Article: EU Stability Pact May Crumble
 

Summary

Growth figures indicate the European Union was on the verge of recession as of Sept. 10. As the repercussions of the Sept. 11 World Trade Center attacks begin to register, Europe faces a much darker economic future. The first European casualty will be the stability pact -- a treaty designed to ensure confidence in the new euro currency.

Analysis

The economies of the eurozone, the 12 European Union countries that share the euro, grew at a barely noticeable 0.1 percent in the second quarter of 2001, according the union's statistical agency, Eurostat.

But before Sept. 11, there was hope that the American economy was clawing its way out of the global slowdown. America's recovery, many thought, would rekindle European growth. But in the aftermath of the World Trade Center and Pentagon attacks, a U.S. recovery will be replaced by recession -- leaving Europe, for now, on its own.

Europe lacks the wherewithal to reinvigorate its own economy quickly. Though EU countries now form a common financial space, it is not a seamless union. Governments have no unified fiscal policy, and they often compete with each other to attract investments.

Ironically, attempts to strengthen European cohesion are temporarily working against the Continent. Most EU states have adopted a "stability pact" to bolster the euro's debut on Jan. 1, 2002. One of the pact's key features is to force fiscal discipline upon signatory countries -- limiting budget deficits to a maximum of 3 percent initially and eventually phasing out deficits altogether.

Germany, historically the European state with the most stringent fiscal discipline, insisted on the pact to prevent the union's more spendthrift members from running high deficits, which would trigger inflation and hurt confidence in the new currency. Berlin was particularly concerned with periphery economies such as Greece and Spain.

As of Sept. 10, however, deficits of the core economies of France, Germany and Italy were inching higher as the months-long European slowdown continued. Now Italy's economy is contracting, Germany's is flat and France's barely eked out 0.3 percent growth last quarter. Barring a quick American-inspired recovery -- which is now impossible -- European growth rates will dip further. All three would have likely tipped into recession even without the World Trade Center disaster; now it is guaranteed.

Europe's new problem is that weakening economies diminish government incomes, which in turn causes higher budget deficits. Complicating matters, since the United States cannot help in the short term, Europe's large states badly need to engage in emergency stimulus spending to push their own recoveries forward.

But with deficits already high and growing, the only way this can be done is to scrap the stability pact itself. German Finance Minister Hans Eichel publicly mulled over the idea in August but was forced to endorse the pact after a closed-door discussion with Chancellor Gerhard Schroeder. In the aftermath of the World Trade Center disaster, the chancellor may be willing to reconsider.

The ramifications for Europe are significant. The stability pact is a keystone of the European Union's efforts to legitimize the euro. Its abandonment will throw much doubt into the European financial mix at a time when global markets already are within arm's reach of panic. More pointedly, the pact will be dumped not because of the fiscal decadence of the European periphery, but of the core. That is precisely what the union does not need in the months leading up to the euro's release.

Once the stability pact is gone, investors worldwide will look to the other remaining source of European credibility: the European Central Bank. But the bank is hardly known for its quick action. Despite an obviously intensifying slowdown, the bank has cut interest rates only twice this year for a total of one-half a percentage point. The U.S. Federal Reserve, in comparison, has slashed rates seven times for a total of 3 percentage points. The bank has missed both its inflation and money supply growth targets for most of its 20-month existence.

European leaders undoubtedly hope the bank can rise to the occasion, but since they themselves are probably already looking to slice apart the stability pact, the prognosis is very poor indeed.

Thanks to:

(c) Strategic Forecasting L.L.C. All rights reserved.