Europe’s Fiscal Struggles Move Central Bank Closer to Action

Paul Dykewicz

Investors should look beyond the Aug. 2 decision of the European Central Bank’s Governing Council to delay taking action to aid the struggling region and instead anticipate measures to help euro-area governments sell new bonds — thereby aiding euro-area stocks.

For stock investors, the valuations of European equities generally are attractive right now, said David McAlvany, CEO, McAlvany Financial Group. But investors still need to be aware that the risk of buying European stocks includes the potential for a further devaluation of the euro, McAlvany said.

A careful reading of the European Central Bank’s (ECB) Governing Council’s statement shows strong interest in adopting policies options to intervene in the market’s pricing of bond, as well as calls for fiscal consolidation and structural reform. The ECB’s Governing Council also urged euro-area governments to pursue other avenues for assistance.

Specifically, the Governing Council voiced a need for the governments to activate the European Financial Stability Facility (EFSF), which is designed to raise money by issuing debt and by distributing the funds to euro-zone countries that need to recapitalize their banks. The council also mentioned tapping the European Stability Mechanism (ESM), another vehicle to provide financial assistance to euro-area member states.

Clearly, the council wants action taken to aid the region economically and fiscally. Investors interested in buying European while they can be purchased at bargain prices should be heartened.

American investors, in particular, should understand that Europe’s “elite” tend to view the region’s “economic mess” through a political lens, McAlvany said. That perspective causes reluctance among key leaders to impose austerity measures to curb hefty deficit-spending in Greece, Spain and other nations, McAlvany added.

Despite the current downward pressure on the price of the euro due to fiscal problems and recessions in a number of countries there, the currency likely will survive and potentially become a challenger to the U.S. dollar’s “monopoly status” as the world’s reserve currency, McAlvany said. Reasons why the euro should survive include continued efforts to save it and to stabilize the region’s economy through coordinated policies among European governments, he added.

Indeed, a euro summit conference that ended June 29 included discussion about creating joint European Union (EU) banking supervision, McAlvany said. Whether or not the unified banking supervision is enacted remains to be seen but it does show strong interest among member nations in preserving the euro.

The original intent of creating the euro was political and fiscal integration but the current crisis now allows politicians to achieve what otherwise might not have been “democratically feasible,” McAlvany said. However, a fiscal union in Europe is “not possible” at the present time.

However, don’t bet against the elite in Europe, McAlvany said.
Indeed, European Central Bank President Mario Draghi said last week that he would do “whatever it takes” to halt the region’s economic crisis. For example, Draghi expressed interest in having the ECB buy sovereign bonds from fiscally embattled countries such as Spain and Italy to curb big price hikes that have put a financial squeeze on their citizens.
However, “wild populism” is emerging in Europe in the wake of the “Arab spring,” McAlvany said. Greece and Spain, in particular, are at the top of the list of European nations at risk for social instability and rapid political disintegration, he added.

While Europe’s elite want integration, an unlimited price for “progress” is not willingly borne by the Germans, McAlvany said. The Germans are not content to be the “European plow horse,” he added.

“If certain conditions are met, Germany will pay,” McAlvany said. “And if they are not met, Germany will play poker with any single European country.”

Germany will allow another EU country to “go the brink” or bear its own financial burdens until the country’s politicians acquiesce to German terms to provide help, McAlvany said.

Loans are not a sufficient elixir for a debt problem, McAlvany said. Everyone is playing for time, not reform, he added.

Germany likes the euro zone as a trade partner, while other euro-zone members like the perks of membership but dislike the accountability that Germany is insisting on if it is going to share resources and shore up the less productive EU countries, McAlvany said.

John Browne, senior economic consultant at Euro Pacific Capital, said that the EU is the “biggest economy” in the world. To understand the EU, an observer must understand Germany and its growing influence as the region’s economic power broker, he added.

“German leaders understood that a common European currency has weakened other European countries and enhanced the power of Germany,” Browne said.

To understand the European Union, Germany must be understood, Brown said. Germany is “grabbing control” of the EU, he added.

Threats to the euro currency could imperil the entire world’s monetary system, Browne cautioned. If so, the price of precious metals would hit the “stratosphere,” Browne added.

Paul Dykewicz is the editorial director of the Financial Publications Group at Eagle Publishing Inc., of Washington, D.C. Eagle publishes four free investment e-letters, seven weekly trading services and five monthly investment newsletters, Forecasts & Strategies, Successful Investing, High Monthly Income, The Alpha Investor Letter and PowerTrend Profits.

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