The end of austerity? Not likely

May 7, 2012

It was Bill Clinton who, after the 2000 U.S. election was thrown into turmoil by Florida’s hanging chads, said the American people had spoken but it was going to take a little time to work out what they had said.
No such dilemma in Greece. A plague on both your houses was the message for the traditional ruling parties PASOK and New Democracy, a result that makes a stable government look a remote possibility and puts a very real question mark over its bailout programme.

Today, the largest party New Democracy will try to form a coalition. Given what they’ve said, the left-wing Left Coalition which leapfrogged PASOK into second place cannot be part of a government committed to the bailout terms so it looks like the two traditionally dominant parties — two seats short of an overall majority between them — must seek support from elsewhere or face fresh elections which could well give an even more fractured result. One thing worth noting is that even the resurgent anti-bailout parties mostly say they want to stay in the euro zone so maybe there’s soom room for negotiation.

The euro has dived to a three-month low, Bund futures have posted yet another record high and European shares are down so we’re right back in fear mode.

Two big questions flow from all that:
1. Could this vote, and socialist Francois Hollande’s victory in France, shift the growth/austerity debate?
2. Does Greece, even its possible euro exit, still have the power to spread damaging contagion to the rest of the euro zone?

On the growth front, the answer is only up to a point because Berlin and the European Central Bank — and the markets — won’t wear anything that will dilute debt-cutting programmes much, whatever the more friendly rhetoric suggests.
Italian premier Mario Monti, a man desperate for growth, talked to Hollande, Germany’s Angela Merkel and Britain’s David Cameron among others after the elections last night, presumably to push that agenda and the argument is gaining force.

EU economics chief Olli Rehn chipped into the growth debate over the weekend, suggesting there is some leeway to temper debt-cutting drives in order to leave scope for growth. But again, details were elusive. Rehn also said those countries under theĀ  microscope had to convince the markets and policymakers of their capacity to put their fiscal houses in order. This sounds rather like having your cake and eating it, or at least reaffirms what we’ve been saying — that there may be some limited fiscal wiggle room, but only as much as the markets will allow, which is not much.

So the growth strategy stills seems to rest on structural reforms (which will take years to bear fruit), plus reconfiguring some EU funds and a beefed up European Investment Bank. Those who really count — Merkel and Draghi at the top of the list — are talking up growth measures while insisting the austerity drive must not be dimmed. The markets would probably respond well to stimulus which did not fundamentally undermine debt reduction. But that’s some trick.
And what’s on offer so far will not do the trick. Will something more profound be cooked up for the end-June EU summit?

The answer to 2. is thornier and we heard opinions from both ends of the spectrum last night. With the euro zone crisis taking a turn for the worse since a calm first quarter, helped by huge ECB cash injections, the prospect of a new Greek default could hardly come at a worse time and markets will doubtless take it badly.

But are we back in the territory of an existential threat to the euro zone? Given the euro zone and IMF rescue funds soon to be in place, the fact that Greece’s creditors have basically written off their holdings and that banks are still depositing 800 billion euros of cash back at the ECB nightly (money that could be put to use buying stocks and bonds if confidence improved) there are reasons to think the threat is not as extreme as it was six months ago.

The ECB seems pretty resolute that its extraordinary support measures are over but if the euro zone was pushed back to the brink that would change pretty quickly — so it is still there to underwrite the currency bloc in extremis.
Spain remains the most obvious euro zone tipping point for now and it could well need a bailout at some point, for its banks at least. Madrid is embarking on a deeper cleanup of trouble Bankia, to the tune of 10 billion euros. However, the government has sold more than half the debt it needs to this year already and most of its banks have gorged on ECB cash so are funded for at least the rest of 2012.

But that things are much darker than they were in March is indisputable.

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