idea with unlimited bond purchases is that the cost of borrowing can be brought down.
For example: Spain cannot borrow at a good rate; it is due to make a repayment of €15bn in November 2012, but the interest on bond repayments is so high that Spain is barely keeping its head above water. With euro bonds – the “shared debt” of which Angela Merkel is so averse – other eurozone countries (with access to better interest rates) could buy up Spain’s bonds, and repay them at more manageable rates. This would help Spain, but would mean that the financially solvent countries like Germany would essentially have to take on 3rd party debt.
So that’s “Plan A”, but where’s “Plan “B”?
Angela Merkel explained her aversion to Eurobonds, saying: “When I think of the summit I feel concerned that yet again we will have too much focus on all kinds of ways of sharing debt”. She further clarified her position, saying that it would be “economically wrong and counterproductive” to agree to Eurobonds. The German Bundesbank (Germany’s Federal Reserve) also sees “significant risks in [the] bond-buying plan”.
Eurobonds are certainly a huge step, and the ECB has certain demands before it will entertain the idea of shared liabilities. Before an indebted country can float bonds, it must formally request a bailout from the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM). It must also accept strict conditions. In truth; Eurobonds are simply another type of bailout.
In PART 3 of our eurozone report, we look at:
- The Greek exit from the euro area (the Grexit)
- Greece’s plans to reduce its debts
- How the remaining eurozone countries will be affected by Greece’s finances