EU RIP? Europe deal fractures union, raises stocks
Twenty-three members of the European Union have agreed to a fiscal compact, intended to create a "genuine 'fiscal stability union' in the euro area" and will result in "significantly stronger coordination of economic policies in areas of common interest." All 17 European members who use a common currency agreed to the pact, plus six more (Denmark, Latvia, Lithuania, Poland, Romania and Bulgaria) that hope to use the currency in the future.
Wait, aren't there 27 EU nations? Sweden and the Czech Republic didn't close the door, but Britain and Hungary are not so keen on the idea of ceding power over their national budgets to a centralized European authority, so they are taking pass on the new pact.
Britain seemed to be the least interested in considering the pact. British Prime Minister David Cameron said he could not allow a "treaty within a treaty" that would undermine the U.K.'s position in the single market. Oh, and the City of London (the financial center of the U.K.) wasn't interested in signing up for a pact that would impose a tax on financial transactions.
Merkel can't flex her muscles in Brussel: stocks up
Although German Chancellor Angela Merkel wanted consensus from all 27 EU members, she has to live with only 23 to "achieve the new fiscal union" and only 23 will "have stronger budget deficit regulations." This essentially boils done to a two-tiered European Union, where depending on your point of view, Britain is either (a) left isolated or (b) off the hook for future bailouts.
The real test is whether investors believe that the pact will work. European stocks were up about one percent, and U.S. stocks closed 1.5 - 2 percent higher after the announcement. But with Europe already at risk of recession, investors may soon realize that there is little in the new fiscal pact to address slowing growth rates and problems in the heavily indebted PIIGS. The real test is the bond market, where confidence in debtor nations is made abundantly clear every day. Today, the cost to borrow money for two years in Italy is 6.12 percent and in Spain, yields are at 4.54 percent, both of which are below nose-bleed levels of two weeks ago, but still a hefty price to pay to finance sovereign debt.
Can we stop talking about Europe now?
Unfortunately, Europe is going to stay with us. The leaders now have to write the new rules; come up with more bailout money; and continue to monitor the weak debtor nations and the European banks. And all of this impacts the U.S. in a big way -- here's how:
Banking: If the Euro and European banks melt down, U.S. banks will also feel the pain. U.S. banks have about $1.2 trillion dollars in loan exposure to European banks, not to mention $640 billion in direct exposure to the so-called PIIGS. If Europe implodes, then U.S. banks will freeze up, making it even harder to get a loan for a house, a car or a small business.
U.S. exports: If the European economy tanks, the U.S. could follow suit. Europe buys 22 percent of all U.S. exports and so a recession there would hurt our exporters.
Jobs: If the U.S. economy slows down, there could be another round of job cuts, just at the time where it seemed we were making some incremental progress.
Stocks: Remember the August swoon that occurred after the debt-ceiling debacle? If Europe breaks down, August will seem like a walk in the park.