Sunday, May 20, 2012

The European Fiscal Tourniquet

  Last year, in the midst of the Greek meltdown and Portugal's problems, the Germans {rightly} insisted that EU states take decisive measures to balance their budgets. On January 31st of this year, the EU agreed on what was called the European Fiscal Compact. This agreement makes it so that EU nations would be forced to balance their budgets by 1/1/14.

* This would have to be ensconed into the member states' constitutions.
* The treaty demands that an automatic correction mechanism be enacted in their constitutions.
* All states would accept the jurisdiction of the Court of Justice to verify the imposition of this rule.
* It requires all states balance their budgets by January 1st, 2014.
* The EU's High Court will be able to fine any nation that does not accept a balanced budget amendment in it's constitution. 
* Any nation which does not ratify this into it's constitution will be ineligible for any aid from the ESM.
* The treaty will enter into force if by January 1st, 2013 twelve of the seventeen EU states ratify the treaty.

So far, only Greece has ratified it oddly enough. Portugal, Poland and Slovenia have all passed it in one of their legislative houses, awaiting passage in the other one. Ireland is holding a referendum on May 31st on this treaty, and as of this writing it looks like it has a good chance of passage. I actually believe it will pass in time. It will be quite interesting to see if France will pass this with the election of Hollande. If this treaty does not pass, Germany will have it's excuse to head for the exits.

  This treaty presents several problems. First and foremost it ensures that the countries in trouble will be forced to apply another deflationary tourniquet to an already constricting economy. Greece's recent example of what deflation can do should be a huge red flag for these nations. For nations like Spain, it will ultimately be forced into a brutal political choice come late 2013-- exit the Euro or apply the tourniquet {assuming they ratify this. If not, then no ESM rescue and a bond crisis hits them very quickly}Other nations like Italy, Portugal and Ireland will also face this brutal choice. Some will do neither-- their governments will fall apart. I'd wager that more than one nation will end up like Greece and Belgium-- essentially without a government that can make a decision. This is not what markets want to hear. These adrift nations's bonds will be immediately punished by the markets, presenting a crisis almost immediately should a nation {for whatever reason} be unable to balance its budget. Damned if you do, damned if you don't. 


  1. The structure of some of these economies must be the starting point. There is no traction in an economy heavily weighted to bloated government. Ergo, damned if you do, damned if you don't.