Euro Drops After Sarkozy, Merkel Reject Joint

PARIS — The leaders of France and Germany on Tuesday promised to take concrete steps toward a closer political and economic union of the 17 countries that use the euro, but it was unclear whether their proposals would be sufficient, or come quickly enough, to satisfy markets anxious over Europe’s debts and listless economies.

They also pledged to push for a new tax on financial transactions, and for regular summit meetings of the zone’s members under the leadership of Herman Van Rompuy, who heads the council of all 27 European nations.

“We are certainly heading for greater economic integration of the euro zone,” Mr. Sarkozy said.

The much-anticipated meeting at the Élysée Palace here produced little that would seem to quell the nerves of bond traders, who are becoming increasingly worried that the economic slowdown in both Germany and France will make it harder to overcome Europe’s debt crisis.

Both leaders ruled out issuing collective bonds, known as eurobonds, to share responsibility for government debt across member states, and they opposed a further increase in a bailout fund that will not be put into place until late September at the earliest.

Mrs. Merkel repeated that there was “no magic wand” to solve all the problems of the euro, arguing that they must be met over time with improved fiscal discipline, competitiveness and economic growth among weaker states.

Even the stronger members of the euro zone have stalled. Official figures released on Tuesday showed that growth in the zone fell to its lowest rate in two years during the second quarter, and that Germany — considered the Continent’s locomotive — came almost to a standstill, growing 0.1 percent.

The German figures followed data showing that the French economy was flat in the second quarter, leaving Europe’s two largest economies stagnant. That means the two pillars of the European economy may be less willing and able to prop up their weaker counterparts, analysts warned.

Across the euro zone, gross domestic product rose only 0.2 percent in the second quarter from the first, when growth had advanced by 0.8 percent, according to Eurostat, the European Union’s statistics agency.

The joint French-German proposals were as modest as German officials had forecast. And the most ambitious idea — that all euro zone states legally bind themselves to working toward balanced budgets and reduced sovereign debt — is unlikely to be accepted by all member states. It may not even get through the French constitutional process, since Mr. Sarkozy does not have a constitutional majority in Parliament.

The proposal calling for twice-yearly meetings and increased integration could formalize the “two-speed Europe” — of those in the euro zone and those outside it — that many warned of when the European Union expanded so rapidly after the collapse of the Soviet Union in the early 1990s.

Both leaders said that France and Germany must set an example, citing their agreement to propose jointly a financial-transaction tax by 2013 as “an example of convergence” needed in the entire euro zone. But such a tax is unlikely in the larger European Union, especially if Britain, which is outside the euro zone and contains Europe’s biggest financial center, continues to resist the idea.

They also said they would work to harmonize French and German economic assessments and, in the future, corporate tax rates.

“France and Germany are committed to strengthen the euro,” Mrs. Merkel said. “To that end we need to better integrate our economies” and “to see that the stability pact will be acted on.”

The stability pact, a central element of the treaty that established the euro zone, commits members to keep fiscal deficits to 3 percent of gross domestic product a year and total sovereign debt under 60 percent of G.D.P. Both benchmarks are regularly missed.

The Sarkozy-Merkel meeting came after a dizzying week in the markets and a general gloom about the lack of European leadership on the euro. Economists said the weak data could simply reflect a pause after two years of brisk expansion. But the numbers could also signal that the sovereign debt crisis is undercutting growth outside the countries like Spain that are most directly affected.

“The longer the sovereign debt market remains stressed, the greater will be the damage to the wider economy,” Lloyd Barton, an economist, said in a note Tuesday.

If there was any silver lining, it was the hope that slower growth would lead to less inflation, giving the European Central Bank more leeway to keep interest rates low and intervene in bond markets. Since last week, the bank has been buying Italian and Spanish debt on the open market to hold down yields so the two countries do not face ruinous borrowing costs.

The euro dropped to $1.4362 at 10:19 a.m. in Tokyo from $1.4407 in New York yesterday. The shared currency weakened to 110.19 yen after slipping 0.3 percent to 110.65 yesterday. The dollar bought 76.72 yen, compared with 76.80 yen yesterday.

