Bill Jamieson ‘They think it’s all over’

COMMENT

BILLJAMIESON | Executive Editor of The Scotsman

‘They think it’s all over’

Despite the summer pause, the euro crisis has a lot further to run.

Call it a flight from reality, or just plain panic exhaustion: for a few blissful weeks this summer European financial markets enjoyed an eerie calm. Markets acted as if the eurozone sovereign debt crisis was a storm on the wane, while investors clung to that reassuring declaration of European Central Bank President Mario Draghi that the bank would do “whatever it takes” to save the euro.

The voice of the ECB had spoken. It left no room for doubt. The fear gauge fell, stock markets rose and yields on problem sovereign bonds sank back. It was as if, in the haunting words of a football commentator speaking from another era, ‘they think it’s all over’.

Unfortunately for those borne along on this surge of wishful optimism, there was no immediate ‘score’ to validate Draghi’s pronouncement. Even assuming agreement is reached on the scale of ECB intervention and the formula adopted – the sliding scale of conditionality – this game is very far from being ‘over’.

First, it is unlikely that the sustained opposition of the German Bundesbank to the ECB’s plans to intervene in sovereign bond markets is going to end any time soon. That opposition is deep-seated. It will not be allayed by cosmetic alterations to the phraseology of conditional intervention. Bundesbank President Jens Weidmann has issued his strongest warning yet that he is opposed to large scale bond market interventions.

Even if a modus operandi is agreed, there is a major question mark in the case of Spain over how big the bail-out would need to be. Here the country’s devolution has left considerable doubt as to the total of public debt across its 17 autonomous regions. Valencia has said it will need a bigger bailout from Spain’s central government than it previously expected. It will ask for €4.5 billion (£3.6 billion) more than had been suggested when it first made the plea earlier in the summer. And debt-ridden Catalonia has also asked for a bailout of five billion euros. Valencia has become infamous for white elephant projects, absorbing large amounts of government spending. For example, Castellon Airport, which cost billions, has yet to have a flight take-off or land.

Spain’s economy overall has shrunk for three consecutive quarters as it wrestles with a property bust. Back in June Spain requested €100 billion of loans from the eurozone’s bailout fund to help support a banking sector brought to its knees by commercial property loans that turned bad. Speculation has persisted that the country will need a full financial rescue.

“The eurozone is in a broadlybased recession. There is clear evidence that the eurozone as as a whole and not just the periphery is in need of policy support.”

Out and in?

Second, for the ECB plan to work, it will require confidence in a successful outcome and an end to persistent speculation of a break-up of the eurozone and the exit of at least one of its existing members.

This seems unlikely, considering that one proposal still doing the rounds as we went into September was a ‘temporary exit’ of Greece. This plan was considered within the German finance ministry to be the most likely outcome and was said to enjoy the support of Finland, the Netherlands, Slovakia and Estonia. The danger here is that a southern European debt crisis would spread out to become a northern European political crisis.

Others have dismissed the ‘out and in’ plan as ‘the stuff of fantasy’, not least because such an exit would still fall victim to the chain reaction and search for the next weakest victim that an outright exit would trigger. Conversely, if a Greek exit and readmission ploy was found to be acceptable to Greece, enabling it to come back into the euro at a lower exchange rate, which other vulnerable countries would be tempted to follow suit? Its very success would surely be the trigger for others to seek the same remedy.

Meanwhile, the eurozone’s descent towards recession continues to gather pace and business confidence continues to fall. The European Commission’s economic sentiment indicator dropped again in August, the sixth consecutive monthly decline. “August’s weaker than expected EC business and confidence surveys,” says Jennifer McKeown, senior European economist at Capital Economics, “provide further signs that the eurozone is in a broadly-based recession. There is clear evidence here that the eurozone as as a whole and not just the periphery is in need of policy support.”

Germany was one of the worst affected countries, with a fall in business sentiment showing how austerity measures striking consumer demand in the eurozone periphery are hitting exports from Europe’s largest economy. German exports to Spain were down 9.4 per cent in the first six months of the year while exports to Greece were down 9.2 per cent and to Italy by 8.2 per cent.

Whatever the outcome of the ECB’s deliberations – and whether the its plan will be approved or opposed by the German Constitutional Court – business managers are predicting that production output and order books have further to fall. The school of ‘they think it’s all over’ is set to have its nerves sorely tested in the period ahead. n