Two years after the eurozone began its downward financial spiral, the European Central Bank is about to unveil a widely anticipated plan to pump more money into the system to stem a wider collapse.
But the plan, similar to the massive bond-buying undertaken by U.S. central bankers four years ago, may be too little, too late.
“It’s going to take a lot more than a few rate cuts here and there to give us a lift,” said Peter Dixon, a senior economist at Commerzbank Securities. “Monetary policy is effectively running out of options.”
Europe is also running out of time. Manufacturing across the continent contracted faster than previously thought last month, according to the latest data released Monday. The recession sparked by a crushing debt hangover in a few smaller members of the 17-nation bloc is now sweeping through Germany and France. The financial turmoil that sank Greece as investors and depositors fled now threatens the much larger economies of Spain and Italy.
European Central Bank President Mario Draghi bought some time last month, calming markets somewhat with a pledge to do "whatever it takes" to save the euro. Now, he has to deliver. On Thursday, the ECB is set to unveil details of a new bond-buying plan that has re-opened long-standing fault lines in Europe’s experiment with a common currency.
“You have the troubled nations -- Portugal, Italy Spain, Greece -- all lined up in one corner and you have the funding nations with capital -- Germany, Austria, Finland, the Netherlands -- lined up in the other corner,” said Mark Grant, an investment banker at Southwest Securities. “It’s going to be a very bloody battle on who gets what capital and in what form and how much.”
The strain on those funding nations’ capital prompted bond rating agency Moody’s Investor Service Tuesday to cut its outlook on European debt to negative, warning that the EU may lose its Triple-A rating. The negative outlook reflects mounting pressures on Germany, France, the UK and the Netherlands, which together account for around 45 percent of the EU's budget, the ratings agency said.
As Europe’s largest economy and biggest contributor, Germany has been the most vocally opposed to expanding financial lifelines to its smaller neighbors. A German high court is expected to rule next week whether one of those key bailout funds is legal under its constitution. German central bankers have also argued that the treaty creating the euro bans Europe’s central bank from bailing out member countries.
Those officials are reflecting a deep frustration among German voters with more than two years of failed efforts to reverse the collapse of the Greek economy.
German Chancellor Angela Merkel is wrestling with the latest appeal by Greece to delay painful budget cuts called for as a condition of its latest 174 billion euro ($220 billion) bailout. Without that lifeline, Athens faces all but certain default on its debts.
But Germans are increasingly wary, and weary, of their role as funders of last resort.
Despite the financial blowback of a Greek default, only a quarter of Germans think Greece should stay in the common currency or get more help from other countries, an opinion poll showed on Monday. The Financial Times/Harris poll of 1,000 adults in Germany, Italy, Spain, France and Britain showed that only 26 percent of Germans believed Greece "will ever repay its bailout loans," compared with 77 percent of Italians and 57 percent of Spaniards.
Some American companies are already preparing for Greece’s departure from the euro. Bank of America Merrill Lynch has reportedly looked into sending in truckloads of cash for its customers in the event of possible shortages; Ford, Mastercard and Visa have contingency plans in place to handle a new Greek currency, according to the New York Times.
The Greek endgame is providing a preview of a more worrisome downward spiral in the larger economy of Spain.
“The real difficulty with the solution that’s being pursued is asking Spain to tighten its belt,” said Kingsley Jones, chief investment officer at Jevons Global. “That’s exactly what we’ve seen in Greece for many years and it is now what we’re seeing in Spain. If you pursue policies like that with very high levels of unemployment, it’s only a matter of time until things break.”
Heavily-indebted Spanish state governments earlier this summer told Madrid they needed bailouts, falling in line behind Spanish bankers coping with mounting losses on roughly 180 billion euros ($225 billion) worth of bad loans made during the country's decade-long property bubble.
The Spanish banking system is also bleeding cash as depositors flee. Spaniards withdrew a record 75 billion euros, or $94 billion, from their banks in July, or about 7 percent of the country’s economic output. Despite Europe’s commitment in June to a 100 billion ($125 billion) bank bailout fund, the run on Spain’s banks has accelerated since last year.
Spain’s economy also faces a flight of human capital as an unemployment rate of roughly 25 percent forces many job seekers, including recent college graduates, to leave the country to find a job.
The more immediate concern is the flight of investors from Spanish bonds, which has forced up interest rates and raised borrowing costs for a government already struggling to stay afloat. Spanish bond rates eased on Tuesday as investors welcomed leaked comments made by Draghi suggesting the ECB will step in as investor of last resort to lower rates.
It remains to be seen, though, whether Europe’s central bankers can overcome this week the political and legal hurdles that have thwarted multiple failed efforts to rescue the euro from collapse for the past two years.
“They’re having to speak to multiple constituencies at once and simultaneously solve a difficult problem,” said Jones. “So they’re likely to stall instead of take precipitate action.”
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