Yesterday the Ibex fell 1.61%, losing support at 8,000 points and hitting lows not seen since March of 2009. The bloodletting affected all stock markets. Is this another crisis like the one that was unleashed by Lehman?
European politicians are responsible for finding a solution that halts the failures that are paralyzing investment, causing prolific losses, freezing credit markets and decapitalizing the banks.
Today, Merkel had to confront a Constitutional Court decision in regard to the legality of the first Greek bailout and recovery fund. It is most likely that she gets approval, but nevertheless, this incident underscores the increasingly large obstacles that Merkel has to work against in order to back the euro. As time passes, more and more Germans indicate that they do not want their tax money going to support undisciplined nations. Merkel's party has suffered various setbacks in important regional elections. And the German press just harangued the European Central Bank (ECB) for having broken with orthodox monetary policy in order to help Rome and Madrid by buying bonds from both nations. Further, Berlusconi is changing his recovery plan back and forth as many Italian protest the cutbacks.
Germany rejected the latest proposal to save Europe by issuing a common bond, because Germany would have to pay for some of the financing cost with no guarantee that the peripheral nations fulfill their obligations. Frankly, we are not surprised by Germany's misgivings. But Merkel's strategy to put as much pressure as possible on at-risk countries could unleash a serious global financial collapse. The damage could crack the euro. Europe should alter its course and anticipate what could happen.
Yesterday, a report from UBS explained what consequences we should expect if the euro were to collapse. The Germans only have to look to what happened in Switzerland in order to verify the good within the eurozone: the Swiss are trying to keep the franc at 1.20 euros because its appreciation is ruining their businesses. Competitive companies such as Nestlé, Novartis or Roche have demonstrated ineffectual leadership as their currency loses value. Something similar could happen to the Germans were there to a common currency. Further, falling stock prices and shrinking savings would be devastating for the European banks. The UBS report indicates that it would turn out to be cheaper to bail out Greece, Ireland and Portugal. With regard to the weakest economies, recent analyses forecast a future far gloomier than bank failures, fleeing capital and contagions.
Ultimately, countries would go back to their trade wars and imposing tariffs, Europe would become less relevant, and there could even be a risk of significant social tensions among EU nations. Nobody can bring themselves to define a plan for Europe. Chancellor Merkel should raise these issues and defend cohesion within the EU. The union has a big mortgage, and only they can pay it down. So they have to look at their losers and determine who is insolvent and who should get guarantees or backing. The bank can handle Greece, Ireland and Portugal.
But Spain and Italy are too big. Both countries could own up to their debt if they manage the situation reasonably. The most sensible proposal at this time is to transfer the recovery fund to a bank were there would be systemic risk, guaranteeing the debt and mitigating the current panic. Inflation would be a touch less harmful than full out economic collapse. The moment of truth is here for Merkel.
