European Debt Crisis Solved?
There are two key reasons the United States should be very concerned about the European debt crisis:
- Collectively, Europe is our largest trading partner.
- The United States is fast approaching Europe’s present condition.
Yesterday, at a crucial summit in Brussels, the EU announced a new plan to solve Europe’s debt crisis.
Equity markets immediately shot up like 4th of July fireworks. The Dow closed at +186, up 1.55%.
What is the solution? Will it work? How does it affect the United States now? How is it related to the United States’ current debt problem?
Today’s New York Times has a nice overview of the agreement:
“German Vision Prevails as Leaders Agree on Fiscal Pact“
-Steven Erlanger and Stephen Castle, New York Times, 12/9/2011
Basically, German Chancellor Angela Merkel got her way. The EU, minus Britain, will move forward to form a “fiscal union” with regional control over individual government’s fiscal policy. That is a big deal!
The EU also agreed to raise $270 billion for the IMF as a bailout fund bringing total European bailout commitments so far to $770 billion euros.
There is already $440 billion pledged to a temporary bailout fund called the European Financial Stability Facility (EFSF) that they pledged in Brussels yesterday to bring online faster. It isn’t operational yet.
There is also $60 billion so far pledged to a permanent bailout fund being created called the European Stability Mechanism (ESM). That one will be set up later.
Confusing, isn’t it?
Is it just me thinking this, or do Merkle and Sarkozy do an excessive amount of kissing, hand holding and touching in public? 😉
What is a “fiscal union”?
What is it and why doesn’t the EU already have one?
A fiscal union is legally binding EU oversight of individual country’s economic policies. The EU didn’t have that before; and it has proved disastrous, but now it will.
20 years ago Europe decided they wanted to be more like the United States. They wanted a union of countries like the United States has a union of 50 states. Just as that benefits each individual U.S. state, it should benefit individual European countries.
They have slowly been moving toward that goal ever since. But they have a LONG way to go.
Yesterday’s agreement is another important baby step in that direction.
The Currency Union
The first important baby step the EU took was to form a currency union with the Euro as it’s currency.
It was so controversial that only 17 of the 27 countries in the EU signed up for it. Most notably, Britain was one of the countries that opted out.
What the 17 “eurozone” countries agreed to was to use the same currency, but not to interfere in each others internal fiscal policies.
The euro came into existence on January 1, 1999. That is nearly 13 unlucky years ago.
The Big Problem
Eurozone members Greece, Ireland and Portugal spent euros like drunken sailors in a brothel and buried themselves in sovereign debt. That came to light beginning 18 months ago.
To maintain the integrity of the euro, they had to be bailed out.
Sovereign debt problems have surfaced in other countries to, primarily Italy, that must also be addressed.
That is what got Europe into the pickle it finds itself today.
Merkel’s initial comment about the deal:
We have achieved a breakthrough to a stability union. A fiscal union, or stability union as I call it, will be developed further, step by step in the years to come.
Here is the mountain still facing Europe today, according to the NYT:
What worries many is the size of the euro zone debts that must be refinanced early next year. Euro zone governments have to repay more than 1.1 trillion euros, nearly $1.5 trillion, of long- and short-term debt in 2012, with about 519 billion euros, or $695 billion, of Italian, French and German debt maturing in the first half alone
Europe doesn’t have years to work out these details. They aren’t even planning to approve the new agreement before next March.
Investors still worry that Europe hasn’t pledged enough in available capital in the short-term to cover sovereign debt coming due next year.
That is the conundrum facing investors who put up the cash to finance European sovereign debt.
One of those investors was MF Global and look what happened to it!
No, Europe is not out of the woods.
With insufficient funds to cover upcoming payments due, it still faces an uphill struggle.
Obviously, given the United States’ fragile economy and that Europe is its largest trading partner, it will go down if Europe goes down. ‘Nuff said!
More important for the U.S., though, is that it has a growing sovereign debt problem of its own.
Sovereign debt growth in the United States has accelerated to a frightening pace now that there are no longer surplus payroll tax collections to help slow it down.
U.S. sovereign debt stands at $10.4 trillion and about 80% of the average $4.2 billion/day the national debt grows is in sovereign debt.
The U.S. has about a 67% debt-to-GDP ratio right now. That isn’t bad. It hasn’t gone viral yet.
But at the current accelerated growth rate of U.S. sovereign debt, it won’t take long before we are in trouble.
And therein lies our conundrum.
If we don’t slow it down soon, our own sovereign debt growth will make us the next Europe.