Tensions between Paris and Berlin are set to flare, as fears grow that the flames of the debt crisis now engulfing Italy could soon spread to Belgium and France.
With Italian interest rates hitting record levels, and the spread between French and German borrowing costs continuing to widen, French President Nicolas Sarkozy has formed the view that the time has passed for technical solutions to the debt crisis. He believes Europe’s political leaders must make some major political decisions that are credible to financial markets. The very fact that there are rumours sweeping through markets about the break-up of the eurozone indicate that investors believe that Germany, and particularly the Bundesbank, is not committed to doing whatever it takes to save the euro.
Paris is worried that the European Central Bank’s efforts to stem the debt crisis are becoming ineffectual because of the continuing political uncertainty in Rome. The Italian government is rushing through a package of measures aimed at cutting the budget deficit and at reforming the labour market, but there are already doubts as to whether these measures will go far enough to boost the country’s stagnant economy or reduce the country’s massive €1.9 trillion ($US2.6 trillion) mountain of debt.
If the situation continues to deteriorate, Italy could get a bailout from the European Union and the International Monetary Fund. At the recent G20 meeting in Cannes, embattled Italian leader Silvio Berlusconi turned down the offer of a €50 billion standby line of credit from the EU and the IMF, which would have given the country a buffer against market turbulence. European leaders are likely to repeat the offer to Berlusconi’s successor.
The problem is that this is only a stop-gap measure. The eurozone’s bailout fund simply doesn’t have enough resources to rescue Italy, which needs to roll over around€300 billion in debt a year. After bailing out Greece, Portugal and Ireland, there is only around €250 billion left in the fund. What’s more, with its economy deteriorating, Lisbon has already asked for a further €20 billion to €25 billion in loans, on top of the €78 billion bailout it received in May.
European officials are working on boosting the eurozone’s bailout fund to more than €1 trillion, but this process is complicated and won’t be finalised until early next year. And emerging countries have shown little interest in investing in a fund devoted to rescuing debt-laden European countries.
As a result, France, with the backing of most G20 countries, including the US, believes that it’s now time for the European Central Bank to play a much bigger role in stemming the debt crisis by becoming the lender-of-last resort for debt strapped eurozone countries.
Paris wants the eurozone’s bailout fund to be turned into a bank, so that it can borrow unlimited amounts from the ECB. But so far Berlin, and particularly the Bundesbank, have refused to countenance this idea. The Germans are deeply worried about an inflationary outbreak if the ECB starts printing money to bail out debt-laden countries.
The issue is an explosive one between Paris and Berlin. But the debate will inevitably resurface as the Italian crisis worsens. Paris now believes that the future of the eurozone rests on a political decision by the German Chancellor, Angela Merkel.
*This article first appeared on Business Spectator