September Showdown in Europe

July 31, 2012

The European Union will face their own “cliff” in September as U.S. lawmakers battle to prevent the fiscal cliff at home. This European cliff has nothing to do with scheduled sequestration and tax increases, but it is a similar perfect storm. Delayed spending cuts and mounting dissension have driven up the cost of the eurozone’s problems driving leaders to a September cliff.

It hardly qualifies as news that the troika of creditors has found Greece to be far behind with reforms needed to improve its finances. Because of failure to implement spending cuts, Greece is still off track to bring down its debt from 160 percent of GDP. As of last week, the troika and Greek political leaderswere able to agree on some of the austerity measures demanded by the nation’s lenders, but the country must still find 1.5 billion euros of savings to comply with terms set in the last bailout. The troika will decide on the next tranche of aid in September.

Italy and Spain continue to worry euro zone leaders, as well. One euro zone diplomat compared the growing costs with a deflating life raft saying, “For two years we’ve been pumping up the life raft, taking decisions that fill it with just enough air to keep it afloat even though it has a leak. But now the leak has got so big that we can’t pump air into the raft quickly enough to keep it afloat.” If Spain, Italy, and Greece apply for aid the costs would be too great for the European Financial Stability Facility (EFSF) and European Stability Mechanism (ESM) to bear.

Furthermore, willingness from the North to support its Southern neighbors is dwindling. The success of the ESM hinges on a September 12 vote from the German Constitutional Court on the compatibility of the treaty that established the $500 billion euro fund with the German constitution. Without the ESM’s biggest lender, the fund would be unable to protect Spain or Italy. That same day, the Netherlands, home to popular opposition of further bailout spending, will hold parliamentary elections, the results of which could complicate talks on further aid to Greece.

The eurozone’s fate now centers on September’s crucial decisions. While European Central Bank President Mario Draghi, German Chancellor Angela Merkel and Italian Prime Minister Mario Monti have voiced their willingness to do everything to protect the eurozone, September may prove to be a greater test than expected. Willingness could be trumped by dissension amongst Northern countries over continued support for the debt-stricken eurozone and a shortage of funds. Only September will tell.

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