Eurozone crisis

The mood was decidedly gloomy at a debate in the European Parliament in Strasbourg on Wednesday.

The president of the European Commission, Jose Manuel Barroso said that the 17 countries that use the euro were facing a “systemic crisis.” He added that these countries need to try to contain the crisis by taking even stronger action than they already had.

The leader of the liberal faction in the European Parliament, former Belgian Prime Minister Guy Verhofstadt told his fellow parliamentarians that the eurozone had reached “a very dangerous, crucial point, at which everything seems possible, even very dramatic scenarios.”

Jean-Claude Junker the prime minister of Luxembourg and chairman of the eurogroup, renewed his call for the introduction of joint eurozone state securities, commonly referred to as eurobonds. However he knows that the chances of that happening remain low, as long as the German government continues to reject the idea of a collectivization of debt. In light of that, Juncker also suggested a change to the decision-making process.

“If we intend to react quickly, we need to do away with the need for unanimity when it comes to financial questions,” Juncker demanded.

The strong words in the European Parliament were sparked by increases in the interest rates being paid by members of the eurozone which had until recently been regarded as stable. On Tuesday, the interest rates for France, Belgium, Austria, Finland and the Netherlands jumped sharply. This indicates a major loss of trust on the part of investors coupled with a wave of speculation against the eurozone as a whole. Then there is also the expectation that apart from Germany, eurozone economies will not continue to grow. Prices for credit default swaps in the eurozone also rose on Tuesday. These act as an indicator of how interest rates for government bonds are likely to develop in the future.

Lack of confidence in Europe's ability to act

“Investors aren't confident about the eurozone's ability to solve its problems. So they are looking for the safest place to put their money. That means Germany - and so everyone else suffers,” Elwin de Groot, an analyst with the Rabobank in the Netherlands told the Reuters news agency.

While Germany pays an interest rate of just 1.77 percent on 10-year bonds, France's rate is currently double that - and the gap between the two continues to grow.

“This can't be maintained in the long term,” Verhofstadt told the European Parliament.

Despite Italy getting a new government, its interest rate is hovering around the critical level of seven percent. Spain is being force to pay more than six percent, and its rate is on the rise. When Ireland and Portugal hit seven percent they were forced to seek refuge in the European bailout fund and were decoupled from the financial markets. However the European Financial Stability Facility (EFSF) would not be capable of financing a bailout of Italy, and it's still not clear precisely how a proposed leveraging of the EFSF's lending capacity to one trillion euros would work.

“What we are experiencing is a race between democracies and anonymous forces, who, through speculation, are exposing those democracies to clearly visible risks,” the leader of the Socialist faction, Martin Schulz, told the European Parliament. He accused the financial markets of seeking to profit from the bankruptcies of entire states, adding that everything possible must be done to protect Greece, Italy and others.

The role of the European Central Bank

But what does “everything” mean in this context? The European Central Bank (ECB) has again started buying up Italian and probably Spanish government bonds, in an effort to lower rates. Peter Bofinger, one of the five members of the German Council of Economic Experts, told the Financial Times Deutschland that if matters become much worse, the European Central Bank could be forced to intervene on a grand scale in order to prevent a collapse of the entire eurozone.

The financial markets are apparently betting on the European Central Bank reacting in the same way as the Federal Reserve in the US and the Bank of England, by making unlimited capital available to finance state budgets.

Jens Weidmann, the president of Germany's central bank, the Bundesbank, and his French counterpart, Yves Mersch, categorically reject such an approach - which would amount to simply printing more money. Both men are members of the ECB`s governing council.

Austrian debt limit

Austria's government is looking to head off trouble by approving the introduction of a debt limit. It foresees the reduction of the level of Austria's overall debt to 60 percent of gross domestic product by 2020. Austria is worried that it could lose its top AAA credit rating because the country's banks are heavily invested in Italy and eastern Europe.

The euro crisis is already taking its toll on Hungary and Slovakia. Both countries are currently having trouble finding any takers for their bonds. In many eastern European countries, consumers and businesses have taken out loans in euros or Swiss francs, making it increasing difficult for them to make their payments.

In Belgium, which is also facing higher interest rates on the refinancing of its sovereign debt, political parties are still trying to form a government - a year and a half after the last election. Negotiations on a budget for 2012 still haven't been concluded. At 95 percent of its economic output, Belgium's total debt is well above the limits set in European treaties.

On Friday, the European Banking Authority (EBA) is to release its report on the level of capital European banks would need to cope with a possible default by Greece or Italy. Financial experts put that figure at about 100 billion euros. It they were unable to raise that capital through the financial markets, governments would have to step in.

What isn't clear, though, is whether the EBA has factored in the risks posed by credit default swaps for government bonds. This insurance against a Greek default was also issued by banks, and sold on many times. At the moment it is unclear what the volume of that insurance is or who actually owns it.

Criticism from Washington

During a trip to Australia, US President Barack Obama criticized the European Union's management of the crisis, saying no clear plan was apparent. He also accused European leaders of lacking the joint political will to defend the euro as a currency.

“The problem right now is one of political will, it's not a technical problem,“ Obama said at a press conference. He added that while there had been progress in forming new governments in Greece and Italy, “at this point, the larger European community has to stand behind the European project.”

At the recent G20 summit in Cannes, the US called on the European Central Bank to play a stronger role in assisting countries carrying too much debt. It also called on European central banks to mobilize their currency and gold reserves. That's a course of action that the Bundesbank rejects.

Author: Bernd Riegert / pfd
Editor: Michael Lawton