May 23, 2012 at 1:41 PM ET
Talk about a Herculean task. Or is it Sisyphean?
Europe's heads of state are meeting Wednesday to come up with a plan to jump-start the second largest economy in the world after painful austerity measures brought the euro zone’s growth to a dead stop.
After two years of trying to jawbone away the fundamental problems, there’s little indication that the latest effort will produce meaningful solutions.
Voters this month swept pro-austerity politicians out of office from Athens to Paris, and Europe’s leaders are running out of time to repair the widening cracks in an historic experiment with a common currency.
After the victors in this month’s Greek elections failed to form a government, Europe has threatened to cut off the country’s financial lifeline. Without the aid, the Greek government is just weeks away from running out of cash.
“It's a knife-edge situation,” said Roger Altman, co-founder of Evercore Partner and a former U.S. Treasury official. “In theory, Greece should not exit the euro zone because that would usher in, I think, a very dark period in Greece where no one would lend to the country, the state couldn't meet its payroll, and it couldn't make all of the social benefit payments.”
On June 17, Greek voters go to the polls for the second time in a month to try to form a government. Without political leadership in Athens to enforce Europe’s mandated budget cuts, Greece will likely lose its financial lifeline and be forced to exit the euro pact.
Rumors are swirling in the financial markets that Greece could depart as early as this weekend, but that appears unlikely. For one thing, there is no government with the constitutional authority to create a new currency.
“Even if the heads (of state) did agree over coffee to show the Greeks the door, they would need to invent a constitutional basis for doing so ... and there is none,” said Carl Weinberg, chief economist at High Frequency Economics. “The (European Monetary Union) is by design like the Hotel California: countries come in but they never come out.”
But preparations are already underway for an event that was unthinkable to the architects of the common currency. In an hour-long teleconference on Monday, euro zone officials agreed that each country should draw up separate contingency plan to cope with the possible departure of Greece from the monetary union, two euro zone officials told Reuters.
A European Working Group made up of finance ministry representatives assessed the potential impact on member states. The group reportedly said if Greece decides to leave, the European Union and International Monetary Fund are prepared to help it do so.
The blowback to the rest of Europe could be severe. The Greek central bank alone owes roughly 100 billion euros to other European central banks. Total external debt runs to more than 350 billion euros.
The meeting is expected to produce no major announcements or agreements, and the proposals on the table have been discussed for some time. Those include the creation of a common euro bond, setting aside a relatively modest amount of money for infrastructure projects, and allowing Europe’s central bank to backstop failing banks and government bailouts.
The last measure has been floated several times in the two years since Greece began sliding into its current debt morass. Europe’s central bankers argue that its mandate limits its capacity to offer the kind of sweeping backstops engineered by U.S. Federal Reserve Board Chairman Ben Bernanke after the financial panic of 2008. German officials are also staunchly opposed to expanding the ECB’s powers and show little signs of reversing that opposition.
The proposal to expand infrastructure investment, likely through an expanded program of guaranteed loans, is designed to provide an offset to the widely-repudiated “austerity’ measures that have been imposed on Greece, Spain and other countries looking for financial aid from European agencies and the IMF.
Such “pro-growth” proposals have been given added momentum following the election of French President Francois Hollande, whose victory in the polls produced a seismic shift in the balance of power over the debt debate in Europe.
Hollande’s predecessor, Nicholas Sarkozy, offered critical support to German Chancellor Angela Merkel in her resolute insistence on holding Europe’s weaker members to promises to make deep spending cuts. But two years of austerity have brought the euro zone economy to a standstill. Hollande took office with a mandate to put greater emphasis on growth.
The infrastructure proposal would raise roughly 230 billion euros to finance a variety of projects. Even if approved relative quickly, the amount is widely considered too small to have any significant impact on the euro zone economy. And it does nothing to address the much wider impact caused by tighter credit across the continent as bankers hoard cash to weather the ongoing financial storm.
There is also little on the table to solve the underlying problem of heavily indebted governments struggling to get out from under borrowing costs that are driving budget deficits higher. One solution being floated is to create a common euro bond, which would create a single interest rate for all euro zone members issuing debt.
The euro bond idea has been discussed on and off for the last two years. Pooling government debt offerings would effectively backstop bonds issued by Greece, Spain and Italy, thereby lowering the interests rates investors expect and reducing borrowing costs for Athens, Madrid and Rome.
The gap in borrowing costs has widened as the debt crisis has deepened. On Wednesday, as investors demanded rates above 6 percent for Spanish and Italian government debt, Germany floated a new round of two-year notes that offered investors zero percent interest. Those investors, in effect, are willing to see no return in exchange for the perceived safety of bonds issued by Germany.
"There’s still a lot of uncertainty around," said Gemma Godfrey, head of investment at Brooks McDonald. "And although rhetoric is obviously still very prevalent, a focus on actual practical plans is missing."
Fusing the debt of weaker euro zone countries to Germany in a common euro bond would raise Germany‘s borrowing costs because investors would reprice all new euro bonds to reflect the added risk of a default by Greece, Spain or Italy.
Germans are loath to see their borrowing costs rise, let alone put their tax revenues at risk to guarantee the debt of other countries. Merkel, reflecting popular opinion expressed in recent local elections, remains steadfast in opposition to such a move.
Below, Jeff Applegate, Morgan Stanley Smith Barney CIO, discusses market volatility and European debt worries and where Wall Street goes from here on CNBC.