By Cyrus Sanati
FORTUNE -- Europe's largest economies shouldn't be able to skirt European Union debt ceilings rules just because it's "too hard" or "unpopular." To do so would not only be hypocritical, as they have insisted on crippling austerity measures in much smaller and more vulnerable EU member countries in the past, but it is also dangerous, as it risks reigniting the sovereign debt crisis.
It is still possible to have economic growth while pursuing belt-tightening policies if meaningful structural reforms are made -- something that the big European economies have been slow to recognize.
The result of such inaction has been overblown deficits and negative growth -- a trend that will surely continue if Brussels allows countries too much leeway as they have recently done this week. Failed promises and unrealistic fiscal targets just won't cut it anymore. While the markets have cut the EU some slack post-Cyprus, it has proven to be mercurial in the past. It is much better to take reforms on now when it is calm than to do so under pressure from an angry market.
It has been over three years since the European sovereign debt crisis paralyzed the continent. While there has been much progress made in fixing the fiscal imbalances in Europe's periphery, such as in Greece, Portugal, Spain, and Ireland, Europe's core, namely France, Italy, the Netherlands and Belgium, have failed to take on the tough reforms necessary to have a meaningful impact on their own fiscal mess. While the periphery had a much larger hill to climb in respect to pension, labor, and tax reform, the time has come for the core countries to follow suit and align their fiscal policies to match their economic output.
From the inception of the euro, member countries have been required to adhere to a number of fiscal measures to ensure the strength and stability of the single currency. The most important measure was the so-called stability and growth pact, which stated, among other things, that a nation could not run a budget deficit that exceeded 3% of its GDP in any given year. If a nation broke that rule there would be consequences, ranging from fines to ejection from the monetary club. But in the decade leading up to the sovereign debt meltdown, Brussels failed to seriously enforce this key rule. As a result, pretty much all EU states, including supposedly prudent ones, like Germany, consistently ran deficits exceeding the 3% rule. This eventually led to an unbalanced and debt-ridden eurozone.
The 3% threshold seems like an arbitrary line in the sand, one that some believe should be seen as a goal rather than a threshold. But given the troubles of the last few years, that line has come to symbolize to the markets and sovereign debt investors the true creditworthiness of a nation.
It is no surprise that those nations that had consistently run afoul of the 3% threshold are the same ones that have faced the wrath of the bond market vigilantes. Greece, for example, never ran a deficit below 3%. Its budget deficits in the decade or so since it joined the euro have ranged from 4.5% in 2001, the first year it joined, to as much as 16% in 2009, the year it started to melt down. Ireland seems to have taken the prize, running a budget deficit of 31% of its GDP, more than 10 times that of the threshold, when the government decided to take on the bad debts of its banks to avoid a total economic meltdown.
The periphery has a long way to go to get their fiscal houses in order, no doubt, but many have made great progress. Ireland, for one, was successful in lowering its debt levels to 7.6% of GDP in 2012. But for others, namely Greece and Portugal, harsh austerity measures imposed by their richer neighbors in the core of Europe have caused their GDPs to shrink to such a degree that it has made their budget deficits jump even after massive cuts in government spending. This has led some leaders in the core of Europe to say that austerity isn't the answer to solve the eurozone's problems. As a result, governments in France and Italy have reversed austerity measures and tax increases implemented by former, more prudent, regimes, in an effort to prove their theory.
The core European nations have far different economic problems than that of their nouveau riche neighbors on the periphery so it is understandable why some are jockeying for a "different" solution. But austerity is still needed in core nations, just not to the extent as was needed in, say, Greece. The core's main problems are legacy issues, namely that of pension and retirement benefits, and inefficiencies dealing with taxation and employment. But unless they get their spending under control, they will never be able to create workable solutions to those long-term issues.
France, in particular, is in need of a total economic makeover, but its leaders refuse to do anything about it. France had a budget deficit of 4.8% in 2012, well above the 3% threshold. But instead of fining or forcing Paris to change its course, Brussels this week gave it a two-year grace period. As things currently stand, France will bust through that 3% threshold again, posting budget deficits of 3.9% in 2013 and 4.2% in 2014.
Brussels has chastised François Hollande, France's President, for reversing changes to the pension laws instituted by former President Nicholas Sarkozy, who raised the pension age from 60 to 62. As a result, France is expected to have a pension deficit of around 20 billion euros by 2020. While Hollande says his government will reveal pension reforms later this year, it is doubtful that he will propose anything that will go far enough to address this dangerous overhang in the system.
France was just one of the nations taken to task by Brussels for violating the budget deficit rules this week, but it seems to be the only one that lacks a credible plan of action to put the country back on sound economic footing. Hollande has tried to excuse his inaction by saying austerity doesn't work. Unfortunately, praying for growth doesn't work, either. France can easily maintain fiscal prudence if it wanted to, but it is choosing not to. It still has one of the most generous social welfare systems and unemployment schemes in the EU, something that Brussels highlighted this week. Bringing the country in line with its neighbors, which by U.S. standards are already super-generous, is a no-brainer. Raising the pension age and reforming archaic employment laws would go far to increase French competitiveness, which has a much better chance of boosting growth and lowering budget deficits than by reversing pension reforms or taxing your richest citizens at 75%.
