12/12/11: In the markets, as in life, there are no guarantees but everyone is entitled to their opinion. Here’s my opinion on four major decisions that the European Union made Friday that could have impact on markets in the future:
1. The bailout fund reserve just doesn’t seem to be enough. Friday’s proposals commit the countries to put the $669 billion permanent European Stability Mechanism (ESM) bailout fund into action in 2012 rather than in 2013 as originally planned. It will replace the temporary European Financial Stability Fund (EFSF), which will cease new bailouts in 2013. Besides a desire by many that it be larger (the Obama Administration favored an amount more in the $2 trillion range), others hoped that the funds could operate “in parallel” for 2012 and provide significant backup. However, the European governments agreed to retain a cap on the combined funds for now that muted any potential “in concert” effect.
2. Fines on European countries that acquire too much debt relative to GDP will now be enforced. As it now stands, the EU’s treaty provides for countries breaching the bloc’s fiscal ceilings to suffer possible sanctions. The problem? It’s never really been enforced and no country has ever been fined. Now, if the European Council – the ministers representing EU countries – decides a euro member is violating fiscal rules, the commission could effectively require the country to put a deposit into escrow that could be converted into a fine by a second decision of the council.
3. Countries are now required to pass a constitutional amendment, or similar law, that pledges balanced budgets. This includes automatic corrections if the structural deficit (the deficit adjusted for the booms and busts of an economic cycle) exceeds .5% of GDP. Simply put, the EU is trying to put “debt brakes” in place much like Germany now has. As is often the issue in Europe, the real problem with this will be in the execution, as no common enforcement mechanism is proposed for the “debt brakes.” The EU’s high court would verify that each country would have such a mechanism in place, but “making it work” is up to each country alone, with no oversight from Brussels.
4. The leaders contributed an additional $200 billion Euros to the International Monetary Fund. Increasing the contribution to the IMF will give that fund more “firepower” to help with Europe. The money is likely to come from central bank reserves and not from the countries themselves. However, we don’t expect all of this to be “earmarked” for Europe, as the ECB has indicated that such earmarking would be illegal. IMF shareholders, including the U.S. which is the largest stakeholder at 17% of IMF funds committed, would face opposition to sending large volumes of cash to Europe at once.
As always, email me here with your questions or comments. I love to hear from you and thoroughly enjoy the “intellectual debate” with our clients and friends that these opinions generate.
Senior Vice President
Note: The opinions voiced in this material are for general information and are not intended to be specific advice. Any indices such as the S & P 500 can’t be invested into directly. Past performance is no assurance of a future result.
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