Make or break week for EU debt crisis
Next week will likely see either an agreement to bind Eurozone nations’ fiscal policies together with irrevocable, enforceable institutions or the beginning of the end for the single currency. We have been here before and so far EU leaders have never failed to disappoint, but they must surely recognize by now that markets have run out of patience and a global financial crisis awaits if they don’t make concrete commitments to credible fiscal governance. I am actually optimistic for the first time in this never-ending saga since ECB Pres. Draghi on Thursday indicated the ECB would deploy its virtually limitless balance sheet to support Eurozone debt markets, but only if there is a new ‘fiscal compact’ between Eurozone nations. The alternative to no agreement would be a collapse of European debt markets, which would trigger EZ financial sector failures and quickly cascade into a global financial meltdown, making Lehman seem like a mom-and-pop candy store going out of business. Even emergency intervention by the ECB after that cascade began would likely be unable to stem the cataclysm.
The action will begin as soon as Monday as German and French leaders are set to hold a critical meeting where they will need to hammer out an approach they can take to the full EU Summit on Thursday and Friday. Further French foot-dragging at this meeting would be a death knell for the process, and despite Sarkozy’s reluctance, he will need to acquiesce and cede sovereignty over budgets to a centralized EU authority or set of rules. Also on Monday, Italian PM Monti will submit his economic plan to parliament. The urgency of the week is highlighted by US Treasury Sec. Geithner meeting with German, French and Italian counterparts next week, where I suspect he will drive home the message that decisive action has to be taken or the risk is catastrophe.
I don’t expect treaties or agreements to be signed next week, but at the minimum markets will be expecting detailed provisions (budget deficit limits, debt limits, surveillance and enforcement mechanisms, and the like) to be spelled out and agreed to at the EU Summit on Friday. If they are successful, the ECB now seems prepared to provide interim support to EU debt markets, likely forestalling an immediate confidence and liquidity crisis. Even if they do reach agreement on concrete terms of tighter fiscal integration, markets may still not be persuaded and stresses could yet break out. If they fudge it again, get the helmets out.
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