The Sunday agreement for a 750 billion euro bailout for European Union countries caused the Dow Jones Industrial Average to increase 404.71 points on Monday, or 3.9%, to 10785.14. The bailout also allowed global equities to surge. The euro rose above $1.30 to the dollar before retreating to close below $1.28. Great news, but let’s look behind the headlines.
The European Union and its euro zone members said on Sunday that any future bailout would occur only in the “context of joint EU/IMF support,” and require a program of “strong conditionality” according to an agreement by EU finance ministers. In plain language, the International Monetary Fund is providing 250 billion euros for the bailout, but the IMF will have the power to approve any loan, and as a condition of any loan, impose tough economic policies on the borrowing country, and will police the loan. Consequently, the IMF’s power to oversee the global financial markets has been vastly increased. The IMF, with U.S. support, has made the leap from making leveraged loans to poorer countries to making fiscal policy for the European Union countries. Now the IMF is going to be the main architect of fiscal discipline for the European Union.
On Sunday, the euro zone countries surrendered a great deal of fiscal sovereignty to the IMF. The European Union is not one nation like the U.S., but rather an affiliation by treaty of sovereign nations, and because of their diverse national economic and political interests, euro zone members have been unwilling to integrate their fiscal and monetary policies under a central bank and a treasury. The European Union’s failure to integrate fiscal and monetary policy across all of the euro zone countries is the root cause of the financial crisis it now faces and, long-term, it’s bad news for the value of the euro. The role of the IMF in the bailout is evidence of the cracks developing in the European Union and the euro. The crisis in the euro has been kicked down the road, but it is not over.
Greece’s bailout will increase capital flows from euro zone investors into the U.S. securities markets, because economic growth will be higher in the U.S., and because of this we can bet on a stronger dollar and weaker euro in the near future.
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