Leaders from EU powerhouses Germany and France will hold talks today (5 August) after a global market rout roused fears that Europe's debt crisis is spinning out of control and the US recovery is stalling.
Belying a sense of crisis, many of Europe's policymakers are still on summer holidays, although EU Economic and Monetary Affairs Commissioner Olli Rehn broke away from his to return to Brussels, where he is planning a news conference today (Friday).
French President Nicolas Sarkozy will discuss financial markets with German Chancellor Angela Merkel and Spanish Prime Minister José Luis Rodríguez Zapatero, Sarkozy's office said in a statement.
The heavy sell-off came after the European Central Bank failed to include Italy and Spain in a fresh round of bond buying, as yields on their debt shot above 6 percent, the highest level since the euro was launched over a decade ago.
ECB President Jean-Claude Trichet said there was not full support in the central bank for the action, underscoring deep divisions within Europe over how to handle a debt crisis that has forced Greece, Ireland and Portugal to seek financial rescues, Reuters reported.
Investors are concerned that Italy and Spain, the euro area's third- and fourth-biggest economies, could be next.
Sarkozy said France, Germany and Spain had talked to Trichet.
Investors had hoped the ECB would target Spanish and Italian debt in reviving its bond-buying stimulus program, but it restricted the purchases to Irish and Portuguese securities.
No longer crisis of EU's periphery
Yesterday, Commission President José Manuel Barroso sent an unusual letter to euro zone leaders, asking for a re-foundation of the European Financial Stability Facility (EFSF), which the EU set up in May 2010 at the height of the Greek crisis, as well as the ESM, its extension which will be enshrined in EU treaties. Last March leaders decided that the ESM will in total hold €700 billion to shield eurozone countries from future debt crises.
"It is clear that we are no longer managing a crisis just in the euro-area periphery," Barroso wrote. Without naming Italy or Spain, he urged "a rapid re-assessment of all elements related to EFSF" and proposed that leaders should decide "how to further improve the effectiveness of both the EFSF and the ESM in order to address the current contagion".
Barroso also deplored "the undisciplined communication" of EU leaders and "the complexity and incompleteness of the 21 July package", namely the decisions of the recent euro zone summit which he personally presented as a major breakthrough at the time.
US problems compound uncertainty
In the United States, a similar sense of political paralysis reins.
Just days after a bitterly fought, last-minute deal to raise the country's debt ceiling and avoid default, realisation has sunk in that many elements of the $2.1 trillion deficit reduction plan are short term and not locked in place.
Doubt has spread through markets that Congress will stick to implementing it in full after the November 2012 elections.
This, combined with a bout of poor economic data, points to a heightened risk of another slump. Lawrence Summers, a senior adviser to the U.S. president until last year, argued in a Reuters column that there is a one-in-three chance of recession in the United States.
US employment numbers due later on Friday will be critical to market sentiment. Forecasts are for a tepid 85,000 jobs added in July, but a weak number or even contraction would boost concern that the United States is heading into recession.
Many economists say chances are slim that Congress would endorse a further round of fiscal stimulus now that it is focusing on fiscal spending cuts.
"I don't see a well functioning government that can do something," said Jeff Frankel, economics professor at Harvard University and former White House economic advisor under Bill Clinton. "If everything is blocked politically, especially fiscal policy, there's nothing much you can do."
POSITIONS:
EFSF resources will not be sufficient to bail out a large country, Julien Beauvieux argues in an editorial in the French daily La Tribune. He claims EFSF financial capacity should be increased to the level of about €2 trillion in order to restore its credibility.
The ability of the EFSF to act is hampered by its member countries, who have not yet ratified its establishment, and this ratification is not expected before September, according to experts. The EFSF should rapidly start buying sovereign debt to contain speculation and limit contagion, he argues.
France needs to act quickly since the crisis is not limited to the euro zone periphery, argues Jean-Marc Vittori in the French Daily Les Echos. But Commission President José Manuel Barroso has no credibility whatsoever and the results of the 21 July euro zone summit are not yet operational, he argues.
France has every interest in the world in doing its utmost to overcome these obstacles, because the barometer is already signalling the impending storm headed its way, he writes. On Wednesday, the interest rate on France's sovereign debt was exceeded Germany's by 0.79%, he stressed that this was something which had never happened before.
Only the ECB can halt euro zone contagion, argues Paul De Grauwe, writing for the Financial Times.
He compares bond markets with banking systems, in which the instability of one bank is usually solved by mandating the central bank to be a lender and to print money.
The EFSF will never have the necessary credibility to stop contagion because it cannot actually print money, De Grauwe argues.
Instead an overhaul of the of the euro zone institutions is urgently needed, the most important being the ECB, which needs to take on full responsibility as lender of last resort in the government bond markets of the euro zone, he argues.
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