German Chancellor Angela Merkel and French President Nicolas Sarkozy also rejected an expansion of the 440 billion- euro ($632 billion) rescue fund .

Transaction Tax, Inflation

The leaders of Europe’s two biggest economies agreed to press for closer euro-area cooperation, tougher deficit rules and a harmonization of their corporate tax rates. A plan to resubmit a proposal for a financial-transaction tax, which the European Union rejected in 2010, sent stocks lower in the U.S. and Asia.

The MSCI Asia Pacific Index of regional shares lost 0.3 percent. The Standard & Poor’s 500 Index sank 1 percent yesterday.

The rejection of euro bonds coupled with the announcement of a financial transaction tax “could weigh on European equity and bond markets on Wednesday,” BNP Paribas SA strategists including Ray Attrill in New York wrote in a note to clients today. The tax plan “could fall flat, but the uncertainty factor will likely linger and weigh on the euro.”

European consumer prices fell 0.6 percent in July after flat readings for May and June, the European Union’s statistics office in Luxembourg is forecast to say, according to the median estimate in a Bloomberg News survey. Annual inflation in the euro region slowed to 2.5 percent from June’s 2.7 percent reading and in line with a July 29 initial estimate, the survey predicted. That still exceeds the European Central Bank’s 2 percent ceiling for an eight month.

Kiwi Declines

The New Zealand dollar weakened against all of its 16 major counterparts after Fonterra said milk powder fell at auction to its lowest level since Aug. 3 last year. Milk powder for October delivery declined to $3,359 a metric ton from $3,477 two weeks earlier.

The so-called kiwi also declined along with the Australian dollar as concern that the global economic recovery is losing momentum curbed demand for higher-yielding assets.

“There are all sorts of hurdles around in global markets,” said Sean Callow, a senior currency strategist at Westpac Banking Corp. in Sydney. “That will hurt risk appetite and that would hurt Aussie and kiwi in particular.”

New Zealand’s dollar fell to 83.20 U.S. cents from 83.61 cents and slipped to 63.84 yen from 64.21 yen. The so-called Aussie decreased to $1.0448 from $1.0486.

Japan Stocks Drop as Sarkozy, Merkel Reject Bigger Bailout

Paris - France and Germany unveiled far-reaching plans on Tuesday for closer euro zone integration and said joint euro bonds may be a longer-term option, leaving the currency area vulnerable to more attacks from traders.

Under heavy pressure to restore confidence in the euro zone following a dramatic market slump, President Nicolas Sarkozy and Chancellor Angela Merkel stopped short of increasing the bloc's rescue fund but vowed to stand side-by-side in defending the euro and laid the groundwork for future fiscal union.

Their message was that the focus should be on further economic integration rather than signing bailout checks, and suggested that straying from euro zone rules and fiscal targets would no longer be tolerated.

"We have exactly the same position on euro bonds," Sarkozy told a joint news conference with Merkel after their talks.

"Euro bonds can be imagined one day, but at the end of the European integration process, not at the beginning."

But many experts said the measures would fail to assuage markets, which believe a common bond is the only way to ensure affordable financing for euro zone members struggling with debt.

U.S. stocks dropped more than 1 percent and the euro slid as the

Toyota Motor Corp., the world’s largest carmaker, lost 1.4 percent. Sony Corp., Japan’s biggest exporter of consumer electronics, dropped 1.9 percent after talks in Paris yesterday between French President Nicolas Sarkozy and German Chancellor Angela Merkel. Inpex Corp., Japan’s No. 1 energy exploration company, declined 2.3 percent on lower crude prices.

The Nikkei 225 Stock Average fell 0.8 percent to 9,039.47 as of 9:31 a.m. in Tokyo. The broader Topix index dropped 0.5 percent to 774.98 with three stocks retreating for every two that rose.

The Paris meeting “confirmed debt issues cannot be resolved in a short period of time,” said Hiroichi Nishi, an equities manager in Tokyo at SMBC Nikko Securities Inc.

