Many commentators continue to look for simplistic solutions to the economic situation in the eurozone. For example, on April 30, 2012, William Larson wrote on SA: "But even with the ability to halt market panic, the ECB cannot permanently resolve the fiscal problems of the debt laden eurozone without the cooperation of member nations. Fiscal responsibility is the only sure road to a permanent solution."
I am sorry to report that there is no sure road to a permanent solution. Even one or more countries exiting the euro would not be a sure road to a permanent solution.
The Competitiveness Problem
It is well-known and generally accepted that one of that major underlying problem of the eurozone is the imbalance of competitiveness among the nations. That imbalance may well persist regardless of fiscal rectitude, even if all the nations are fiscally responsible. Although a nation leaving the eurozone might be free to float its currency, thus becoming internationally more competitive, that ability to float the currency would not either repay the nation's debts or satisfy the natural desire of the people of the EU, who, for example, drive freely between their nations, to be able, for example, to pay tolls in a single currency.
The Possible Long-Term Solution
The closest solution to a possibly permanent one would be a political and fiscal union-a United States of Europe, for short. At the moment, there is not the political will to achieve that solution. Therefore the leaders of Europe are likely to continue to buy time.
The Coming "Growth Compact"
The recent talk of a "growth pact" is a symptom that desire to buy time. Apparently spurred by French presidential candidate Francois Hollande, the idea of a "growth compact" alongside the fiscal stability compact pact is catching on. I am confident that it will be added to the Treaty because ECB President Mario Draghi is now saying that such a thing might make sense. Mr. Draghi has the reins, and so long as he okays such an apparently good thing, it is highly likely to occur.
Mr. Draghi has been quite consistent in his views over the last six months. Here is some of what he said to the European Parliament on April 25:
"Now, I would like to discuss the second topic selected for our exchange of views, namely macroeconomic imbalances in the euro area.
Of course, divergences of economic developments are a normal feature within a monetary union. But they should not become of a persistent and structural nature.
Unfortunately, very large imbalances were allowed to accumulate over recent years in several European countries. These imbalances stemmed from different sources: insufficient fiscal discipline, financial excesses, failure to implement structural reforms especially, but not exclusively, in the labour and product markets and significant competitiveness losses. All of this necessitates urgent and resolute adjustment.
[The ECB] cannot address divergences among individual euro area countries.
That is the task of governments: they must undertake determined policy actions to address major weaknesses in the fiscal, financial and structural domains. We note that progress is being made in many countries. These measures need to be complemented by growth-enhancing structural reforms to facilitate entrepreneurial activities, the start-up of new firms and job creation. Here, governments should be more ambitious.
At the European level, there has been substantial progress towards reinforcing the economic governance framework. We have seen a strengthening of the fiscal rules of the Stability and Growth Pact and the introduction of the Fiscal Compact, about which we spoke in the Parliament last December. And we are implementing the new focus on correcting macroeconomic imbalances."
The FT and others reported that in that speech "The president of the European Central Bank urged the eurozone to adopt a 'growth compact' to boost economic prospects," although that language was not in his prepared remarks and is not yet to be found on the ECB website.
But what might such a "growth compact" look like? Anyone who thinks the growth compact is going to reverse austerity programs and provide fiscal stimulus misunderstands the situation. My best guess is that the growth compact will be window dressing that gives cover to M. Hollande and some other European socialists to come over the side of the euro's defense. It also will be designed politically to say to the people of the austerity countries, "We feel your pain, and we [the Great Powers of Europe] are going to do something about it." Its substance, the Growth Compact is likely to require support from all European governments for the kinds of structural reform of tax, labor and business laws that Mr. Draghi believes are an important part of solving the long-term competitiveness issue.
In order to satisfy the socialists, the language concerning labor will have to be incomprehensible. But European politicians are good at fashioning such language, so it is likely to happen.
Marginalizing the Bundesbank and Buying Time Politically
In a practical sense, the growth compact is likely to give opponents of Jens Weidmann, the Bundesbank President, conceptual ammunition against his strict interpretations of economic imperatives. As far as I can tell, except in some parts of Germany, Mr. Weidmann has made himself genuinely disliked, and that dislike probably will assist the leaders of Europe to move the growth/austerity needle back toward growth, at least verbally. Whether moving the needle verbally can have a significant effect on policy, I do not know. I -- and many others -- believe that Mr. Darghi's set of policies is the one with the best chance of success, and it is his policies that are prevailing at the moment. Whether they can succeed probably will depend upon whether Spain and Italy can turn the corner economically over the next year, perhaps plus a bit. I believe they can get that much time politically (though that is not a sure thing). The Growth Compact might well buy time politically.
What does this mean for investing in European securities? Steady she goes. Nothing has changed radically. Both risks and opportunities abound. Which prevail on the whole is any investor's guess. As I have been suggesting, I would not invest in Spain or Italy at this time. But selected investments in French or German banks or companies might well make sense for investors who are willing to take on significant risk in the search for significant gain.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
