EU Aid Package Should Boost Euro and Markets, but Not for Long

Last Updated May 8, 2010 3:54 PM EDT

European Union leaders, facing plunges in the euro and in bond and stock markets and public confidence, announced over the weekend that they had set up a massive support program intended to push back against speculators who have been selling, well, everything. It's not clear precisely what steps will be taken or how much money is involved, only that the program will be in place when the markets open on Monday.

Based on an understanding of the woes besetting the euro zone, it's safe to say that the EU program will be a spectacular success - for maybe a week.

The euro could bounce back five cents or so against the dollar when EU finance ministers start rocking and rolling in the markets, and interest rates on the debt of the weaker members of the 16-nation euro zone - Spain, Portugal and especially Greece - could come down a percentage point or two or three. Stock markets in a lot of places, including the United States, could stage a dramatic comeback from the pasting they have taken in the last week.

New Lows Ahead?
The gains could be just as quickly undone, however, followed by even lower lows. As Douglas McIntyre points out on AOL's DailyFinance website, European leaders have few reasonable choices in confronting the run on their markets.

"The European Central Bank and the financial ministers of its member nations have a modest number of options. They can directly buy sovereign debt from the weakest economies; buy debt or equity in large banks; make investments that will bring down the rate at which sovereign debt is insured; or, they can directly buy euros."
McIntyre does not say which approach or approaches he expects European officialdom to take, but he does allude to the shortcoming inherent in each when he asks: "Where will the money come from?"

The euro zone is a closed system. Its members probably could pony up several hundred billion euros to try to prop up markets, but any support program amounts to robbing Heinrich to pay Stavros. It may smooth out the region's financial frailty, but it won't lessen it.

Think of it this way: European governments collectively are running deficits of about 6 percent of the region's economic output this year. That means any money used to defend their currency and financial markets is essentially borrowed money. Borrowing to buy your own debt isn't much of a solution.

Allez-y, Faites Mon Jour
French President Nicolas Sarkozy vowed to "confront speculators mercilessly," according to press reports, and he warned that they would soon "know once and for all what lies in store for them."

It may not be what he has in mind, but what lies in store for them probably is more profits. The speculators no doubt will stand aside as treasuries send in their billions of euros and push prices higher. Indeed, if they take a few days off, it will amplify the impact of the state intervention.

That will just give the speculators a brief vacation and then a ripe opportunity to attack the euro and peripheral European bonds at more attractive, artificially inflated prices once markets stabilize.

That would almost certainly pay off because what ails Europe fundamentally isn't financial speculation but persistent fiscal imprudence that has created a double whammy of very high taxes and excessive indebtedness. That in turn has resulted in chronically slow economic growth, which reduces state revenues and perpetuates the cycle.

If European leaders were to cut tax rates, ease regulations on businesses and overhaul their generous-to-a-fault pension systems, there's a good chance the euro and asset prices across the region would go up and stay up. It won't happen, at least not soon, so look for any pop in the markets to prove short-lived and perhaps the last decent selling opportunity for a long time.

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  • Conrad Aenlle

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