The Euro Crisis Once Again


05/14/2011 by Dr. Harald Malmgren

The Euro crisis has boiled up once again. Debate is raging about a variety of options to relieve stress in the Greek debt market, including altering the interest imposed by the EU bailout, debt extension, some kind of “workout” or restructuring, etc.

The Irish and Portuguese are already asking for reconsideration of their bailout requirements in light of rethinking Greek debt. EU Finance Ministers held an emergency meeting in early May to consider what to do about Greece. It was intended that there be an early follow-up meeting, but there is no agreement among Euro member ministers on what the agenda for a second meeting would be.

The Germans continue to insist on even more severe fiscal austerity measures to qualify for consideration of any kind of relief. The French are preoccupied with potential consequences for Ireland of any change in the Greek package. (The Irish not only insist on continuing to maintain their low corporate tax rate, encouraging European corporations to relocate headquarters in Ireland.

Adding insult to injury, the Irish have dropped duties and VAT on tourism from the Continent, with the result of a deluge of French and other Continental European tourists going to Ireland in preference to remaining in, or traveling to, France.)

Several lesser Euro governments are questioning whether any of the existing bailouts are legitimate, as they have not yet gained parliamentary approval. Some are questioning whether they would or even could agree to any further assistance to their “profligate” neighbors.

Chaos now reigns among the Euro finance ministers. All seem fearful of the negative consequences for their banking systems if any doubts are raised about any of the sovereign debt of any Euro members.

In addition, there is growing controversy about whether the ECB should be raising interest rates now when the consequence could be to strengthen the Euro. Only Germany is happy with a stronger Euro.

Others are quietly arguing that a stronger Euro will have devastating effects on already weak economic performance. The transition to a new ECB President presents additional challenges. If the Bank of Italy President Draghi takes up the post in October, he will likely need to raise rates once or twice early in his tenure to convince markets that he is not a typical “flexible” Italian, but rather a stern protector of the Euro. If so, raising rates now might make it inconvenient to raise rates later.

In the background, the performance of the Eurozone economy remains driven by Germany’s economic performance. Recent weak industrial data are consistent with our expectation that German industrial expansion is slowing and that the German export engine is losing strength.

German export growth is increasingly oriented towards Russia, China, and the rest of Asia. China is showing signs of rising levels of inventories of raw materials and finished goods. China’s strong demand for machinery and equipment to expand industrial capacity is coming up against evidence of industrial overcapacity.

Of course China’s economy will continue to grow, but the main impetus for growth may change from industrial investment to a different mix of domestic priorities. Germany will continue to sell high-end automobiles, but sales of German industrial machinery are likely to weaken.

If Germany’s economy slows, the Eurozone economy will definitely look much weaker.