Brussels may be too weak to enforce its own rules, but the markets aren't going to stand for such arrogance indefinitely. The governments of France and other core European nations who are violating budgetary rules are playing with fire. Why would investors continue to park their money with governments that are on a one-way trip to insolvency?
Just because funding costs are low now doesn't mean it will stay that way forever -- the market is fickle, and as we have seen, rates can explode overnight. While such a scenario was deeply troubling when it played out in Greece and Ireland, if it were to play out in Italy and France the results would be catastrophic. There simply isn't a bailout fund or a printing press big enough to keep the likes of Italy and France going for very long. But if the markets see the core nations taking concrete steps to correct their bad budgetary behavior, that will go a long way to rebuilding trust, helping to avoid yet another "crisis."
From up close, it looks like the 'poorer' nations could do just fine without a single currency.
By Erin Burnett, contributor
FORTUNE -- This summer trips to Europe opened my eyes to something: There's a lack of passion in Europe for keeping the euro. Yes, the pain of a breakup would be severe. But many of the poorer southerners of Europe don't seem to feel that they need "Europe" anymore.
That, at MORESep 12, 2012 5:00 AM ET
Greece leads massive increase in global restructuring activity.
FORTUNE -- There was $335.9 billion worth of completed distressed debt and bankruptcy restructuring activity in the first half of 2012, according to data released today by Thomson Reuters (TRI).
That's a whopping 223.9% increase over the first half of 2011, albeit with 242 fewer deals. The big skew came from Greece's $263.1 billion debt exchange transaction, which is the largest-ever restructuring.
U.S. activity totaled $31.3 MOREDan Primack - Jul 10, 2012 10:42 AM ET
It's time to press the reset button in Europe -- if members of the EU want a common currency, they should give up their national identities in favor of a European one.
By Cyrus Sanati
FORTUNE -- There is growing fear that the European debt crisis may have given the euro an incurable disease that could not only bring down the common currency, but also lead to the total collapse of MOREMay 30, 2012 9:46 AM ET
If the EU's leading nations aren't willing to forgive the debt of their troubled bretheren, then maybe they need to start printing more euros.
By John Cassidy, contributor
FORTUNE – From the U.S., the European debt crisis can seem like a black comedy populated by regional stereotypes: iron-fisted Anglo-Saxons, feckless Mediterraneans, and haughty Brussels bureaucrats. Closer to the action, it isn't funny at all. In the words of Mervyn King, governor MOREMay 30, 2012 5:00 AM ET
If Greece leaves the euro, it may mean more to us than just another cheap vacation spot.
FORTUNE – A curious development happened last week in the ongoing euro zone crisis. Finance ministers from the 17 countries that use the euro agreed they needed to develop back-up plans in case debt-troubled Greece leaves the euro. The tone was unexpectedly bold, given that officials have mostly kept mum about a potential Greek exit to avoid panicking MORENin-Hai Tseng, Writer - May 29, 2012 11:10 AM ET
The new leaders in France and Greece should reassure the markets that they're willing to work within the existing framework of agreements and that they're committed to the euro.
By Cyrus Sanati
FORTUNE -- The elections in France and Greece over the weekend have created a crisis of confidence that could eventually drown the euro and push the continent into a deeper recession. Talk of tearing up past agreements and a MOREMay 9, 2012 10:05 AM ET
The debt restructuring last week was deemed a success, but if Greece continues in its current state with no outside economic stimulus, it will burn through that 130 billion euros in no time.
By Cyrus Sanati, contributor
FORTUNE -- French President Nicholas Sarkozy declared Friday that the long-running Greek debt "problem" had finally been "solved," following the successful implementation of a massive debt restructuring in the country. But while the restructuring was more successful than many MOREMar 12, 2012 12:07 PM ET
The Greek bailout could keep investors from making additional sovereign debt purchases, further exacerbating the crisis. This will make the governments even more dependent on the ECB for funding -- something it may not always be able to provide.
By Cyrus Sanati, contributor
FORTUNE -- The latest Greek bailout has done little to convince Wall Street that Europe has gotten a grip on its debt woes. If anything, the deal has cemented the view that private MOREFeb 22, 2012 12:37 PM ET
Greece's problems aren't all about debt. They're about competitiveness, and changing the arcane rules in areas from the cruise industry to pharmaceuticals would help it reboot its economy.
FORTUNE -- The searing images from Athens -- the streets choked with rioters, stately buildings and Starbucks' ablaze -- are masking a drive to liberate markets that's unlike anything any nation has attempted to do in decades. The platform is being pushed hard MOREShawn Tully, senior editor-at-large - Feb 15, 2012 9:20 AM ET
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