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Spain and Greece may head for euro exit

If German court insists that country’s liability needs to be limited to 190bn euros, then something needs to give.
Last modified: 12 Sep 2012 19:22

With a few caveats to protect parliaments sovereignty and taxpayers, Germany’s Constitutional Court cleared Europe’s new 500bn euro bailout fund for operation, to the relief of eurozone political leaders.

At the same time, the European Commission's president, Jose Manuel Barroso, in his state of the union address called on the European Union to become a "federation of nations sates" and proposed some 6,000 banks across the eurozone should fall under the supervision of the European Central Bank (ECB).

Despite Bundesbank objections, the ECB has promised to buy "without limit" bonds from distressed eurozone members. The pieces to a plan to save the euro are falling into place, but saving some peripheral euro zone nations is an altogether tougher task.

Like a huge sticking plaster dipped in water, this will all unravel as high-levels of debt continue to weigh heavy on proliferate states.

It’s clear that the mandate under which the European Stability Mechanism (ESM) operates needs to be changed to meet German demands.

For example, article 25(2) of the treaty states that members are jointly liable for any losses arising from loans made by the ESM. That means if one or more of the ESM members fail to meet their agreed financial contributions, the other members are liable for the shortfall. That situation is already a reality, because Greece and Portugal are unable to make any contribution.

Article 21 further authorises the ESM to borrow on the capital markets, from banks or from other financial institutions, which presumably includes the European Central Bank.

If the German court insists that the country's liability needs to be limited to 190bn euros, then something needs to give. The court also says any demands above their limit must be brought before parliament.

No Plan B

The court is safeguarding neither the country's sovereignty nor its taxpayers. In fact, once you start to throw out the bathwater, the baby will go with it. At what point do you stop funding this euro project?

There is no Plan B, this much is clear. Mario Draghi, ECB president, did the only thing he could, promise to buy bonds of nations that first seek a bailout from the ESM. It’s up to the politicians in Greece, Portugal, Spain and Italy to deliver by burning through their debts and losing sovereignty, if they haven't already surrendered it.

Greece needs more time and money, but the troika are not obliging. However, with the ESM's and ECB's increased firepower, Jennifer McKeown, senior European economist for Capital Economics, suggests:

the eurozone authorities might be more willing to let the likes of Greece and Portugal leave the eurozone. Accordingly, our long-held view that a limited eurozone break-up will commence in the coming months is unaltered.

… bond purchases of any size can address only one of the symptoms of the euro-zone crisis and not the cause. Even assuming that Spain and Italy are bought some time with large and rapid bond purchases, their debt burdens will remain un-sustainably high.

… And they must still undergo many years of internal devaluation, involving painful wage deflation, if they are to restore their competitiveness and achieve sustainable growth within the single currency area. So while the immediate risk of Spain or Italy leaving the eurozone has receded, there remains a significant chance that they opt to quit in the longer term.