The U.S. stock market rallied Friday on hopes that the most recent bailout would save the common European currency and thus reduce the risk of economic and banking problems around the world. Almost immediately, however, cracks started showing in the new bulwark against global economic disruption. Not only did the U.K. refuse to join in the deal, but banks and corporations are continuing to move their money out of the most troubled parts of the Eurozone.
In theory, the euro should be savable. The European Union is not in such bad shape when viewed in the aggregate. The hope for a successful bailout plan always begins with the fact that Europe would be OK if it could just average out its deficits and its debt among all the individual countries. Indeed, though a handful of countries in the Eurozone have annual budget deficits of 6% to 10%, the average is just over 4%. (By contrast, the 2011 deficits for both the U.K. and the U.S. are around 10%.) And the deal announced last week could bring deficits more or less into line by imposing tighter deficit limits on all 17 Eurozone countries.
The problem is that some countries – most notably Greece and Italy – already have extremely high levels of debt equal to more than 100% of annual GDP. Overall, the Eurozone has to refinance more than a trillion dollars of debt in 2012. To help rolling over that debt, Friday’s deal boosted the amount of money backing the bonds of overindebted countries (by accelerating the creation of a second fund, the European Stability Mechanism, in addition to the European Financial Stability Facility). But there are various restrictions on the use of these pools of money. And there is no guarantee that they are large enough and flexible enough to ensure that all the necessary funds will be available as existing bonds come due and new ones need to be sold.
Much of the talk, after the deal was announced, focused on the last minute refusal by the U.K. – citing worries about protecting its large and vital financial services industry – to participate in the deal. But the fact is that Germany itself remains unwilling to put its full resources behind a solution. In particular, Germany resists making the bailout funds a lot bigger, wants to limit the European Central Bank’s ability to purchase the bonds of troubled countries and, most importantly, refuses to consider common European bonds that all Eurozone countries would back collectively.
Basically, all the deals to save the euro raise enough money to postpone problems but not enough to solve them permanently. Indeed, the Obama Administration, worried about a global economic crisis in an election year, has been urging Germany and other rich European countries to make more money available to save the euro.
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Banks and corporations have not been waiting, however, to see whether the Eurozone countries really are willing to share the burden. Companies are moving money out of the Eurozone when they can and stashing it in the U.S. and U.K., a trend that is helping to keep interest rates low in those countries despite their own deficits. And some businesses are taking more extreme measures. Spanish companies, for instance, are moving money to banks in Germany or even considering moving their headquarters northward, according to a recent Bloomberg story.
Banks, too, are reducing their exposure to the most troubled parts of the Eurozone. Three big French banks – Société Générale, BNP Paribas and Crédit Agricole – have been reducing their holdings of bonds issued by weak European countries, especially Italy. Analysts expect that European banks will continue to reduce such debt by tens of billions of dollars over the coming months and that they will certainly limit new purchases as Italy refinances early next year. That, in turn, would put even more pressure on the European Central Bank to buy excess Italian bonds – the very thing that Germany is trying to limit. In any event, the banks’ attempts to reduce their exposure to risky bonds may be too little too late. On Friday, Moody’s downgraded the three big French banks.
So even if the stock market continues to rally or European leaders trumpet the success of their new financial pacts, be skeptical. It may be true that the U.S. economy would improve if there are no shocks coming from Europe. But the euro crisis is nowhere near solved. In fact, most analysts think that at least one country will eventually be forced to abandon the euro. So be prepared for setbacks at some point in the coming year. That may mean trimming some stocks that you’ve been meaning to sell or just keeping a little more than usual in cash in your retirement accounts. But if banks and corporations are trying to lower their exposure to fallout from a potential euro crisis, you should be doing the same.