There’s just one week left to save the euro – at least according to Mario Monti, the prime minister of Italy, who made the prediction ahead of the European summit that takes place on the 28/29th June.
So could Monti be right and if there aren’t bold moves taken at the summit could the entire eurozone project fall apart?
The markets are well used to these summits in Europe and so far they haven’t come up with a sustainable solution to the sovereign debt crisis, yet the eurozone hasn’t collapsed. So why the tone of panic in Monti’s voice?
Essentially countries like Spain and Italy have started to come under attack and have seen their bond yields rise to unsustainable levels that are pushing up their debt costs. At the same time the German-imposed austerity has weakened their economies, which threatens to keep them in recession for many years.
The voting public in Spain and Italy is not happy; many people are unemployed and are calling for a different approach to tackling the debt crisis.
If Europe can’t deliver this time then Spain and Italy may decide the only way to generate growth in their economies and bring their borrowing costs down to a sustainable level is to leave the currency bloc altogether.
As Monti hints, at this summit there is more than just Greece at stake, it could also determine the future of the third and fourth largest economies in the currency bloc.
How can it survive?
The first thing needed at the summit is a softening of Germany’s stance towards fiscal targets. Thus, give Greece, Spain and the rest four years instead of just one to get their budget deficits down to 3% of the size of their economies.
This doesn’t cost Germany anything, as it merely widens the economic goal posts. Added to this, by lengthening the period of fiscal consolidation for an economy like Greece it may reinforce the mantra of “living within your means” on the national consciousness and help to foster an attitude of fiscal responsibility.
Due to these benefits we see this proposal as has having a high chance of success of getting accepted by Merkel at the Summit.
There is also immense amount of pressure on Merkel to widen the remit of the ECB so that it can act as a lender of last resort. This would give the ECB the power to print euro and bring its powers in line with the Fed and the Bank of England.
Because the ECB has a strict mandate not to intervene on behalf of governments, this would be a dramatic shift in the currency bloc as it would mean that centralised eurozone authorities could target members who are in trouble.
This is a much harder sell to Merkel as you can’t have the ECB printing money for every country that gets itself in trouble without protecting itself against moral hazard.
In return for the promise of indefinite “emergency” ECB liquidity the union needs powers to collect tax from member states and control spending plans, which in essence is fiscal union.
This could also lead to the eurozone issuing debt under one entity, whereas now each country issues its own government bonds.
The chance of this being agreed upon next week is fairly slim. While we don’t expect full-blown fiscal union immediately after next week’s summit, it is likely that Germany will have to give some ground.
Essentially if Europe’s leaders can agree on a compromise between providing more support for troubled economies and centrally managed national budgets then we could come to some sort of resolution.
Germany vs the euro
Merkel is unlikely to unlikely to take any steps that are not in Germany’s interest at next week’s summit, but with pressure coming from the currency bloc and global authorities pressing for Europe to act decisively it will be hard for her to ignore their calls.
While Fiscal Union may not become a reality straight away the market at least expects a roadmap to be put in place that could see the currency bloc strengthen its union in the next six months to a year.
We can only wait to see if that is going to be enough to placate the financial markets and ease pressure on the sovereign debt markets of Spain and Italy.
Right now the answer to the eurozone’s crisis seems to be more Europe and not. Unlike other EU summits this one may take real, concrete decisions that could change the future of the currency bloc and bring the sovereign crisis under control at last.