EUROPE: ONE STEP CLOSER TO A FISCAL UNION?

The new Euro bailout package is essentially more of the same.  But with a very different tone.  In my opinion, the recent commentary is showing all the signs of moving towards some form of fiscal union.  Let’s review a few of the comments, which can be found in their entirety here.

“6. All other Euro countries solemnly reaffirm their inflexible determination to honour fully their own individual sovereign signature and all theircommitments to sustainable fiscal conditions and structural reforms. The Euro area Heads of Statesor Government fully support this determination as the credibility of all their sovereign signatures is a decisive element for ensuring financial stability in the Euro area as a whole.”

This sounds to me like the Europeans will do everything in their power to avoid a default.  The risk, as I’ve said before, is that the voters alter the playing field at some point, refuse austerity and force a default.  But if left in the hands of the EU leaders there appears to be a very small chance of default.

“9. All euro area Member States will adhere strictly to the agreed fiscal targets, improve competitiveness and address macro-economic imbalances. Deficits in all countries except those under a programme will be brought below 3% by 2013 at the latest. In this context, we welcome the budgetary package recently presented by the Italian government which will enable it to bring the deficit below 3% in 2012 and to achieve balance budget in 2014. We also welcome the ambitious reforms undertaken by Spain in the fiscal, financial and structural area. As a follow up to the results of bank stress tests, Member States will provide backstops to banks as appropriate.”

Austerity will continue to rule.  So, in essence, this is more can kicking.  They will attempt to grow their way out of the mess by cutting government spending.  As we’ve seen in Greece and other periphery nations this is going to continue to be a long and painful process.   I am not optimistic about the sustainability of this.

“12. We commit to introduce legally binding national fiscal frameworks as foreseen in the fiscal frameworks directive by the end of 2012.”

There were rumors that today’s package might mention some sort of Eurobond.  This would really seal the deal on a move towards fiscal union.  I can’t be certain that the above statement is affirmation of this rumor, but it’s clearly a consideration.

All in all, I don’t think today’s announcement is a huge game changer.  This plan essentially kicks the can by extending maturities and avoiding default in the near-term.  The key is the lack of any real fix to the structural problem in the EMU.  For now, the markets should continue to dictate the direction of this crisis.  And given this morning’s very weak Eurozone PMI I think it’s very foolish to bet on these periphery nations being able to improve their financial standing via growth.  What does it all mean?  I think it means things will get interesting again this autumn and the Europeans will be forced to break out a bazooka.  Will it be a Eurobond?   They know they have it in their back pocket.  And if they can pull it out before the voters revolt then I have to assume we’re on our way to a fiscal union, muddle through, but no worst case scenario of broad defaults and mass contagion.  If, on the other hand, they are slow to act when the markets once again flare up, this could all get out of hand faster than one might think.