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EU leaders seek unlikely happy end to euro's annus horribilis
Date: 2010/12/20 Click: 1039
For anybody who has followed the euro's horrible year, this week's European Union (EU) summit followed a predictable scenario.

First, leaders held a bout of late night wrangling before emerging to proclaim a ground-breaking agreement that will resolve months of market instability and restore confidence in the battered euro.

"This is a great day for Europe," exclaimed German Chancellor Angela Merkel, after the summit agreed to create a permanent bailout mechanism to replace the current 750-billion-euro (995- billion-dollar) rescue fund, which is due to expire in 2013.

Markets were briefly positive. The euro rose after Thursday's announcement. But then analysts started to pick apart the deal.

They worried that the current fund will not be big enough to rescue Spain, if it follows Greece and Ireland down the path to financial meltdown. They highlighted divisions over plans to create "euro-bonds" that might form the base of more durable solution.

Fears emerged that parliaments in any of the 27 EU nations might reject the changes in the EU's Lisbon Treaty needed to set up the new fund. The influential ratings agency Moody's downgraded Ireland's debt after issuing warnings that Spain and Greece may soon face a similar relegation.

The crux of the issue is that markets remain to be convinced that Ireland, Greece, Portugal, Spain and perhaps other eurozone nations will be able to meet the interest rate payments on their huge national debts.

While that doubt lingers, the markets will only loan more money to those countries in return for ever higher interest rates. That creates a vicious circle by making borrowing more expensive for the highly indebted nations.

The four nations are already implementing drastic austerity packages, slashing public spending, laying off civil servants and holding down pensions in the face of widespread public discontent.

Markets fear the prolonged austerity will be unsustainable as it stifles hopes for the economic recovery needed in the long term to pull the countries out of the red. So without a massive bailout, the prospect of one or more of eurozone nations defaulting on its debts looms over the markets, a development that risks hitting European banks hard and dealing a blow to confidence in the euro.

The message from the summit on Thursday and Friday is that the EU will not allow that to happen.

"We have added a crucial piece to this year's work to make the euro zone's economies more crisis-proof," said Herman Van Rompuy, the president of the European Council. "We have a joint economic strategy and a political will to do whatever is required to ensure the euro-zone's stability."

The problem is that EU leaders have said the same before, repeatedly since the crisis began in Athens at the start of the year, and so far the strong words and case-by-case bailouts to Greece and Ireland have failed to calm markets for more than a few weeks.

Of particular concern at the moment is that the current bailout mechanism simply will not be big enough should the contagion spread from Greece and Ireland to the much larger Spanish economy.

Spain's debt problem is nowhere near as big as those in Ireland and Greece. Total Spanish debt in 2010 is around 64 percent of gross domestic product (GDP), compared to 140 percent in Greece and 97 percent in Ireland.

However the Spanish economy has been hard hit since 2008 by the global financial crisis which burst the country's property bubble and the country is running a budget deficit of around 9.3 percent of GDP.

Government austerity measures aim to bring that down to 6.4 percent in 2011, but that will do little to stimulate economic growth which is not expected to rise above 0.7 percent next year after contracting over the past two years, hence the continued concern.

At previous meetings, EU nations have faced criticism for taking temporary steps to halt the Greece or Irish meltdowns but doing little to address the structural problems at the root of the euro's troubles.

This time, they provoked concern by failing to reinforce the temporary mechanism, despite preparing longer-term measures such as laying down the post-2013 funding mechanism and launching debate on a closer "economic governance."

The process that led to the launch of the euro in 1999 was known as European Economic and Monetary Union, but while that led to a single currency now shared by 16 EU nations, economic policy remains largely in the hands of national capitals, a situation which has led to divergences within the currency bloc.

Germany for example is enjoying a healthy 3.7 percent growth rate this year and runs a deficit of just 4.8 percent, while the Greek economy is set to shrink by 4.2 percent and Ireland runs a deficit of 32.3 percent. German taxpayers have been groaning all year about the EU's biggest economy having to pay up to bail out its stricken partners.

Merkel knows that German banks will be among the hardest hit if Greece or one of the others defaults and she is aware of the benefits which the European currency has brought to German exporters who have fueled the country's current boom.

She has therefore agreed to the bailouts so far, although she put her foot down against the proposed increase of the emergency fund and firmly rejected a proposal put forward this week by Italy and Luxembourg for the EU to issue so-called "euro-bonds" which would have eased the burden on the weaker EU economies but could have led to Germany paying higher interest on its borrowing.

At the summit on Friday, Merkel and French President Nicolas Sarkozy said they would soon present proposals for closer coordination of economic policies within the euro-zone.

"We will have to go further to confirm the necessity of convergence of economic policies in the euro zone," Sarkozy told reporters after the summit. He insisted European leaders were aware of the high stakes that went well beyond the short term economic crisis.

"The euro is at the heart of Europe. If the euro crumble, Europe will be fundamentally hurt," Sarkozy warned. "European integration has brought us peace and the euro is a symbol of this. If euro falls, it is Europe which will explode, so the euro will not collapse."
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