Sword of Damocles Hangs Over Europe: Economist

A "sword of Damocles" hangs over Europe and could lead to a fundamental change in the way nation states view the region's single currency, according to Bank Sarasin economist Jan Poser.

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“There is a latent risk that national referendums or new elections could fundamentally alter a country’s stance on the euro. The events surrounding new elections in Greece and the proceedings beforeGermany’s Federal Constitutional Courthave sown doubts that cannot be easily lifted,” said Poser in his monthly note to investors.

The euro zone debt crisis rumbled on on Friday, with Moody’s decision to downgrade Italian debt the latest in a long line of negatives for the single currency. With Spain debating the merits of massive austerity measures and IMF boss Christine Lagarde demanding more than lip service from Greece on spending cuts, tensions remain high.

Despite significant progress at a summit of EU leaders in late June, Poser believes much more needs to be done and fast, or at least faster than EU policymakers are willing to move.

“The summit outcome represents an important step towards genuine monetary union. Some key elementsare still missing, however,” said Poser.

“The rescue mechanism does not have enough resources to shield all highly-indebted countries in a crisis situation. This creates a lack of confidence, which in turn increases credit spreads. It would take—at least in theory—the threat of unlimited resources to prevent a potential escalation of the crisis. One solution would be to allow the ESM direct access to the ECB ," he said, referring to Europe's permanent rescue fund known and the European Stability Mechanism or ESM.

Poser believes the ECB’s decision to cut interest rates last week was largely symbolic and not enough, and wants to see more liquidity injections, or “LTRO 3”.

But investors are still worried about the safety of their principle investment, he said.

“Bond investors are more concerned about the return of investment than the return on investment. If repayment is at risk, all buyer groups will stay away. Words must be followed up by actions if bond investors are to return to the market. But we will know only after several years have passed whether the consolidation measures have borne fruit. There is a risk that confidence will not return for a long time,” warns Poser.

Having watched policy makers muddle through for over two years, Poser now believes the politicians will be forced to pool national debts, whether they like it or not.

“If a euro member state loses access to capital markets, there is no institution which would give it the needed funds. There is no lender of last resort," he said.