Armageddon now or Armageddon later. According to Investment Solutions economist Chris Hart, that’s the outlook for financial markets, as EU policymakers continue their apparently fruitless quest to sort out the mess.
The immediate problem is that voters and taxpayers of the core economies are becoming resistant to funding further rescue packages for the troubled euro zone states. And politicians are getting twitchy.
According to Reuters, Germany, which is the bloc’s economic powerhouse, foots over a quarter of Europe’s bill for the bailouts. Without funding from Germany and other core European countries, the basket case economies would have to be run on a cash basis.
In other words, if taxpayers don’t pay enough tax to meet the governments’ commitments, the bills won’t be paid. Not only will these governments default on their debt repayments and interest bills, but government employees will face wage cuts, or even wage freezes, as the coffers run dry.
As liquidity disappears, interest rates will soar, putting enormous pressure on indebted businesses and households.
There are also implications for the region. If the worst case materialises, the afflicted countries will fall out of the euro zone – possibly the beginning of the end for the region, some commentators fear.
But, according to Hart, this nightmare scenario is preferable to the alternative – postponing the day of reckoning to give the debt-laden countries time to run up more and more debt.
The problem apparently has no solution: austerity measures strangle growth, cutting people’s ability to earn an income and therefore pay income tax, reducing governments’ ability to manage their finances into a more acceptable shape. Greece is looking at a possible economic contraction of 5 percent.
But many economists argue that not imposing austerity measures is not an option. “The burden will only get worse,” Hart says.
This is the state of play. Greece, Ireland and Portugal have needed international bailouts. And Greece has failed to meet the deficit reduction target set as a condition of its second bailout.
More casualties are on the horizon. Italy and Spain have needed support and are seen as the next countries to become burdens on their neighbours.
There have been terse interchanges between the funders and the recipient countries. A junior coalition partner in Germany’s government said Greece was shirking its responsibilities and putting the euro zone in danger.
And European Central Bank (ECB) president Jean-Claude Trichet called on Italy to implement austerity measures. The ECB began buying Italy’s bonds last month to help out the country, which has e1.9 trillion (R18.6 trillion) worth of debt, making potential investors reluctant to buy its bonds.
Against this backdrop, some tough decisions have to be made in Europe.
Tomorrow in Paris, the French parliament will vote on a budget amendment to include approval of French contributions to the Greek financial rescue. On Wednesday, Germany’s constitutional court will announce its verdict on whether the government broke the law with last year’s euro zone and Greek bailout packages.
Boom times are often accompanied by a perception that “this time it’s different”. In other words we have defeated the economic cycle. Now perhaps we have. The global economy seems unable to move decisively out of recession.