The much anticipated EU summit in which European leaders discuss the state of the Union is due to begin shortly, and obviously the big topic of discussion is the EMU debt crisis. For instance The Telegraph reported this morning that the markets almost abandoned Spain in its recent auction of Government bonds, pushing insurance costs to a decade high.
Obviously then both EU leaders and the currency exchange markets are eager to unveil a solution at the end of the two day summit. So what solutions then might we expect? In short EU officials are divided into two camps regarding the EMU debt crisis and the answers available, and these will determine what happens.
Camp One: Let The Indebted Nations Take Responsibility For Themselves
The EU leaders in the first camp believe that indebted nations such as Portugal and Spain should take responsibility for their own financial woes. They ought implement crippling austerity programs to compensate for (1) the excessive borrowing of their Governments and (2) the excessive lending of their banks.
Perhaps unsurprisingly the EU leaders in this group belong to the relatively solvent nations of Northern Europe. The German Chancellor Angela Merkel is the obvious example: she has vetoed all suggestions to collectivise EMU debt either through ECB bonds (E-bonds) or increasing the EFSF rescue fund. Other members of this group include the Swedish Prime Minister Fredrik Reinfeldt.
Camp Two: The EMU Needs To Be More Closely Integrated
The EU leaders in the second camp believe that the EMU should collectivise European debt to take the pressure off individual members. Equally unsurprisingly the EU leaders of this group belong to indebted nations such as Greece and Portugal.
The solutions posited by these members are unlikely to be implemented because they involve fundamentally altering the EMU. Presently the EMU is a monetary union in which member states retain responsibility for their own economic policies. If European debt is collectivised this would begin the process of creating a centralised European authority, which is extremely unlikely now.
So What’s Going To Happen?
The EU leaders in the two camps are unlikely to work out their differences in the upcoming summit. Two days isn’t enough to work aside the fundamental differences in their opinions. Yet the currency exchange markets clearly demand some kind of decisive action in order to be reassured that the debt crisis will not become worse.
So in all likelihood EU leaders will do the least possible to reassure the markets without altering the status quo. This might involve making the EFSF rescue fund a permanent mechanism of the EMU: this tells the markets that Spain and Portugal will not be abandoned in the event of a bailout but doesn’t change the existing political relations between member states.
By Peter Lavelle with foreign currency exchange specialist Pure FX.
