By Paolo von Schirach
April 5, 2012
WASHINGTON – Until yesterday the EU leaders and many international analysts concluded that the European debt crisis had been successfully dealt with. After the admittedly long and painful rescue of Greece and new fiscal austerity measures in Ireland, Portugal, Spain and Italy, (all accompanied by political upheaval), it seemed that the worst was over and that going forward there would be no repeat of the excesses that originated the crisis in the first place. To make sure that this will never, even happen again, the EU countries agreed on a new Fiscal Compact about to come into force that commits member states to fiscal rectitude.
Feldstein: Fiscal Compact may not work
Except that it does not, really, argues Harvard Professor Martin Feldstein in a recent WSJ op-ed piece, (Europe Needs The Bond Vigilantes, April 5, 2012). The Compact commits EU countries to a “cyclically adjusted” budget deficit no larger than 0.5% of GDP. The problem is in interpretation. There is no clear definition of “cyclically adjusted”, and each country will argue whatever it wishes to justify whatever level of spending and whatever deficit there will be, claiming that it is within the rules.
The real issue, as Fedlstein notes, is that most countries at the EU Southern periphery are inherently weak and thus incapable of running at the same speed of stronger and more efficient Germany or Scandinavia. Recent rescue plans may work –for now; but unless these economic laggards learn something new, the reckoning has just been postponed.
Austerity, as Nouriel Roubini and others have noted, is inherently recessionary. Beyond spending cuts, (necessary as they are), countries need growth strategies so that they can grow out of debt and prosper. But the economic outlook for the non competitive South of Europe is not good.
Bond markets already penalizing weak economies
And the bond markets have already taken notice. A recent auction of Spanish bonds was under subscribed. Yields on Spanish 10 year bonds hit 5.81%, the highest rate since last December. Italian bonds are back up to 5.49%, the sharpest rise since last November. In contrast, Germany’s 10 year bonds are at 1.74%. The spread is wide. Quite clearly, investors do not want the bad stuff. Soon enough you will see bond prices of weak countries go further down and yields creep up even more.
Very simply, markets will not be fooled by EU Fiscal Compacts establishing iron rules that will be circumvented. Southern Europe cannot get economic efficiency and real growth through treaties. It needs vibrant economies, and Brussels cannot supply them.
Some countries too weak to stay in the Eurozone
In the end, and may be sooner than any risk averse policy maker would like, the Eurozone stronger economies will have to deal with the simple fact that some of the current members just do not belong. While getting them out of the monetary union would be extremely complicated, keeping them in may just not be viable.