Europe News

Euro Zone Crisis: Markets Fret That Austerity Medicine Will Kill Patient

Peter Spiegel, Financial Times

Ask senior EU officials whether enough has been done to stem the two-year-old euro zone debt crisis, and many point to the number of new rules and institutions they argue would have been unthinkable before the upheaval.

Supporters of Alexis Tsipras, the head of Syriza, celebrate outside the political party's election tent after beating the Pasok party in the parliamentary elections in Athens, Greece, on Sunday, May 6, 2012.
Bloomberg via Getty Images

There is the permanent 500 billion euros rescue fund; firm rules with penalties for growing budget deficits and a new Brussels-based head of a “euro working group”, among others.

But after three months of relative calm at the start of the year, thanks to the 1 trillion euros pumped into the region’s credit-starved banking system by the European Central Bank, markets have begun to wobble again, worried that the underlying causes of the crisis have not yet been addressed.

Indeed as Standard & Poor’s, the credit rating agency, said in its recent downgrade of Spanish debt, there is increasing market sentiment that the medicine – tough debt and deficit limits imposed by the new rules that euro zone leaders have agreed to – may kill rather than cure the patient, by stifling economic growth.

“[W]e believe front-loaded fiscal austerity in Spain will likely exacerbate the numerous risks to growth over the medium term,” S&P wrote in its April 26 downrade statement.

Privately, euro zone officials acknowledge the creation of efficient and effective monetary union is far from finished.

Although significant power over euro zone government budgets has shifted from national parliaments to Brussels, the goal of fiscal and economic union to accompany the single currency remains far off.

“European integration has brought peace and prosperity,” Mario Draghi, the ECB president, said during a recent hearing of the European parliament.

“While I hesitate to sketch out the long-term end point of the integration process, I am convinced that we need to actively step up our reflections about the longer term vision for Europe as we have done in the past at other defining moments in the history of our union.”

But achieving the fiscal union that many economists believe essential for the survival of the euro, demands clearing several hurdles that some worry may be insurmountable.

The first problem, which has hindered responses to the crisis so far, concerns how to create a fiscal union and has divided north from south, new member states from old, and Germany from France. So far, integration has largely followed a path backed by Germany and a like-minded group of northern euro zone countries whose creditworthiness have been relied on in euro bailout efforts.

This system has been largely rule-based, culminating in the new fiscal discipline treaty that would forever enshrine balanced budgets and low debt in national constitutions.

Other countries, particularly Italy and other southerners, but also some more northern countries, such as France and Luxembourg, have argued that the new rules must be accompanied by pooling of financial resources if a workable fiscal union is to be achieved.

Mario Monti, Italy’s technocrat prime minister, and a respected economist and veteran EU official before he took office in Rome, has long urged the euro zone to issue common bonds backed by all 17 countries in the currency union.

By spreading lending risk among the 17 and including the triple-A rated economic giant Germany, the whole bloc would be able to borrow at lower rates, argue advocates of common bonds, giving weaker countries time and resources to reform their economies and make them more competitive.

German leaders have resisted the plan, arguing that cheaper borrowing would also remove the pressure on weak economies to make improvements.

But Berlin has also resisted other less ambitious ideas, including a Paris-backed push to give the 500 billion euros euro zone rescue fund unlimited resources by linking it to the bottomless pockets of the ECB.

The French government, with backing of other G7 countries such as the US and UK, has argued that showing the euro zone’s willingness to protect the currency through the ECB, could tackle panic in peripheral bond markets, where traders are worried they may not be repaid for the debt they hold.

But Germany has objected, and the integrationist push that enthused eurozone leaders in 2011 has largely stalled in 2012.

In recent weeks, European voters have shown they are also becoming more resistant to the path the bloc is taking, demonstrating a new willingness to back candidates who reject the status quo.

In the first round of the French presidential election, for instance, nearly 30 percent of voters supported candidates of the far left and right with firmly eurosceptic views.

Similarly, recent polls in the Netherlands, where the government fell because of disagreements over Brussels-mandated deficit targets, show that euroskeptic populist and fringe parties could make up nearly a third of the new parliament after elections in September.

Indeed, euro zone leaders’ big recent achievement, the fiscal discipline treaty, is under attack on many fronts: from the new Socialist French president, François Hollande, who has vowed to revisit it, to Irish voters, who appear likely to reject it in a referendum scheduled for the end of May.

“No matter the outcome, this is a necessary and healthy infusion of democratic legitimacy into our body politic,” says one Brussels-based EU diplomat of the raised profile of the “Europe question” in national elections.

“Good intentions and sound policies are not enough. Ultimately, [integration] must be supported by those for whom it was made.”