Futures on the Standard & Poor’s 500 Index slid 0.4 percent today. In New York, the index fell 1 percent to 1,192.76 yesterday as the German and French leaders rejected selling euro bonds and expanding the 440 billion-euro ($633 billion) rescue fund. The leaders also proposed resubmitting a financial- transaction tax that was rejected in 2010.

Gross domestic product in the 17-nation euro area expanded 0.2 percent in the second quarter from the previous three months, when the economy grew 0.8 percent, the European Union’s statistics office in Luxembourg said in a statement yesterday. That’s the weakest growth since the euro region emerged from a recession in late 2009 and was less that the 0.3 percent median estimate of 34 economists in a Bloomberg News survey.

In the U.S., housing starts fell 1.5 percent in July from June, the Commerce Department reported yesterday. Building permits, a proxy for future construction, also dropped.

“The U.S. housing numbers were not strong, and that signals a slowdown in the U.S. economy may persist,” Nishi said.

Exporters declined after reports showed economic growth in Europe and the U.S. is slowing, hurting the outlook for overseas earnings. Sony slumped 1.9 percent to 1,668 yen. Toyota lost 1.4 percent to 2,860 yen. Honda Motor Co., Japan’s third-largest carmaker, sank 2.3 percent to 2,556 yen.

Mining companies dropped on lower oil prices. Inpex lost 2.3 percent to 514,000 yen. Japan Petroleum Exploration Co., the second-biggest oil driller, slid 0.8 percent to 3,330 yen.

Crude oil for September delivery declined 1.4 percent to settle at $86.65 a barrel in New York yesterday. The London Metal Exchange Index of prices for six industrial metals including copper and aluminum dropped 0.5 percent.

Euro dream threatens to become nightmare‎

Europe has dramatically scaled up its efforts to stanch its sovereign-debt crisis since the start of last year, but to no apparent avail as the turmoil threatened this week to overwhelm Spain and Italy.

Yet, governments still have some unused weapons in their armory—though the political cost of firing them will be high.

As the common currency of 17 nation states, the euro isn't like national currencies. Governments borrowing in their own currencies don't usually need bailouts, because, as a last resort, national central banks stand behind their banks and their governments.

The euro zone is different. The European Central Bank is prevented by treaty restrictions from lending to governments and has been a reluctant buyer of government bonds in the secondary market. Willem Buiter, chief economist at Citigroup, argues that this creates a "black hole" at the center of the euro zone that constitutes "a fundamental design flaw" of the currency union.

Euro-zone governments have tried to patch over this flaw by setting up bailout funds. Over the past 18 months, they have rescued Greece, Ireland and Portugal after they were shut out of financial markets.

But these steps haven't been enough to stop the much bigger economies of Spain and Italy from drifting into the debt vortex. One reason for this, according to analysts, is that the bailout funds haven't been big enough or flexible enough to handle large liquidity crises.

Euro-zone leaders made big strides boosting the tools available to the main rescue vehicle, known as the European Financial Stability Facility, at a summit July 21, which also set new aid for Greece.

The Italian state marked the 150th anniversary of its creation earlier this year. Its people did so with little celebration. Apart from Italy’s post-second World War decades of successful modernisation, most of this history has been one of underachievement and worse.

The Italian state’s first 50 years were marked by instability and weakness before two decades of fascist night descended over the country. Invasion, defeat and civil war in the 1940s left deep scars.

Now, the economy has been stagnating for almost two decades, with living standards barely rising and its once-vaunted industries – from textiles to autos – shrinking in the face of low-wage competition.

Italian entrepreneurialism and design flair succeeded in medium-tech industries when foreign competition was less intense, but success in high-tech sectors operating in a globalised context has been much harder to achieve.

One reason is schooling. Italy’s education system is ever more inadequate in preparing its young for the modern world of work and many of those who manage to do well are stymied in one of Europe’s least meritocratic societies.

