Euro on the brink with whole continent 'in jeopardy'

Published on Wednesday 19 May 2010 23:34

THE euro hit a four-year low against the dollar yesterday as the future of the single currency was called into question by the German chancellor, Angela Merkel.

• Angela Merkel: 'If the euro fails, then Europe fails

Shares fell across the world as jittery markets reacted to Ms Merkel's warning that the euro was "in danger" and tried to fathom Germany's surprise unilateral attempt overnight to crack down on the irresponsible traders that Berlin believes are threatening the European economy.

The euro fell to $1.214 against the dollar – the lowest level since 2006 – before rallying to $1.236 at the close of business last night. At the same time, key share indices in London, Paris and Frankfurt fell close to 3 per cent.

The slump came after Ms Merkel's pledge to introduce tougher regulation aimed at what she called "extortion" by stock and bond traders, in particular the practice of "naked short-selling" of eurozone government debt and shares of major financial companies.

Naked short-selling involves traders selling shares or investments they don't hold in hopes of buying them cheaper later. Such practices have been blamed by the Greek authorities for the financial meltdown facing their country and threatening economies across Europe.

Yesterday Ms Merkel urged German MPs to pass their share of a new 750 billion rescue package designed to prevent the Greek debt crisis from spilling over to other vulnerable eurozone countries such as Portugal, Spain and Italy.

In the German parliament, Ms Merkel also claimed that strict financial regulation was needed to ensure the survival of the eurozone, which is struggling to cope with the Greek economic crisis.

Ms Merkel said defending the currency was "about no more and no less than the preservation of the European idea.

"That is our historic task; if the euro fails, then Europe fails," she said. "The euro is in danger – if we do not avert this danger, then the consequences for Europe are incalculable, and then the consequences beyond Europe are incalculable."

Recommending tough moves against "notorious deficit sinners" in the eurozone, such as withdrawing voting rights, the German leader also told parliament: "Above all, what's necessary is to develop a process for an orderly state insolvency.

"With that we would create an important incentive for eurozone member states to keep their budgets in order."

But some analysts believed that her comments that the "current crisis" facing the euro was "the biggest test Europe has faced in decades" undermined rather than helped the single currency.

Her negative view of the currency had been picked up on by traders, leading to share prices falling. Her remarks may have fuelled international uncertainty about the future of the euro but they were addressed to politicians at home.

Ms Merkel appeared anxious to portray a bleak picture of the state of the European economy in order to win political support for the 750bn package. Germany, Europe's biggest economy, is to contribute at least 123bn in loan guarantees to the new rescue package. The German parliament is expected to vote on the issue tomorrow – just two weeks after approving a separate package for Greece – a move that was hugely unpopular at home.

Many politicians in the coalition led Bundestag are uneasy about using more German taxpayers' money to make up for the failings of economies far weaker than their own.

There has also been disquiet about the future of European unity after it emerged that the Germans failed to inform the French that they intended to tackle naked short-selling.

A clearly irritated French finance minister, Christine Lagarde, yesterday said France had received no word of the German plans.

"Governments affected should be consulted," she said.

Hans Redeker, the currency chief at BNP Paribas, agreed that the euro could be heading for deep trouble.

"There is a risk of collapse, even Merkel is saying that," Mr Redeker said.

"But what really worries me is the lack of political communication across Europe.

"The Germans imposed this regulation, but the French government didn't know anything about it."

• Commentary: Merkel may think this is power struggle – but all she has done is make euro's fight for survival even harder

The state of Europe's economies

ITALY

ITALY suffers from a huge amount of public debt, but its economy has not quite slipped on to the same critical list as Greece, Portugal or Ireland. Nevertheless, the debt it has taken on means its position remains precarious.

Although the government adopted only a modest fiscal stimulus, its budget deficit rose in 2009 to 5.2 per cent of GDP. That is lowish, but Italy's public debt stands at 115 per cent – second only to Greece in the eurozone. The government has a primary deficit – ie, spending before interest exceeds revenue – for the first time since 1991. Public debt weighs less heavily on markets because much of it is owned by Italians, whose high savings mean that aggregate public plus private borrowing is in line with other eurozone countries. The government has promised Brussels the deficit will be back to its 2008 level of 2.7 per cent by 2012. But to achieve that without savage cuts in public spending will take solid GDP growth. And that is where the biggest question-mark arises.

BRITAIN

BRITAIN, of course, is not in the eurozone, but a knock-on effect from the crisis is inevitable.

The eurozone represents our biggest trading partner. Weak neighbouring economies mean that our EU partners lack purchasing power – a state of affairs that will not help British exports. If their economies are not growing, Britain is not exporting.

On the other hand, a failing euro is likely to strengthen the pound – helping build confidence in the British economy.

Britain faces many of the same economic problems as its European neighbours with our 162 billion deficit. But unlike countries such as Greece and Portugal, our debt is "long-term". As far as the markets are concerned, fears that the UK may default on its debts are next to non-existent.

Much depends on the performance of the new Tory/Liberal Democrat coalition government. If the markets perceive that Cameron and Clegg are determined to take the difficult decisions to turn round the economy, then Britain should eventually emerge from the tough times ahead.

GREECE

GREECE lies at the root of the crisis. Its government has borrowed far too much and spent far too much, and its economy is crippled by a massive budget deficit. In the past decade, public spending soared and public-sector wages practically doubled – while tax income was hit by widespread evasion. An EU/IMF bail-out was agreed on condition Greece boosted tax revenue and slashed public spending – measures that have led to public protests and strikes.

IRELAND

WITH an economy built on rampant property speculation during the Celtic Tiger era, Ireland can expect much pain over the coming years.

But the Dublin government did at least act decisively when the property market imploded. Towards the end of last year, severe budget cuts were imposed and tax rises were put in place. The budget delivered by the finance minister Brian Lenihan was described by economists as the most painful for a generation. Despite deep unease from the unions, the pain seems to have been gradually accepted by the public.

In the meantime, the cost of bailing out the Anglo Irish Bank pushed Ireland's deficit for last year to above 14 per cent of GDP, one of the worst in the European Union.

Ireland can expect sharp economic pain over the next couple of years, but solace can be taken from the fact that there appears to be the political will to deal with the financial crisis, and the Irish government has forecast that the country will return to growth by the second half of this year.

SPAIN

LIKE Ireland, Spain's economy relied too much on property speculation and a massive building boom.

For 14 years, Spain was one of Europe's top economic performers, and for a while it looked set to pass Italy in terms of GDP.

Things went badly wrong when the overheated construction sector, which had contributed more than 10 per cent of the country's gross domestic product, went into meltdown.

PORTUGAL

PORTUGAL'S crisis is among the most serious and, with tourism one of the first sectors to suffer in an economic crisis, there is little for it to fall back on. In an attempt to prop up the economy, the government borrowed money, which led to very high levels of debt, and it is having severe difficulties in funding that debt. It has imposed an austerity plan, including a public sector pay freeze, sparking anger from unions and leftist parties.