Eurozone under threat

France is facing the spectre of a downgrade in its AAA credit rating by an unprecedented two notches in the aftermath of the Thursday summit together with 13 other eurozone members. The reason: high indebtedness, coupled with low growth. The outcome of last week's summit was marred by David Cameron's insistence that the UK be allowed exemption with respect to financial obligations, a claim that he considered legitimate given that a significant portion of financial activity in the European Union (EU) takes place in the city of London. The French President, Nicolas Sarkozy, dismissed British prime minister's legally legitimate stance given the EU charter as 'unacceptable' for two broad reasons. First, because opting out by any member state necessarily implies that EU institutions including the Commission and the Court of Justice cannot be used to inflict penalties on any of the remaining 26 members that fail to achieve a proposed cap of 0.5 percent of GDP on annual structural deficits with automatic consequences on those whose deficits exceed 3 percent of GDP, without UK approval. In other words, the 26 states of EU would be compelled to operate within the framework of a treaty between governments and not within the EU. And secondly, several UK and US financial institutions as well as companies with significant exposure to Eurozone countries began preparing contingency plans and hedging bets in case one or more country was compelled to leave the euro several weeks ago. Thomson Reuters stated at the time: "Our currency dealing systems are specifically designed so that we can add and remove currencies very easily and quickly. The systems are built and tested to cope with very significant volumes." Graham Leach, chief economist at the Institute of Directors, stated that if "Club Med" countries came out of the euro, their national currencies would face "a dramatic devaluation of around 40%," or profits derived by firms in the crisis countries would plummet when converted to non-euro currencies, with significant asset write-downs as well as the eruption of issues involved in honouring contracts based on payment in euros. Needless to say contingency planning by UK financial institutions, as well as companies engaged in eurozone countries not bound by EU treaties would exacerbate the crisis in the eurozone in days to come. Further complications have been witnessed in the aftermath of the failed Thursday summit for all EU member states, including Great Britain. David Cameron's decision to leave the summit was public-supported but privately criticised by the coalition partner and his Deputy Nick Clegg, who reportedly told one of his confidante's that Thursday last's negotiations in Brussels were "a spectacular failure to deliver in the country's interest. It leaves us isolated in Europe and that is not in our national interest. Nick's fear is that we become the lonely man of Europe." Those who began arguing that this may presage the withdrawal of the Tory coalition partner the Liberal Democrats support from the government were quickly disabused of this view by the Lib Dem Business Secretary Vince Cable who stated "Our policy was a collective decision by the coalition. We finished in a bad place." Be that as it may, fissures between the two coalition partners in the matter of policy have emerged on this issue and time will tell if the Lib Dems would be forced to leave the government or whether Britain is isolated as a consequence in Europe. What is fuelling considerable concern in the UK are stories emanating from Brussels that the 26 members (barring only UK) maybe considering utilising EU institutions without an agreement from Britain - a stance that would compel Britain to seek legal reprisal as well as isolate it till such a time as the matter is resolved legally. The rest of the 26 Eurozone countries have agreed on the caps on members' deficits, penalties for failing to meet the deficit targets, the establishment of a European Stability Mechanism with a 500 billion euro limit, though the adequacy of this amount is being debated, and the eurozone as well as all other euro countries to provide 200 billion euros to IMF to assist the debt-ridden eurozone members. These measures have yet to calm speculative fears and the euro crisis continues. There is little doubt that the cause of the crisis needs to be dealt with on an emergent basis. Europe is floundering as much as what the South East Asian emerging economies did in the aftermath of the 1979 financial crisis. While the eurozone bloc cannot be compared with South East Asia in terms of the scale of the crisis, given the size of individual and collective economies yet two facts need to be considered. Speculative activity, of the foreign variety, as noted by Malaysian Mahathir Mohammad at the time, was responsible for much of the crisis. In the case of the Eurozone contingency plans by the US and UK financial/industrial and commercial institutions with links to the 26 countries of the EU would necessarily undermine the success of any bailout package. And secondly and equally pertinently, the issue of public acceptance of the bailout packages and associated conditions, including the proposed loss of sovereignty to Brussels would be considerably greater in the eurozone with strong traditions of democracy as opposed to what was evident in South East Asia. While the publics of Greece and Italy have succumbed meekly to a Brussels-imposed technocrat-led government yet Greece has already witnessed strike action against the implementation of reforms. The original euphoria over those committed to reform as opposed to politicians focused on political compulsions has clearly passed. Time will tell if the Europeans would patiently and meekly wait for years for their economies to stabilise with Brussels-directed reforms and non-representative governments at their helm implementing them. Common sense suggests otherwise. Copyright Business Recorder, 2011