Government influence on economies is often overstated, but it is important. Bad government in particular can have big negative effects on growth. The evidence that mismanaged public finances stifle growth is strong. And in this area Italy has long been a European leader – it is the only country to have a national debt bigger than its GDP uninterruptedly since the 1980s.

In the early 1990s the sweeping away of the cold war political parties and the jailing of many of the most corrupt politicians brought hope of better and cleaner government. Those hopes have long since been dashed.

The country’s long-time prime minister, Silvio Berlusconi, has dominated for most of that period. Even by the low standards of Italian politics, he has plumbed new depths. But however bad his actions, his inactions have been even more damaging.

Many of the reforms that could help spur the economy have gone unimplemented, despite his promises to shake the country up. Nor has he made much of a dent in Italy’s public debt mountain. His main appeal – that he could bring to the business of government the same get-things-done approach that made him one of Europe’s richest men – has proved baseless.

But Berlusconi will not lead Italy forever, and the country’s political class has shown that it can push through painful reform. Perhaps ironically, its biggest achievement in recent times was ensuring that Italy squeezed into the euro as a founding member. There is no such prize for taking radical action now. Instead, incentive comes from the need to avoid disaster. Italy’s politicians might yet rise to the challenge.

If Italy faces huge challenges, Spain’s are no less daunting.

Unlike the plodding Italian economy, Spain enjoyed a decade-long boom from the late 1990s. But the Iberian tiger, like its Celtic cousin, became engorged on credit. Property prices soared, construction boomed and competitiveness evaporated.

When the bubble burst the public finances went into a tailspin, the banks teetered and unemployment soared. It has suffered a much bigger shock than Italy and its economy is still on the floor, with consumers and households pinned down by huge mortgage debts.

Spain’s economy faces bigger challenges than Italy, with the exception of its government’s indebtedness.

With debts of 60 per cent of GDP in 2010, Spain has some breathing space (in Italy the figure was 120 per cent and in Ireland almost 100 per cent).

With such a manageable debt burden Spain does not look close to being insolvent, as the bond market has been moving towards concluding in recent weeks. So why the panic?

One reason for the recent loss of confidence in the country has been because fears are rife that its banks are not coming clean on their property losses. So far, those admitted to have been a tiny fraction of Irish banks’ losses, despite a property collapse there that is much more than a fraction the size of ours. Another suspicion is that the country’s 17 big-spending regional governments are keeping liabilities hidden.

If either or both of these suspicions have some basis in truth, Spain’s true debt levels are higher than officially stated.

But one reason to be optimistic about Spain relative to Italy over the long term is its more effective political system. This has been in evidence since the crisis erupted, with the government earning praise for undertaking some bold reforms and for reining in its budget deficit.

Although the Spanish are sometimes called the Germans of the south, the more likely explanation for their better governance is not cultural but institutional. Whereas in Italy the executive is weak and unstable – famously, the government has changed on average once a year since the second World War – in Spain, since the return to democracy in the late 1970s, governments have been stable and more effective.

This did not happen by accident but by design, and was informed by the lessons the two countries learned from their respective decades of dictatorship. While Italy’s 1948 constitution deliberately created a weak centre to avoid a repetition of the abuses in Mussolini’s time when power was highly centralised, Spain’s 1978 constitution created a strong and stable executive because weak government was seen to be a big factor in Franco’s seizing power in the 1930s.

Spain’s better political system gives reason to believe that it can manage its public debt problems, but no government can magic away a huge private debt burden or restore at a stroke chronic economy-wide uncompetitiveness. Even with lots of luck Spain faces a long and painful struggle.

Europe is in a bad place now. It looks increasingly likely that the euro zone countries will have to throw their fiscal lot in together in order to avoid cataclysm in the short term. But this brings its own risks.

Northerners will not like it. If they feel they will permanently foot the bill for southern profligacy they may rise up against it. That could get very ugly. The longer Italy and Spain remain in a slump, the greater the chances of that happening.

Southerners may not take their medicine lying down either. If their economies don’t return to growth, their peoples may reach breaking point. If they come to believe that an uncaring and alien force is imposing its will on them resentments could boil over.