Satyajit Das: Saved for now – but eurozone's chronic disease will re-emerge

Midweek View: Germany's willingness to continue financing the existence of the eurozone cannot be taken for granted
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The Independent Online

The eurozone leaders' summit was viewed by many participants as "encouraging". The European Central Bank (ECB) has cut rates by 0.25 per cent. Financial markets temporarily were calmer. But the results of the summit are unclear. The proposals are vague and details sketchy.

After the meeting, the German Chancellor Angela Merkel told the Bundestag that "differing communications" from various eurozone leaders about the exact agreement had "led to a whole number of misunderstandings".

Spain and Italy's gleeful boasts of unconditional aid do not square with Dutch and Finnish insistence that any money would require compliance with strict conditions. Finland is insisting that any aid has priority over commercial lenders.

The initiatives may require complex and time-consuming changes in European treaties. The German constitutional court must also rule on some aspects of the current proposals. Given issues of national control and sovereignty, the risk of delays and failure of agreement are not insignificant. In essence, implementation risks remain.

Importantly, there was no commitment of new money of any kind. Since mid-2011, Germany has resisted any increase in the size of existing bailout facilities. The ability of the EU to support the peripheral nations on an ongoing basis is questionable.

The €440bn (£348bn) of the European financial stability facility (EFSF) is largely committed to the Greek, Irish and Portuguese bailouts as well as the €100bn required for Spanish banks. When the new European stability mechanism (ESM) is fully operational, there will be €500bn available.

Potential requirements include a third bailout for Greece and further assistance for Ireland and Portugal. Additional money for recapitalising European banks, especially Spanish banks, may be needed. Spain and Italy have financing requirements of around €600bn in the period to 2014, mainly to pay maturing debt.

This also assumes that the EFSF (which is backed by guarantees from eurozone members including Spain and Italy) and the ESM (which will require capital contributions totalling €80bn from all eurozone members) can issue any required debt to finance its activities.

Support from the International Monetary Fund (IMF) is uncertain. The lack of conditions and supervision of loans may complicate IMF participation. Domestic politics within the US in a presidential election year may also limit flexibility.

The monetary arithmetic of European debt problems remains unsustainable. The EU may simply not have enough funds to carry out their programmes, unless the bailout fund are increased in some way or the ECB follows the US, UK and Japan into full-scale quantitative easing to monetise European sovereign debt.

The June summit also highlighted deep fissures within the eurozone itself. Germany, which is expected to pay substantially to solve the European debt problems, finds itself increasingly vilified and isolated. At the same time, the German Chancellor faces increasing domestic criticism for providing assistance without extracting agreement to suitable tough conditions from recipients.

Even without agreement on eurozone bonds, mutualisation of debt is already a fact as stronger countries, especially Germany and France, effectively underwrite support for weaker members of the eurozone. As more financing for weaker nations moves to official institutions, the commitment will increase. Germany faces potential losses of €800bn to €1.4trn. France also faces large losses.

Germany's willingness to continue financing the existence of the euro-zone cannot be taken for granted. Chancellor Merkel has increasingly emphasised that Germany's financial strength is not infinite. Facing complex, domestic political pressures, Finland and the Netherlands remain equivocal.

Ultimately, it is not possible to solve the problem of excessive indebtedness with more debt or by simply changing the lender.

Having avoided a life-threatening emergency, the eurozone's condition is that of a chronic disease requiring constant management. With treatment options limited, the strategy is palliative care. Baring the miracle of strong growth, the European sovereign debt and banking crisis will re-emerge in more virulent form.

Satyajit Das is the author of 'Traders Guns & Money' and 'Extreme Money'