Friday, December 9, 2011

Less to this than meets the eye .

What a peculiar summit .

The British hoped that in return for backing a new fiscal treaty Germanys Chancellor Merkel would allow ' opt outs ' for Londons financial markets . Prime Minister Cameron wanted UK banks to have capital requirements higher than the proposed EU legislation would allow . He was ill advised . Germany backed France . Already on the hook for a €100 bn refinancing programme , neither Germany nor France want to stump up the cash to recapitalize their banks to UK standards. In addition neither of them is keen to have the Eurozones main financial centre and its huge tax revenues remain ' offshore' in London .

The French President took delight in saying the British demands were ' unacceptable ' . This default position will go down well at home and substantially boost his re-election chances . The fact that this has nothing to do with the problem at hand is neither here no there . In the absence of any willingness by its partners to horse trade the UK has therefore been politically outmanouevered and now finds itself in spendid isolation . French diplomacy 1, British diplomacy 0.

For the UK this situation is both unintended and unpredictable. The likelihood of a UK referendum on membership has just risen . Withdrawal no longer seems improbable . The effect of UK referendum on continued membership may lead to similar calls in Ireland, Finland , Greece and the Netherlands . Secretly some smaller European countries actually quite like having the British around as a counterweight to Berlin and Paris .

In the short term France is the big winner . British influence within core euroland has evaporated . The natural beneficiary is Paris which can now claim that it, together with Berlin , is the twin centre of European decision making. Smaller European countries may bristle at French bullying but have fallen in line . President Sarkozy's plans for re-election have been boosted and protectionism , Paris style, is once again on the front burner .

Germany has got what it wanted . Tighter political and fiscal union . All those profligate southern Europeans will have to save more and spend less. Berlin has also become the de facto European superpower and much of Euroland faces a decade, possibly two, of enforced austerity as it adjusts to teutonic rigour . Sound money but at what cost ?

So much for the politics but what about plans to save the €uro ? There may be enough in the promise of a treaty enshrined balanced budget 'golden rule ' to allow the European Central Bank to enter the market to buy Spanish and Italian bonds in size. There may also be enough willingness for the IMF to step in and lend a €200 billion helping hand to the Stabilization Fund. However , the agreements so far fall remarkably shy of the ' big bazooka ' that markets were hoping for. The question of paying down debt to the 60% level enshrined in the proposed new treaty will also require attention . For Italy this means not only an austerity package but the laying off of $850 billion of debt. Spread over 20 years that's a deflationary impact of about $50 billion a year .

Cynics must wonder what the impact of this austerity will have on the Italian political landscaope in two years time . What an EU without a strong free trade, open market proponent like the UK will look like is a question for another day . A treaty calling for fiscal austerity that is imposed without democratic legitimacy might also cause problems down the road .France is hoping that Germany relents in its pursuit of monetary rigour. The can has just been kicked down the road again .

Markets are likely to take their time to digest the outcome of the summit . The feel good factor at work at the end of the year may still drive equities higher . However, come the New Year investors will be looking for action not signals . The news headlines have focused on British exclusion . The real story is the lack of substance in addressing the Euro crisis and the danger of French style protectionism . The dollar looks more and more attractive .

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