EU Agreement Yields Temporary Confidence Boost; Problems Remain
The stock markets had been looking for a reason to celebrate and they got one with the latest EU patch. On the bond market the effect was in sharp contrast with the interest on debt of the problematic states, which refused to recede markedly from all time highs.
Economics is part psychology, part reality and factors such as consumer confidence are now regularly researched because they definitely impact on the economy. For Brussels there are some encouraging signs but question marks remain.
The EU finally took a clear direction in terms of Greek debt and wiped off a major chunk of it. It also faced down the banks on the issue of Greece by imposing a 50% "haircut", achieved by holding out the threat that if they don't agree to the haircut things would get worse. In fact, to continue the metaphor, they could become skinheads in the event of a Greek default.
There were the indications that Europe will move to greater economic centralization as evidenced by the pressures on Silvio Berlusconi to get Italy's economic house in order. EU President Herman Van Rompuy indicated that tougher controls on the budgets of member countries, integrated taxation, and a new framework for the Eurozone paralleling the EU's commission are on the way.
The Commission can prosecute delinquent EU countries on issues such as competition and impose penalties. Some have argued that true fiscal union is the only way to keep the euro on even keel.
The pessimists however have a case in arguing that the confidence boost will be short lived.
Greek debt is still 120% of GDP and can only be overcome with an uneasy partnership between austerity and growth. As both the Greek left and the Greek right have assailed the plan and its initiators, it is not certain whether Greece has been saved or merely reprieved.
If Greece is no longer on the radar, attention may shift to countries with lower debt ratios but with higher debts in gross terms, namely Italy. European solvency is contingent on a modicum of growth, but with the arrest of German growth a question mark remains over the entire plan.
The EU did not succeed in recruiting additional cash commitments and is now going to look outside - to the Chinese and the Gulf States. Putting aside the weakened political hand towards these countries (can a EU dependent on Chinese loans press Beijing on more equitable trade practices?), will this money be forthcoming and under what terms?
FDR was right in arguing that overcoming the paralysis of fear was a precondition for recovery programs. The EU has overcome the immediate fears of imminent collapse, but it must now also cope with hard competitive reality.