On Thursday, global markets suffered their worst single-day losses in months.The causes were many and the losses spanned the major economic zones. The sigh of relief that first heralded the end of the American debt crisis quickly gave way to a traditional American panic attack.
Japan intervened—massively—in the currency market for the first time in months to stem the yen’s rise. Switzerland, which also suffers from an abnormally strong currency, implemented a somewhat unorthodox strategy of cutting interest rates to zero in an effort to scare investors out of the country. European Commission President Jose Manuel Barroso openly maligned the eurozone’s newly improved bailout fund, calling for a “rapid reassessment.”
Each of these factors warrants a discussion of its own, but in STRATFOR’s opinion only the last—Barroso’s statement—is geopolitically critical.
The EU bailout mechanism is called the European Financial Stability Fund (EFSF). It was formed in 2010 in the aftermath of the first Greek bailout in order to assure markets that the Europeans had the institutions and the resources in place to deal with any future debt crisis. Since its inception, the EFSF has been used for three bailouts: Ireland, Portugal, and a second bailout of Greece in June. During Greece’s second bailout negotiations, the function of the EFSF was adjusted considerably. The fund was given more autonomy and wider discretion over the kinds of crises to which it can apply its funds. Most importantly, though, the Germans now have far more control over how the fund functions.
In STRATFOR’s opinion these shifts effectively end the threat of outright national defaults in Europe. Germany definitively decided that it will allow its wealth to underwrite the union, but only in exchange for political control over how its wealth is used. With these changes, the Germans have staked their claim to European leadership.
However, preventing defaults is not the same thing as avoiding bailouts, and here is where Barroso’s statements come into play. Barroso asserted that the EFSF suffers from two serious flaws, and STRATFOR agrees wholeheartedly.
The first problem is that the changes to the fund agreed to at the last summit must be ratified by eurozone governments (in most cases through parliamentary approval). However, enshrined in the laws of most EU states is a robust vacation benefit for workers—six weeks a year is common.
In Europe, August is vacation time. The plan for the new EFSF may be fully agreed to, but the fund cannot act in its new capacities until the various parliaments reconvene after their summer recesses. At present no European parliament has been called back for an emergency session to ratify the EFSF changes. (Incidentally, Barroso made his comments today while on vacation back home in Portugal.)
The second problem is the latest summit’s failure to formally increase the EFSF’s maximum funding above its current level of 440 billion euro. Many observers—particularly bond traders—are concerned that the rolling eurozone crisis will not end until it becomes crystal clear that the Europeans have allotted sufficient financial resources to stamp out any reasonable crisis.
The colloquial term in the financial world is on the crass side, so we’ll paraphrase it as “shove it” money: The idea being that the Europeans would be able to point to the stack of reserve cash as proof that no European state will be allowed to fail.
The Germans, as the ultimate guarantors of the European system, would prefer not to increase the EFSF’s funding level for three reasons.
First, the required volume would be astounding. Right now the bond markets are treating Spain and Italy particularly badly. Bailing out the two of them would require at least an additional two trillion euro. Germany knows it will have to increase the EFSF’s war chest in time, but that much that fast is simply beyond the capacity of the German voter to support.
Second, in the German mind, any expansion of the EFSF should only be done in league with additional restrictions on borrowers’ actions. With the current revisions, Germany has seized de facto control of negotiations for bailouts, but those strictures were designed for smaller states and have yet to be tested.
The Italian economy is roughly seven times the size of Greece’s. Furthermore, the methods used to bring Greece to heel cannot be applied to a founding state of the European Union. If Germany is going to commit the massive resources required to bail out a major state, it will first want its political dominance codified, and it will want to test out the current system, which is still new and unused.
Finally and somewhat paradoxically, Germany reaps some benefit from the continuation of the crisis. So long as bond markets are pressuring EU states, those states are forced to come to Germany to humbly ask for assistance.
This assistance comes with a price that the Germans are now able to name. So long as the crisis does not spiral out of control, Germany actually needs the market pressure to steadily rewire the European architecture more to its liking. Berlin actually has a vested interest in keeping the crisis—and several EU states—on an aggressive simmer.