The world breathed a temporary sigh of relief after the European Union (EU), the European Central Bank (ECB) and the International Monetary Fund (IMF) announced a trillion-dollar relief package for ALL of the troubled countries in the euro-zone. In one move, these three powerful supra-national entities tried to heal the sovereign financial problems of all the “PIIGS,” i.e., Portugal, Ireland, Italy, Greece and Spain. Essentially, the ECB transformed itself from the world’s leading inflation “hawk” to a flock of doves.
The ECB will try to explain this move by saying it will “sterilize” its government bond purchases by reabsorbing the extra liquidity, thereby limiting future inflation. In other words, these sovereign debt purchases do not involve printing money – euphemistically known as “quantitative easing.” Instead, the ECB will say these bond purchases will be offset by removing equal amounts of cash from the banking system. If so, that means the ECB may crowd out private capital, which will constrain economic growth.
Although ECB President Jean-Claude Trichet said this bond-buying was endorsed by the “overwhelming majority” of the ECB council, the President of Germany’s Bundesbank (and a leading candidate to be the next head of the ECB), Axel Weber, publicly distanced himself from the ECB’s decision by saying, “I see this part of the governing council’s decision critically, even in this extraordinary situation.”
The French aren’t happy, either. French President Nicolas Sarkozy apparently threw a hissy fit in private meetings last week. Some Spanish officials at the meeting said “Sarkozy ended up banging his fist on the table, threatening to leave the euro … This forced Angela Merkel to give in and reach an agreement.” Another source at the meeting said, “France, Italy and Spain formed a common front against Germany, and Sarkozy even threatened Merkel with a break in the traditional Franco-German axis.”
Europe Sovereign Debt Woes
In the interim, there was new hope last week that some troubled European countries are trying to get their budgets in order. First, Spain announced on Wednesday that it was implementing its own austerity measures by cutting government salaries 5%, along with a salary freeze in 2011. Naturally, Spain’s General Union of Workers (UGT), its biggest and most influential trade union, announced a strike of public sector workers on June 2. Then on Thursday, Portugal introduced tough new austerity measures and a “crisis tax” on wages and corporate profits. This crisis tax includes a 2.5% increase in corporate taxes (to 27.5%), a 1% increase in the value added tax (VAT) to 21% and a 1.5% income tax increase.
Despite austerity measures by Greece, Portugal and Spain, most Germans remain aghast at the bailout of Southern euro-zone countries who were fiscally irresponsible. The German media continues to question why its citizens, known for their high savings rate, must use their savings to bailout other countries in the euro zone. Most Germans are increasingly unhappy with Chancellor Angela Merkel’s decision to use German money to bail out southern euro-zone nations. (The U.S. is also contributing to the IMF bailout package with an estimated $50 billion, while several American states seek a similar kind of bailout.)
As Euro Sinks, Europe’s Economy Slows
The euro sank to $1.2358 over the weekend, its lowest level in four years. Contributing to the euro’s weakness, fixed-income giant Pimco reportedly sold all its holdings of Greek and Portuguese sovereign debt. Ramin Toloui, a senior portfolio manager at Pimco, said the ECB’s decision could backfire: “The risk is that investors are using the ECB as a vehicle to exit their positions.” Steve Barrow, currency strategist at Standard Bank, added: “Finance ministers in the euro-zone might argue that they acted to save the euro but, in reality they acted to save national bond markets … and the euro is the fall guy.”
Not surprisingly, amidst all the euro-zone infighting, GDP growth in the euro-zone is slowing down, especially in the troubled PIIGS. On Wednesday, Eurostat announced that GDP growth in the euro-zone was only 0.5% in the first quarter, compared with the same quarter a year ago. Greece’s GDP contracted 2.3% in the past year and there are now fears that Portugal and Spain’s GDP may start contracting soon.
Not surprisingly, gold hit a record high this week at $1,240 (or 1000 euros per ounce) due to continuing euro weakness. (Gold was only 800 euros per ounce in March.) I should add that UBS, one of the largest bullion banks in the world, said that its gold sales desks in Geneva and Zurich experienced the greatest demand for gold coins and small bars since March of 2008, when gold first topped $1,000 per ounce.
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