Maybe the weekend will have sobered market sentiment that embraced Thursday’s eurozone debt initiative by abandoning risk-aversion, fleeing the franc, yen and dollar and reversing the fortnight-long euro downtrend. Yet my crystal ball continues to support euro shorts, predicting more trauma down the road as the conflict of interest between investors and taxpayers intensifies.
As France and Germany push to collectivise Europe’s debt burden, their commitment to maintaining the single currency also sets the precedent of larger fiscal injections from solvent countries. In addition to significant cut back in sovereignty, it will burden productive taxpayers with financing peripheral debt built on moral hazard, something both Sarkozy and Merkel will find impossible to sell to angry electorates.
So, basically, more than a year after promising a smooth Greece bailout harming neither lenders nor Europe’s sovereigns, the Brussels summit acknowledged the complete failure of the ‘prosperity through austerity’ conviction, instead pledging unprecedented resources to revive the economy. EU leaders have also agreed to delay debt maturity periods and reduce interest payments on outstanding loans. The ECB is now willing to accept Greek bonds after a partial default.
But despite the significance of the congregation, and Trichet’s unannounced flight from Frankfurt the night before, the summit was mysteriously mute about more dangerous debt time bombs ticking in larger EU economies. The new framework will sooth concerns about Ireland and Portugal, but Spain and Italy have much larger debts, ‘too large to fail’, yes, but also too big to bail out. Once these bubbles begin to burst, tremors will unsettle currency and export markets far beyond Europe; prompting yet another safe-haven trading rush, further inflating the yen and franc (with BoJ and SNB already mulling intervention), driving up gold and rushing hot money to higher yielding emerging markets.
It is no longer possible to contain the crisis within the periphery. Even Italian excesses will morph in comparison to the market rattle stemming from a far more sinister crisis right at the heart of the monetary union – the deficit and debt overhang brewing in France. With its financial muscle second only to Germany, France’s fiscal indicators are more in the league of Greece and Portugal. Its fiscal deficit doubled from 3.3 per cent of GDP in ’08 to seven per cent in ’10, while the public debt ballooned from 67.5 to 81.7 per cent.
Though a traditionally strong export economy, France is set to record an unprecedented trade deficit this year, further straining the government’s fiscal space. Its export reach within the EU has dropped from 15.6 per cent in ’00 to 12.5 per cent half-way in H1-11, according the SocGen figures. And while it retains its AAA credit rating, its banks have huge, potentially debilitating, exposure to eurozone debt. In May, Standard & Poor’s set the tone of things to come by lowering Credit Agricole’s rating owing to its exposure to Greece.
As President Sarkozy lobbies to avert a collapse of the euro, he can do the single currency no bigger favour than implementing urgent structural reforms in his own country. Yet while reforms like increasing the formal retirement age, limiting minimum wage increase, and reducing healthcare and unemployment benefits will provide much needed fiscal elbow room, the country’s strong labour unions are not likely to facilitate such measures, especially in election season.
The situation becomes more worrisome once the growing loss of competitiveness of French industry is considered. By not reducing spending and enacting wage restraint over the last decade, its big players in auto, pharma and chemical industries are losing clients to lower-cost producers in Europe and Asia. Increasing taxes is also self-defeating, from fear of discouraging investment and in turn reducing taxable income.
It is ironic that France finds itself at the centre of the collapsing euro structure. More than a decade after France’s ruling left successfully pushed for the single currency, even getting Germany to abandon the mark in return for unification, the euro’s death rattle may well sound from the doors of the Elysee Palace itself.
Last week’s trader euphoria owed to the market’s fanatic herd culture that defines the very essence of free market capitalism – profit hunting – not sudden confidence in the EMU’s debt containment capability. If anything, it should sound loud warnings about how quickly it can turn. When the crystal ball starts pricing in increasing borrowing costs for France, the EMU itself will begin to unravel.
The writer is Business Editor, Pakistan Today
