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How Long Will the Eurozone Agreement Hold?

Markets were pleasantly surprised that the Euro zone leaders were able to reach an agreement. Skeptics fear it will unravel.
By Amiel Ungar
First Publish: 3/14/2011, 7:57 PM / Last Update: 3/14/2011, 10:51 PM

 

On Saturday, process won out over substance in the reaction to the agreement by leaders of the eurozone on measures to combat the European debt crisis. Since there was so much advance speculation that no agreement could be reached, the very fact that the leaders reached an agreement touched off a wave of financial optimism. The countries most economically imperiled - Spain, Portugal and Greece -  saw the interest on their bonds drop by a fraction of a percentage point. Greek debt was the biggest beneficiary, dropping a third of a percentage point.

The odd man out was Ireland, that feels ebuffed by the eurozone because it would not acquiesce to raising the tax on corporations. Greece was given an extension on debt repayment and a slight interest reduction, due to its willingness to sell off $50 billion worth of state assets.

The main features of the deal was an expansion of the bailout fund, or by its official name, the European Financial Stability Facility, to €440 billion. This is nearly twice the previous level, presumably setting investors at ease. Secondly the EFSF can buy state bonds direct from governments, enabling them to resist market pressures for higher interests. The price for this favor will be the bond-issuing government's willingness to assume austerity measures.

Ireland's government , which won the election on a pledge to renegotiate the previous government's bailout deal with the EU, came away embittered. Both France and Germany made a softening of interest and repayment terms contingent upon Ireland's revising the corporation tax rates. The Irish claim that such a request is unfair.

As opposed to Germany, positioned advantageously in the center of Europe, Ireland is on the periphery. The main way it can attract corporations and investments is by a lower corporate tax. When Irish voters originally nixed the Lisbon Treaty, Ireland received reassurance that the lower corporation tax would not be touched. The Irish also claim that sanctimonious countries such as France provide hidden subsidies so that they effectively have a lower corporation tax than Ireland's.

The Irish press is filled with talk that Ireland will make the EU come to its senses by threatening to bring the financial house down not only upon itself, but simultaneously on the EU. A bail out was necessary to prop up the Irish banks. Perhaps, they hint, it would be best to let them fail and have Ireland default on its debt.  Ireland would suffer, but so would the EU countries that hold substantial loans to the same banks. If Ireland defaulted, this would create pressure on Greece and Portugal to default.  

The European Union claimed to be satisfied with the restructuring of the Irish banking system (in other words they do not believe that Ireland will carry out its threat). There is a certain irony in the situation. Ireland became an EU stalwart because of European aid to its distressed regions, but also because EU membership helped Ireland shake off economic dependence on Great Britain. Now some Irish are complaining that the EU and particularly Germany are imposing a similar vassalage.

The skeptics believe that despite the deal, the real problems remain. The problematic countries in the European Union need debt restructuring. They cannot take further austerity measures without inviting major public pushback. Portugal, that will cut its budget by 5.3% this year, witnessed a demonstration of 300,000 in Lisbon whose participants compared it to Egypt's Tahrir Square.

Others view the austerity demands as tantamount to the dismantlement of the welfare state.

Everybody has his interpretation. While some welcome German leadership, others fear Teutonic dominance. German voters have no sense of victory, but feel they are being played for suckers by bankrolling the debts of others. These problems have only been exacerbated.

Then there are totally unrelated outside events that can upset the entire applecart. If German Chancellor Angela Merkel appeared to be the iron maiden in Brussels, her position has been undermined by the recent Japanese disaster. Merkel has been an advocate of nuclear power, at least until replaceable energy can kick in. The Chernobyl nuclear reactor disaster was ascribed to obsolete Russian equipmen .With modern technology and the appropriate safeguards it was believed that it would not be replicated in an advanced country. Japan has demolished that argument and placed Merkel in a precarious position prior to important state elections.