Why we still need to worry about a European meltdown: Maley

Fresh European tensions are likely to emerge this week, with signs that Germany is determined to force other eurozone countries to commit to sharply reducing their budget deficits in a bid to stabilise the euro.

Germany is expected to press other eurozone countries to follow its own lead and introduce laws that require governments to virtually eliminate budget deficits, as the price for its reluctant support of last week’s $1 trillion rescue package.

Last year, Germany introduced legislation that prevents its federal government from running a deficit of more than 0.35% of GDP by 2016, while German states are not permitted to run deficits after 2020.

Weaker eurozone members are likely to resist this initiative because it would force them to adopt even harsher austerity measures. There are already widespread fears that the tax hikes and wage cuts that Greece, Spain, Portugal and Ireland have already introduced will plunge their economies into deep recession, and could spark a double dip recession in the entire eurozone.

Yesterday, Angela Merkel, German chancellor, warned that the $1 trillion rescue package had only bought Europe time, and that further steps were needed to address the differences in competitiveness and budget deficits between the member countries.

In a speech to the annual German trade union conference, Merkel emphasised that speculation against the euro was only possible because of the huge differences in economic strength and the levels of debt between individual eurozone members.

Meanwhile, the head of the European Central Bank, Jean-Claude Trichet, emphasised that it was urgent that eurozone countries rectify their budget deficits.

In an interview with the German magazine, Der Spiegel, Trichet said that the world was now facing “the most difficult situation since the Second World War – perhaps even since the First World War. We have experienced – and are experiencing – truly dramatic times.”

He said that after the events of 2007-08, “private institutions and markets were about to collapse completely”. That triggered governments to step in with very bold and comprehensive financial support.

The problem was that markets were now questioning whether some governments could afford to repay their debts.

“This is a problem for almost all industrialised countries. In the G-7, the major economies have a yearly deficit of around 10% of gross domestic product (GDP). In the euro area as a whole it averages 7% of GDP. In this situation with extremely elevated deficits across the globe, the markets have singled out a weak link: Greece.”

Faced with this atmosphere of crisis, Trichet expressed confidence that governments would take the appropriate steps to cut their budget deficits. “They are committed to accelerating the consolidation of their budgets. They know what is at stake now,” he said.

But markets continue to be assailed by doubts over whether the $1 trillion ‘shock and awe’ eurozone rescue package will work. Last Friday, eurozone share markets tumbled, with Paris dropping 4.6%, while Madrid was down 6.6%. London and Frankfurt both finished slightly more than 3% lower.

Many economists are concerned that spending cuts and tax hikes will force countries into recession, which will slash the government’s tax receipts and make the task of cutting the budget much more difficult. In addition, some argue that austerity measures do not address the basic problem that Greece, Spain and Portugal face, which is a lack of competitiveness. They argue that the best remedy for restoring competitiveness would be for the weaker eurozone countries to temporarily leave the euro, and adopt a lower exchange rate.

There are also questions as to whether Greek, Spanish and Portuguese voters will agree to long-term austerity.

These doubts were fuelled by comments made by Josef Ackermann, boss of Germany’s Deutsche Bank, on German television late on Thursday where he said that he was not convinced Greece could overcome crippling budget deficits and repay its debt.

“I consider it doubtful whether Greece over time will really be in a position to achieve this,” he said. But he added that restructuring Greece’s debt was a last resort, because it could result in “a type of meltdown”.

This article first appeared on Business Spectator.