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Analysis
Not for the first time, euro optimism starts to decline

Not for the first time, euro optimism starts to decline

Weidmann’s warnings on ‘wall of money’

by David Marsh

Mon 2 Apr 2012

After the quick burst of optimism over the European Central Bank’s liquidity injections, and a record-breaking first quarter upturn on the stock markets, governments and financiers are coming down to earth. This was underscored by the European Union’s warning to finance ministers last week that the underlying causes of Europe’s sovereign debt crisis are not yet resolved.

There are some powerful reasons of self-interest why the US and China are avoiding rocking the boat on Europe’s troubles. This was underscored by an unusually warm statement from the US Treasury over the weekend saluting Europe’s efforts to overcome its difficulties.

China, confronting higher domestic production costs, a stronger renminbi and more fragile markets for its exports, wishes to avoid a weaker euro and thus prevent too sharp a domestic slowdown. In the US, ahead of the November elections, President Barack Obama has no desire to upset the euro, hoping that a semblance of order on European financial markets will help shore up global confidence, prolong the improvement in the US labour market and help him stay in the White House. Washington has told Berlin to make sure the European turbulence is firmly under control during the election run-up.

However, fault lines are still all too apparent. European leaders said they believe the heavily-trailed €200bn increase in bail-out rescue money agreed on Friday was enough to persuade the international community to supplement euro area efforts in the fight against debt contagion. However, there are strong doubts whether Europe has put up enough cash. Not for the first time, Wolfgang Schäuble, German finance minister, said he wanted to end speculation that funding would be increased any further. ‘There is no sum with which you can convince financial markets,’ Schäuble said, referring to the combined €700bn for the euro’s two rescue funds. ‘You can only be convincing with structural measures.’

Friday’s decision was the least demanding of the three options suggested by the European Commission, which included alternatives to raise the ceiling to as much as €940bn. This less ambitious approach may fail to generate additional funding from non-European G20 countries.

Behind the scenes, both China and the US are worried about how slowly Europe is steering out of trouble. There is talk that Europe’s banks need to deleverage to the tune of $2 to $2.5tn in the next two years. Where is the money going to come from? The increase in the euro states’ bailout funds would not be enough, especially since it is concentrated on the sovereign states and not the banks.

Indeed, in relation to any kind of effort to prop up the euro edifice, ‘Merkel’s Law of Permanent Disappointment’ has come into play. The German chancellor will always do more than she originally promised to help out errant states, but the funds committed will always be less than actually necessary to solve the euro’s problems once and for all. So people on both sides of the argument, whether among conservative German voters or from the hard-up countries, will always be disappointed – although for equal and opposite reasons.

With the Bundesbank leading complaints from the sidelines about the ECB’s fall from a pure form of central banking independence, the hawks on the ECB council are starting a campaign for an ‘exit’
from the ECB’s liquidity injections. Observers in Washington say this is premature and shows up Europe’s hesitancy and lack of resolve about what do to.

Meanwhile Jens Weidmann, the Bundesbank president, is leading the charge of the hard money brigade. In an uncompromising speech in London last week, he said the ‘wall of money’ erected around Europe’s financial problems would, like the Tower of Babel, ‘never reach heaven.’ Weidmann’s message is clear. In coming months, the calm on the markets, like the Tower of Babel, may turn out to be unsustainable.

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