A summer of turmoil in the Eurozone

By Angus Bromhead

Summer holidays are being cut short on the continent this month as politicians scurry back to their capitals in an attempt at averting crisis. News that financial turmoil in the Eurozone has spread from its periphery to its core has shocked many in Europe. On Tuesday, pedestrian second quarter GDP growth figures of only 0.2% were announced for the region as a whole, even the German economy is stuttering. Whilst stocks from last week’s market panic ‘’ might ’’ well be slowly recovering all the warning signs point to a drastic need for Europe to address its financial woes to avoid a return to recession.

Despite this, when slow Eurozone growth is put into a wider context the figures are not quite as surprising and ought to have been better anticipated. Germany’s unsustainable growth and forecasts from the first few months of this year in addition to a global decline in demand, the economic fall-out from Japan’s horrific tsunami and the political stalemate in Washington mean that GDP figures are being universally revised down. Eurozone ministers must work, however, towards more stable and sustainable growth to better shield it from global events, and improve the prospects of many of its citizens who are remaining unemployed as a consequence.

Angela Merkel and Nicolas Sarkozy met in Paris on Tuesday in a long anticipated meeting which hoped to promote a cohesive and effective fiscal policy. In the run up to the meeting many European economists have been calling for the creation of Eurobonds as a potential solution to the crisis. The idea of which is simply that the Eurozone would be able to issue bonds which would backed by all members. This would divide responsibility amongst members and make the cost of borrowing cheaper for the area’s weaker economies but would equally increase the price for stronger economies. Issuing and importantly guaranteeing mutualised Eurobonds would be an enormous political decision and would mean greater fiscal and economic unity. A step most in Europe are unwilling to take.

Unsurprisingly, both Merkel and Sarkozy have rejected the idea of Eurobonds. Their unambitious and confused proposals are unlikely to be widely accepted. The suggestion that governments legally bind themselves ‘constitutionally’ to working towards stable balanced-budgets doesn’t seem a realistic prospect. Many members would struggle to get this through parliament, not least Sarkozy who does not have a majority. In addition they pledged to work towards the implementation of a common corporation tax and a Europe wide tax on financial transactions. Both leaders resolved to stand by the Euro as their common currency and looked towards greater integration in the future planning twice yearly Eurozone meetings. The consensus was a move towards more aggressive austerity measures.

Wider economic disruption should not distract the Eurozone countries from the pressing need to improve their finances. In addition to its periphery, core countries such as France are at risk of returning to recession. The recent collapse in its stocks, in particular those of Société Générale, indicate investors’ fears and is a warning. Despite this France and Germany are not in as much danger as Italy and Spain for example and may still have room for manoeuvre in their fiscal policy given their high tax revenues.

This begs the question, are the austerity measures needed and prescribed for one part of the Eurozone necessarily the solution for the other? Both the German and French economies amongst others are still relatively strong and resilient despite recent sluggish growth. Whilst drastic austerity measures and tax rises may be a necessary long-term evil, Eurozone leaders must be aware of their social consequences: further riots, strikes and protests are not out of the question. Austerity can also have the opposite effect of smothering growth and demand in key areas and sectors. European, especially Eurozone economies, are closely linked. Rising consumer demand in Europe’s stronger countries will help those countries who are forced to impose austerity measures, whose domestic demand will fall.

Angela Merkel is correct in saying that there is ‘no magic wand’ which will solve the Eurozone’s problems and none of the potential solutions are clear in their outcomes. The sovereign debt crisis may indeed last longer than anticipated but the Euro should survive. None of the leaders will be prepared to take the political risk of issuing mutualized bonds, so further alternatives need to be explored. One thing is clear however: whilst the Euro and the Eurozone continue to bring benefits, France and Germany will continue to invest in their future. Economic growth and job creation will happen eventually, it is just a question of when and whether we will see a recession beforehand.

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