A few months ago, when my gym buddy Robert Downey Jr. was still rockin' his metal suit in Iron Man 2, the European Union set up the EFSF to help euro zone economies in financial mess. However, around late 2010, those economies were still in trouble and debates about increasing the size of the fund started heating up.
Germany quickly became a villain in the EFSF drama after German Chancellor Merkel strongly opposed the plan and stated that there is no need to inject more money above the original 440 billion EUR. And like Apple fanboys (includingDr. Pipslow) agreeing to everything Steve Jobs says, economic ministers from the region decided in their EcoFin meeting early this year to keep the original size of the fund.
So why is Germany willing to give an inch now?
Well, its support certainly doesn't come cheap. Germany wants euro zone member states to adopt tough new economic reforms that would harmonize economic and social policies of the region, and whip up those struggling economies into shape.
The first agenda in the "pact of competitiveness" is copying Germany's own "Debt Brake" law, which forces Berlin to cut its structural deficit, which is the amount politicians can borrow for investments, to only 0.35% of GDP by 2016. For comparison, Greece's structural deficit is at 4.7% of GDP, Spain has a 4.8% figure, and Ireland's has 8.9%. Talk about setting high standards!
If that's not enough to give EZ politicians sleepless nights, Germany also wants to coordinate the region's corporation tax policy, which would end Germany and France's bad vibes towards Ireland's ridiculously low corporate tax rate (around 12.5%). On top of that, citizens of euro zone economies will also face synchronized retirement age, and even wages that are linked to inflation.
What's in it for Germany?
Ahh, excellent question. While many investors believe that the "pact of competitiveness" is just what the region needs to shape up, others also think that Germany will stand to benefit more on the deal.
For one, German voters would be more lenient on giving up their savings for the sake of the shared currency if reform is led by Germany. You see, approval ratings of Angela Merkel's coalition partner, the Free Democratic Party (NYSE:FDP), is in danger of falling below 5%. With Länder elections only a few days away, Merkel will probably do anything (even hiring Angelina Jolie as her spokesperson) to gain good publicity!
Easing up on the EFSF could also have economic benefits for Germany. German banks currently have roughly $394 billion worth of exposure to weaknesses in Greek, Irish, Portuguese, and Spanish economies, including a 10 billion EUR direct exposure to the Irish sovereign through the EU/IMF bailout package. Since Germany's total exposure is already around 12% of its GDP, increasing the EFSF might be a cheaper option.
This weekend the European Union leaders are meeting for the EU summit, and many expect Merkel to pitch her plans to the EU leaders. If Germany's "pact of competitiveness" pushes through, it would most likely be bullish for EUR/USD. Markets might cheer at the possibility that the euro zone economies are finally taking concrete solutions to their huge debt problems. After all, isn't it better for someone to step up and take charge no matter what its motivations are?