From Panic to Relief: The EU Steps Up

Morris Segall     

In our last posting, “From Optimism to Panic…”, May 6, 2010, we stated last week’s panic in the capital markets needed a quick and forceful international response to restore order to avoid further destructive speculation. Refreshingly, the Europeans moved quickly and decisively and along with assists from the IMF, the Federal Reserve and the Bank of Japan, structured an aid and liquidity package totalling almost $1 trillion. Importantly the package includes mechanisms for the European Central bank to purchase sovereign and bank debt and, along with other central banks, add liquidity to the Eurozone. Clearly, the EU leaders and finance ministers meeting in Brussels over the weekend learned the lessons from their mistakes in the Greek bailout. They wasted little time and came up with a large package that addressed the current problems facing  European governments and banks. It was also important for the response to be global so the participation of central banks around the world left no doubt of the international support for the euro and the eurozone.

In response, equity markets around the world, led by Europe, have surged today, relieved at the strong international response to the current crisis.

However, the sovereign debt problems in Europe are not solved and the countries of southern Europe and the U.K. will need to initiate significant spending reduction programs as part of overall debt reduction plans. Those spending reduction programs will not be popular domestically and social unrest should be expected.

 There are political costs as well as seen in the indecisive elections in Britain which turned out the long reigning Labor Party but left the victorious Conservative Party short of a majority in Parliament. The Conservatives will have to fashion a parliamentary coalition in order to govern. In yesterday’s regional election in Germany, Chancellor Merkel’s governing Christian Democratic Party lost decisively thus depriving Chancellor Merkel of a mjority in the Upper House of the German Parliament. She will now have to compromise with opposition parties to successfully govern. Indeed, today Chancellor Merkel announced she would not be seeking tax cuts that she had promised to pursue in her fiscal agenda but have been opposed by her principal political opposition.

The political uncertainty now being created in Europe will raise political and economic risks in Europe and the U.K. While Europe has for the time being avoided financial disaster, the longer term problems of sovereign debt risk remain.

Morris R. Segall, CFA, CIC