2012: Between Doom and Hope
Alexander Privitera is the Washington-based Special Correspondent for the German news station N24 and is a frequent contributor to AICGS publications and events.
Let’s take a deep breath, 2011 is finally over. Unfortunately, those involved in the continuing saga of the euro zone crisis will hardly welcome the New Year with a sigh of relief. In fact, they are gripped by anxiety.
A good friend of mine who works for a big international institution in Washington D.C. recently told me that he had liquidated all his stocks and was not planning to invest in equities for at least three months. Every time I try to extract some optimism from him or others familiar with the European crisis, I am treated like a fool. Eventually I will stop trying.
All self-appointed oracles have proclaimed that as we head into the New Year, things will get worse before they get better − possibly much worse. Even politicians are now going along with the conventional wisdom. Exuding her customary quiet confidence, German Chancellor Angela Merkel warned her fellow citizens in a televised New Year’s address that 2012 was going to be harder than 2011. Her words echoed those of French President Sarkozy, and the two leaders were not alone in issuing warnings. Market gurus have spoken of a dire first quarter. Bank of America Merrill Lynch told its investors to stay on high alert: “we are all Europeans now.”
So, what lies ahead as we walk in to the New Year across this European minefield? France was the first euro zone country to come under the spotlight. Its bond auction on Thursday of this week went relatively well. But many observers still expect France and possibly even Germany to soon lose their top rating status. A downgrade would be a severe blow for France, but only if its more powerful neighbor to the east was to be spared by the rating agencies. If that happens, Paris would find it harder to refinance its debt. But a downgrade would also affect the ability of Europeans to fill the coffers of the bailout fund, the European Financial Stability Facility (EFSF). In the absence of a lender of last resort, a well functioning EFSF is badly needed to keep Europe’s periphery afloat, particularly if Spain and Italy come under renewed fire.
Next is the task of turning the commitment for a fiscal compact, made by 26 EU governments, into a treaty ready for ratification. In a now familiar pre-summit flurry of diplomatic activity, French President Sarkozy will meet with Chancellor Merkel on January 9th to set the agenda for the next big gathering of European leaders later this month. Some governments need a better deal. In particular, Rome is asking Berlin to agree to a roadmap for common Eurobonds. Italian Prime Minister Monti needs concessions from Berlin in order to solidify his power base at home. He too has a very busy travel schedule in the coming weeks. His visits include Brussels, Paris and most importantly Berlin. With Italy facing difficult months ahead, the country needs both fiscal discipline and economic growth. On top of Italy’s needs, there is a mountain of debt to be refinanced over the next three months. In effect, the survival of the Euro hinges on Italy’s capacity to get back on track.
Furthermore, the sovereign debt crisis could deepen even further if the European banking sector remains under severe stress. With Hungary loosing investors’ confidence, Eurozone banks exposed to Middle and Eastern Europe are already suffering. Italy’s Unicredit experienced a brutal week on the stock market. In a sign that banks still don’t trust each other, financial institutions continue to park cash at the European Central Bank (ECB). Weaker institutions could even face nationalization. Public finances in cash stripped countries would face additional strains.
Last but not least, it is worthwhile taking a quick look at the epicenter of this mess. The Greek rescue deal could come unstuck in March. Creditors have been asked to consider a more dramatic haircut on their bond holdings. On a recent visit to Berlin, a high level negotiator was rebuffed by a German government official with the words: “We don’t want to hear about bad news from Greece anymore.” Although Athens’ debt has been written down by most of its creditors, a disorderly default could mean an exit of Greece from the Euro and would trigger a new bout of panic.
While there are many dark scenarios for the next three months, reasons for hope do remain.
Firstly, even if France and other countries lose their triple-A rating, markets appear to have already accepted and priced in this possibility.
Secondly, recent data released by the Federal Reserve Bank (FED) indicate that most European banks have sold significant amounts of their low yielding U.S. treasuries. Some of that cash could be reinvested in higher yielding European bonds, including those of France, Spain and Italy.
Thirdly, Rome has so far successfully placed all its bond offerings. If the trend continues and spreads go lower, Prime Minister Monti would be able to show Italians that markets are willing to give the country a chance, and to make a convincing argument that modernizing Italy’s economy truly is the only way forward. Despite mounting opposition from trade unions, Monti has a good chance of successfully pushing through some of the badly needed structural reforms, such as the liberalization of the labor market. Most Italians, and even the majority of the political parties, still want him to succeed.
Fourthly, there is a good chance that the fiscal compact might turn into a EU treaty, paving the way for closer fiscal integration. At the end of the road, Germany may decide to agree to the introduction of Eurobonds.
Fifthly, the ECB plans to inject more liquidity into the banking system in February. This will ease the pressure on the troubled credit system and perhaps avoid a crippling credit squeeze.
And lastly, as the Euro weakens against other major currencies, euro zone economies are regaining some of their global competitiveness. A weaker Euro will not change the dire state of the Greek economy, as its exposure to the global economy is far too limited. But for bigger economies like Germany, Italy, Spain and France, a weaker Euro could spurt export driven growth and mitigate the effects of the many austerity packages that governments are imposing on their citizens.
Surely, this year is destined to have a very rocky start. But perhaps, after so many twists and turns, 2012 will finally see a breakthrough in the battle to save the Euro.