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Economics & Finance

Eurozone: State of siege

Shellie Karabell |

Could stronger ties between France and Germany get to the heart of what ails the single currency?

It’s hard to find numbers these days that add up to anything but recession for the Eurozone, if not the 27-nation EU as a whole: figures released on 2 December 2011 show Eurozone unemployment at 10.3 percent, inflation at 3 percent, GDP growth at 1.4 percent and 10-year government bond yields at 2.2 percent. The UK soared on the inflation front: 5 percent, unemployment at 8.3 percent, GDP growth at 0.5 percent and 10-year gilts at 2.3 percent, their lowest level since the 1950’s. These bond yields used to be justified given sovereign debt was considered virtually infallible. That was then. Today, even German bunds are coming under pressure: a recent bond auction was under-covered by some 35 percent.

Aside from the ‘fundamentals’ is the gestalt that brings it all together: confidence. Or, as is the case today, the lack thereof. That’s creating an underlay of fear and chipping away at trust. Ratings agencies circle the financial markets threatening downgrades not just of companies but of entire nations, taking the lustre off government bonds and wreaking more havoc: Italy, for example.

Confusion rather than consensus

This was the arena in which the 27 EU members began their negotiations to settle the Eurozone debt crisis which was already creating problems within the entire EU. What German Chancellor Angela Merkel hoped would be a unanimous agreement on a change in the EU treaty giving new power to EU institutions such as the European Commission and the European Court of Justice – thereby endowing them with the political clout to enforce ‘safer’ economic measures – turned into a rout. The U.K. flatly refused to sign, while a handful of other countries declared themselves unable to sign without first getting parliamentary approval – a little thing like the democratic process standing in the way of calming the financial markets. They ended up with an intergovernmental treaty for the 17 Eurozone members and a half-dozen of the other EU members. Not enough to restore confidence; but more than enough to put pressure on the euro. By 15 December, the single currency had fallen to its lowest level of the year against the U.S. Dollar.

France and Germany are the backbone of both the EU and the euro, and 80 percent of some 1300 French and non-French business leaders in France surveyed by INSEAD recently say closer relations between these two countries is key to weathering the current economic crisis. And they said this relationship was more central to survival than France’s relations within the EU or the Eurozone. The study, produced by Ludo Van der Heyden, Mubadala Professor of Corporate Governance and Strategy, and Bruno Lanvin, Executive Director of INSEAD eLab, also found that another 90 percent of the respondents said putting a pan-European debt stabilisation programme in place is crucial to securing future prosperity.

Germany needs the EU

Indeed, Germany’s exports to France (10 percent of German exports within the EMU) is the highest of its trade with other key EU members Spain, Italy, and the U.K., and has been growing at a rate of 7 percent a year since the single currency was introduced as a trade currency in 1999. Germany has a very good reason to want to find a way to hold the euro and the EU together: 40 percent of its overall trade is within the Eurozone and about two-thirds are within the EU-27.

And as for the euro…it had been declining steadily since the last round of EU talks failed, but compared to the ‘fundamentals’ on which it rests, it is still pretty high – certainly above its low of the spring of 2010 when it sank to US$1.20. “Exchange rates are highly volatile and move by reasons which are unrelated to fundamentals. The fact that the euro remains high in the face of market sentiment and expectations means that not many are panicking about the value of the euro, says INSEAD economics professor Antonio Fatas who is also the Portuguese council chaired professor of European Studies. “One explanation is that even the extremely pessimistic observers who believe that the euro will break up, or a break-up of the euro area is on the horizon, the euro will continue to exist as a currency. One can imagine a scenario in which France and Germany are the only countries behind the euro. The euro might even appreciate in that scenario!”

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