Euro Debt Crisis - The End Game for the Euro

The Euro debt crisis is increasingly resembling the film Groundhog Day, without the comedic relief, of course. Every time the European leaders appear to devise a long-lasting, concrete set of solutions for the crisis, they are immediately discarded as insufficient by the markets. The latest attempt of a compromise at the G-20 summit in Cannes, France resulted in an agreement to set aside more money to recapitalise the troubled European banking sector (which have taken a hit with the partial default in Greece and the increasing uncertainty around the currency), and increasing the effective capacity of the European Financial Stability Fund – the bailout fund established in 2010 - to €1 trillion (although this will be achieved through leveraging, which does not mean that the amount is immediately available). German attempts to get funding from so-called BRIC countries to help shore up the EFSF was unsuccessful, presumably because these countries do not wish to contribute to helping maintain the high living standards that Europeans have come to expect, and for which they seek to emulate.

These measures, however, have done nothing to reassure the markets of the sustainability of the Euro, with Italy paying a record high of 6.5% interest on 6-month bonds on November 25^th – an increase of nearly double of what was paid the previous month. Even more incredibly, the only country that was thought to be immune from the Euro crisis, Germany, failed to sell all €6 billion in 10-year bonds, with the Bundesbank being forced to purchase 40% of the bonds. In addition to these worrying developments, the bond yields of Eurozone countries are creeping ever upwards, forcing speculation of bailouts for Spain, Italy, and even France. The impracticality (most economists would say impossibility) of such bailouts for the giant economies of the Eurozone has sped up the search for an ultimate solution – to reach some kind of end game for the Euro.

It is obvious now to many commentators the previous dogma which stated that the cause of the crisis was simply due to over-spending, lazy continental economies was overly-simplistic, and did not acknowledge the great advantage of the Euro to the big economies – particularly Germany. Although Germany benefited hugely from the introduction of the Euro, Chancellor Merkel is reluctant to contribute her fair share for the saving of the currency. Instead, a German attitude to fiscal matters is being demanded of all countries in the Eurozone – particularly within the PIIGS countries – with the proviso that Germany may shoulder some burden in the future.

The political consequences of this attitude have been highlighted many times in the media, with new technocratic, ECB-friendly governments being appointed in Greece and Italy (without any general elections, it must be added). The political crisis in Greece appeared to be intensified by the Franco-German threat that it could be thrown out of the Eurozone, if it does not play by their rules. Although this threat could have been construed as a poker play by Merkel and Sarcozy to shore up Greek resolve for austerity, it backfired spectacularly and caused further turmoil to the already fatally-damaged regime of George Papandreou.

The gravity of the situation is being underlined by European leaders, with many linking the fate of the Euro to that of the whole European Union. EU President Herman Van Rompuy had previously said - "If we don’t survive with the Eurozone we will not survive with the European Union.". Nobody expects short-term changes like beefing up the EFSF, or appointing different governments in Italy and Greece to really solve the crisis, and there are wildly different ideas on how to go about it. The primary solution to this day has been for fiscal stability – cutting spending and increasing taxes, as well as privatisation. While some may view this exercise as essential for indebted nations, it can also be argued that this course of action has seriously depressed domestic demand, and caused the economies in Greece and Ireland to deflate, which then requires harsher fiscal measures.

A more long-term option available for policy-makers is for the establishment of Eurobonds. This has been proposed by the European Commission and remains a viable, though controversial, option. Although the eventual make-up of Eurobonds is highly disputed, the main premise of them is that the 17 members of the Eurozone jointly issue a government bond, with a single bond yield for all countries. This would lower the borrowing costs for risky, high-debt, high-yield economies such as the PIIGS countries, as well as speeding up the re-introduction of the bailout countries into private bond auctions. However, it would also increase the costs for low-risk countries such as France and Germany, and a trade-off of closer fiscal integration would be an inevitable prerequisite for this measure.

An increasingly likely option which is being pushed by Merkel and Sarcozy is for tighter supervision of national budgets, with severe penalties for countries that break specific targets. This is aimed at preventing another Greek case of a country spending way beyond its means, as well as increasing market confidence in the Eurozone. There is a sense of déjà vu with this proposal, however, as it resembles the previous Stability and Growth Pact – which Germany and France broke numerous times in the past. To counter this similarity, it is planned that the European Court of Justice would be given powers to ensure that irresponsible governments are punished should they go beyond the set criteria. Although this move would be welcomed by several European governments, it would almost definitely requires Treaty changes, and it is hard to see how these could be passed at the hands of the Irish people.

And finally, there is the spectre of a nightmare solution – the break-up of the Euro itself. This is the scenario that everyone dreads, but which increases in probability for every day in which European leaders dither. The only certainty is that a final solution to the Euro sovereign debt crisis will be fraught with more political-wrangling, back-room negotiating - and will require a genuine sense of compromise.