Euro is close to suffering the knockout blow as trouble rises

Philip Salter
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THE euro is facing so many existential threats that markets don’t know where to look: anti-bailout elections have rocked Finland; umbrage is growing across Germany; austerity tightening is squeezing Portugal; Greece is on the precipice; banks are junked in Ireland; and jitters grow in Spain.

In Sunday’s Finnish elections, the True Finns Party claimed 19 per cent of the vote, gaining 39 seats. The True Finns are a populist party driven in large part by grassroots concerns about immigration, rural affairs and senior citizens. Finland’s participation in future bailouts is in question if they live up to the colourful rhetoric of their electioneering. But despite the media focus on the True Finns, it should be remembered that Finland’s Social Democratic Party, which won 19.1 per cent of the vote, also opposed the Greek and Irish bailouts. Whatever the consensus finally reached in Finland, James Hughes of Alpari says that in response “Euro area members could restructure the facility,” so it “shouldn’t be a deal-breaker” for the Eurozone. Nevertheless, if the Finns refuse to pay for future bailouts, voters in other countries will surely ask why they have to shoulder the debts built up beyond their borders.

Michael Hewson of CMC Markets suggests the success of the True Finns Party is an expression of wider discontent across Europe: a belief that the more austere nations shouldn’t fund the profligacy of the periphery. Angela Merkel has lost three local elections on the trot in the face of growing resentment that Germans are picking up the Eurozone’s bill. As Hewson points out, given that the Germans are retiring at 67, the French at 63 and the Greeks are still giving up work in their 50s, this rising intolerance is justified.

Meanwhile the €80bn Portuguese bailout is being worked out in Lisbon. The Social Democratic Party, which effectively forced out Jose Socrates by rejecting his austerity plans, is apparently willing to comply with the European and International Monetary Fund (IMF) representatives. Ironically, as Hewson suggests, the terms imposed externally will likely be tougher than Socrates put forward. Time will tell whether the people will be able to swallow the necessary medicine of fiscal retrenchment.

Many Greek citizens have reacted to their troubles with violence and strikes. Ian O’Sullivan of Spread Co thinks “Greece is probably a lot worse than the policy makers and European central bankers are letting on. The Institut fur Wirtschaftsforschung’s (Ifo) Hans-Werner Sinn recently said that he sees a formal default in Greece in the near future.” O’Sullivan also points out that in Greece unemployment is at 14.1 per cent, its Purchasing Managers’ Index (PMI) numbers declined in March and car registrations fell by 55 per cent year-on-year in March. He concludes: “The country is struggling and does look right on the edge.” Germany’s Finance Minister Wolfgang Schaeuble has gone on record as saying that if Greece fails a June audit “further measures may have to be taken.” The gulf between the countries has been confirmed by yesterday’s Eurozone PMI figures. Although up to 57.8 in April, from 57.6 in March, this was driven by the core and hides an increasing divergence between the flourishing core and weak periphery.

Ireland does not look to be in much better shape. On Monday, ratings agency Moody’s downgraded the bonds of Allied Irish Banks (AIB), Bank of Ireland, EBS and Irish Life to junk on the back of a “high level of uncertainty around whether the government would extend further support to the banking sector if required.” Ireland’s Prime Minister Enda Kenny is busy reassuring markets that Ireland isn’t going the way of Greece, but much will rest on whether he is able to renegotiate Ireland’s debt, while holding on to Ireland’s vital competitive edge in the form of its 12.5 per cent corporation tax, which is under assault from both President Nicolas Sarkozy and Chancellor Merkel, who want to harmonise EU rates.

Contagion from Greece and Ireland is the big fear. “Spain has to be in the firing line too because it is tied in too heavily with Portugal and Greece with their banks,” says O’Sullivan. On Monday, Spain’s 10-year bonds shot up to 5.3 per cent, from 1.7 per cent the previous week. Elena Salgado, Spain’s finance minister, knows how serious things are and responded yesterday by arguing that she still expects 1.3 per cent growth in 2011 and will introduce measures to reduce the black economy, liberalise retail opening hours and reform civil servant pensions. However, this puts her at odds with Prime Minister Jose Luis Rodriguez Zapatero who has previously insisted that there won’t be any more major reforms. There is talk of Italy being the next country to fall after Spain, but Spain would likely be a default too far. As Hewson suggests, Spain is “too big to bail, too big to fail.”

“Spain is definitely at risk of being dragged into the debt mire primarily because of its overleveraged and underperforming banking sector,” says Hughes. He “wouldn’t be surprised to see an officially two-tier Europe with a strong core, while the indebted periphery is sidelined and potentially forced to return to their own currencies that existed prior to 2000.” He thinks “in the long-term the euro will survive, but its member countries will probably be reduced to improve confidence and reduce the strain of high government debt.”

France’s enlightenment philosopher Baron de Montesquieu believed that the climate played a part in determining human nature. Following Herodotus, he thought that the nations of Europe were set apart in character, determined by their differing weather patterns. The Frenchman believed, perhaps unsurprisingly, that France offered the perfect blend of the stiff north and the hot-tempered south. No doubt an unjust oversimplification, the nations of Europe have nevertheless proven unable to shake off their stereotypical differences. Though tied together by its monetary experiment, they still remain very much divided.