A funny sort of Union

February 13, 2012

The pictures from Athens at the weekend showed a city in turmoil: protests turned violent, buildings were alight and an anti-German feeling was clear for all to see. German flags have been burnt as Greek politicians have agreed to yet more austerity, which means reduced pensions, a 20% cut to the minimum wage and mass layoffs in the public sector.

Added to that the EU has demanded that Greek politicians from both sides of the political aisle sign a pledge to implement cuts regardless of the outcome of the general election scheduled for April. Thus, even if the Greek people vote for an alternative to cuts the troika will insist on them.

But while the Greeks protested at this loss of sovereignty the financial markets have been surprisingly calm. While Greek politicians have been in the throes of austerity, negotiations the bond markets in Italy, Spain and Portugal have continued to recover and apart from a slight blip at the end of last week, euro-based risk assets have continued to rally. Added to this, those calling for the end of the euro have been frustrated by the resilience of the single currency.

So does this mean that the markets will have a delayed reaction to what is going on in Athens, or does Greece not matter anymore? I tend to lean towards the latter. That doesn’t mean that no one cares about Greece or her citizens – the pictures at the weekend were truly disturbing – it’s just that in terms of the euro zone crisis, what happens in Athens is not such an important part of the equation anymore.

A trader I know put it this way: rather than spook the markets, the current events in Greece may spur Italy, Portugal and Spain to act to meet fiscal targets and implement structural reform. After all, it shows just how harsh the Troika can be if you repeatedly fail to live up to expectations when it comes to fiscal consolidation.

An Italian tax crackdown has already yielded positive results. A recent article in the New York Times reported that Rome’s tax police swooped on a small workshop near the Vatican that sold religious souvenirs but failed to pay the Italian Revenue its share. Other arrests have been made in ski resorts and high profile nightclubs around the country. The warning is clear: if you live in Italy, drive a Ferrari and report earnings that could hardly pay for a Fiat Punto then the tax police are coming to get you.

Fraud in Italy is said to be worth 255-275 billion euros a year by some estimates. Thus, stories of raids on the rich and famous not only catch the public’s imagination, but are also a way for Italy to score brownie points from Germany.

Likewise, the new Spanish government announced far reaching labour market reforms in an attempt to cut the 50% unemployment rate for 18-24 year-olds. But the job was made slightly easier in Spain after a poll found that the majority of Spaniards said they would accept changes to their contracts even if it meant lower severance pay.

But while the periphery works at fixing its public finances, the core has problems of its own. In an unprecedented step, Angela Merkel has joined President Sarkozy on the campaign trail in France to try and help him get re-elected in elections that begin in April. The alternative Socialist candidate Francois Hollande must give Berlin nightmares. He wants to spend an extra 20 billion euros on public services if he gets elected, to be paid with higher taxes – hardly the reform sought by Merkel and co. So while Germany and France might be allies right now, a Socialist French President is unlikely to swallow Merkel’s message of austerity.

We are currently in a strange limbo whereby it looks increasingly likely that Greece could be cut loose and the euro zone would survive and maybe even thrive without the weight of supporting its weakest member. However, the glue that binds the union together is German austerity/ fiscal responsibility and if Sarkozy fails to secure a second term as President of France, the whole edifice of the union could unravel, and what makes this even more strange is that it may not be because of Greece.

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