Europe seemed to make the right moves towards solving the eurozone’s sovereign debt crisis this week, and with the political stalemate in Greece and Italy finally broken, Europe’s leaders were hoping for a bit of breathing space.
Yet markets instead have responded negatively as an increasingly fierce EU debate over the role of the European Central Bank (ECB) undermines investors' trust that the eurozone will recover. Many experts believe that the attempts of Europe’s southern countries to reform are coming too late.
“All forecasts indicate that European economies are either already in recession or only a step away,” says Sebastian Dullien, an economist at Berlin’s HTW University. “Austerity will put additional pressure on these economies. They will need help from outside to sort their debts and get back to growth.”
Greek, Italian moves fail to soothe markets
Greece’s new prime minister Lucas Papademos, who heads an emergency cabinet that is supposed to keep the country from defaulting, won a vote of confidence this week with a comfortable majority. That victory allows him to now embark on reforms Greece needs to implement before it gets fresh money from the EU and the International Monetary Fund. Today Greece submitted a draft budget ahead of meetings today and tomorrow with the EU, the IMF, and the ECB.
In Rome, Italy’s new prime minister Mario Monti, the ex-central banker who succeeded Silvio Berlusconi, presented a cabinet consisting exclusively of technocrats instead of career politicians. The cabinet also presented an austerity program that, Mr. Monti said, was vital for the survival of the eurozone.
“We must make sure Italy is no longer perceived as Europe’s weakest link,” he said.
But the markets didn’t buy it. Sovereign bond yields for Italy remained high, while yields for Spanish and French 10-year bonds rose – close to the critical 7 percent mark in Spain. At that level, borrowing gets prohibitively expensive. When countries like Ireland and Portugal crossed that threshold, they were forced to ask for help from the EU.
Should the European Central Bank intervene?
Spain’s Prime Minister José Luis Rodríguez Zapatero launched a dramatic appeal to his eurozone partners. “We need a European Central Bank that does justice to its name and defends the common currency,” he said on Thursday, suggesting that the ECB should on a large scale buy bonds of countries under pressure. This appeal was mainly directed at German Chancellor Angela Merkel.
Germany is strictly opposed to the ECB intervening on behalf of struggling economies. Wolfgang Franz, who heads the German government’s council of economic advisers, calls it “a deadly sin.”
“There’s a deeply engrained fear of inflation in the German collective consciousness,” says Mr. Carl-Ludwig Holtfrerich, an economic historian at Berlin’s Free University. “Germans living in the first half of the twentieth century saw their savings wiped out twice when the central bank started the printing press. The memory is still alive.”
Germany proposes strict measures
Chancellor Merkel has made it clear that she wants the European Treaties to be changed. Those members of the eurozone who don’t stick to the rules and overspend should be taken to the European Court of Justice, she demands.
Germany is also supporting the idea of levying a tax on financial trading, an idea very much opposed by the US and especially Britain – the latter worried about preserving London's status as an international hub of finance.
It is doubtful though that Germany is going to use all these bargaining chips, says Mr. Dullien. “If the choice is survival of the euro or the ECB turning into the lender of last resort, Germany is not going to walk away from the euro. And chances are, this decision has to be made soon.”