Sarkozy and Merkel announce plans for closer EU integration

THE story of the crumbling Eurozone took a new twist yesterday with a joint press conference given by German chancellor Angela Merkel and French president Nicolas Sarkozy. This followed an afternoon of meetings between the two premiers, as they discussed ways to shore up the euro.

The plight affecting the euro has largely been centered on the woes of the periphery Eurozone countries, as the stronger central economies bailed them out lest they sank under the weight of their debt burden, dragging the stronger economies down with them. But this change became even more apparent when France posted zero growth in GDP and the perceived industrial powerhouse of Germany posted only 0.1 per cent quarter on quarter growth yesterday.

Piled on top of the doubts cast upon the ability of German taxpayers to bail out their profligate European cousins via the ECB and the EFSF, speculation abounded that French government debt was going to be hit with a downgrade from its current AAA status. These worries triggered rumours of the introduction of a combined eurobond. But Merkel rebutted these rumours saying: “I neither think that Europe is at the point of needing its last resort, nor do I think that we can solve these problems with what I have called a bang. I do not think euro bonds will help us in this.”

But though Merkel brushed off speculation of a eurobond, the common theme of the conference was a move towards fiscal union of Eurozone countries. Sarkozy said that proposals would be put forward to elect a Eurozone president for two and a half years, proposing current EC president Herman Von Rompuy for this post. Sarkozy was less solid in his stance against the idea of a Eurobond, but supported its introduction only after further European fiscal integration. According to Alejandro Zambrano, market strategist for FXCM, there are more problems holding back eurobonds besides fiscal integration: “In the long run eurobonds are most likely a part of these proposed solutions, which is also good for the euro. However, who will dictate the premium that Eurozone countries pay to borrow? If this is not set by markets rather by officials we might end up wrong in either case.”

Angela Merkel’s opening gambit in yesterday’s press conference was to announce: “Our proposals are designed to win and secure the trust of the markets with action.” Merkel added: “We believe that Eurozone member states must, with a higher commitment, ensure that the core of this stability and growth pact will be strictly adhered to.”

However, despite Merkel’s aims of restoring market confidence in the Eurozone, the announcement seems to have had quite the opposite effect, with the euro falling against all of its major currency pairings. “There were a lot of fascinating things to come out of the press conference which started to see the euro tick up, almost hitting yesterday’s highs of $1.4476,” says Ian O’Sullivan, head of marketing at Spread Co. “But the early excitement faded and reversed as soon as they moved on to the issue of the EFSF and that it was big enough, no need for expansion, as increasing it would just invite speculation. This sent euro-dollar crashing back below $1.440 as traders were pinning hopes on eurobond news or expansion of the ESFS to shore up the peripheral Eurozone countries.”

Yesterday’s press conference also saw the Tobin tax rear its ugly head, as Sarkozy announced that France and Germany would propose a tax on financial transactions in September. Though European markets had already closed by the time the announcement was made, it is likely that this announcement will cause European bank stocks to take a hit when markets open this morning. As well as short term hits for the equities markets, this measure would also have long term ramifications, as the tax distorts the real world information conveyed by the price system. “In some cases, a Tobin tax can increase the size of asset bubbles, if the assets are illiquid, by forcing traders to make larger and fewer individual transactions,” says Sam Bowman of the Adam Smith Institute. “Trying to blind markets to reality won’t change the fundamental reality that the Eurozone is broken and can’t be fixed, and might even make things worse.”

Though this will not have an immediate effect on currency markets, any volatility could see a recurrence of the trend for investor flight into the safe havens of the Swiss franc as well as gold as a de facto haven currency.

Plans were only sketched out in yesterday’s announcement, with little in the way of concrete plans as to how these would be implemented, according to Kathleen Brooks, research director for “The only thing that we do know is that Sarkozy and Merkel aren’t willing to ditch the Eurozone and let the peripheral nations drown just yet.”